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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-K**

 

**(MarkOne)**

 
| **x**                                            | ** ** | **Annual Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**     |
|--------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| ** **                                       | ** ** | ** **                                                                                              |
| **For the  fiscal year ended May 31, 2008** |
| ** **                                       | ** ** | ** **                                                                                              |
| **OR**                                           |
| ** **                                       | ** ** | ** **                                                                                              |
| **o**                                            | ** ** | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**Commissionfile number 000-50450**

 

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**OPEN ENERGY CORPORATION**

(Nameof small business issuer in its charter)

 

| **Nevada**                                                           | ** ** | **98-0370750**                        |
|----------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)      |       | (I.R.S. Employer  Identification No.) |
| ** **                                                           | ** ** | ** **                            |
| **514 Via  de la Valle, Suite 200****Solana Beach, California** | ** ** | **92075**                             |
| (Address of  principal executive offices)                            | ** ** | (Zip Code)                            |

 

**(858)794-8800**

(Issuer’stelephone number, including area code)

Securitiesregistered pursuant to Section 12 (b) of the Exchange Act:

 

| **Title of each class** | ** ** | **Name of each exchange on   which registered** |
|-------------------------|------------|-------------------------------------------------|
| None                    |       | None                                            |

 

Securities registered pursuant to Section 12(g) of the Exchange Act:

** **

**Common Stock, par value $0.001 per share**

(Title of class)

 

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or 15(d) of theExchange Act.

Yes  o    No  x

 

Indicate by check mark if the registrant is a wellknown seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  o    No  x

 

Indicate by check mark whether the registrant (1) hasfiled all reports required by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes x  No o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-B is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer, or asmaller reporting company.  See thedefinition of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer  o          |   |                                           |   | Accelerated filer o          |
|-------------------------------------|--------|------------------------------------------------|--------|------------------------------|
| Non-accelerated filer   o |   | (Do not check if a  smaller reporting company) |   | Smaller reporting  company x |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).

Yes oNo  x

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates of the registrant (based on theaverage bid and asked price of such stock on such date) as of November 30,2007 (the last business day of the registrants most recently completed secondfiscal quarter) was approximately $32,035,000. (See definition of affiliate in Rule 12b-2 of the ExchangeAct.)  Without acknowledging that anyindividual director of registrant is an affiliate, all directors have beenincluded as affiliates with respect to shares owned by them.

 

At August 22, 2008, there were 127,952,397 sharesoutstanding of the issuer’s common stock, the only class of common equity.

 

####  

#### **DOCUMENTS INCORPORATED BY REFERENCE**

####  

Portions of the information required by Part III of this Form 10-Kare incorporated by reference from our definitive proxy statement to bedelivered to stockholders in connection with our 2007 Annual Meeting of Stockholders.

 

Transitional SmallBusiness Disclosure Format (Check one) Yes o     Nox

 

 

 

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**TABLE OF CONTENTS**

 
| PART I  | SPECIAL NOTE REGARDING FORWARD-LOOKING  STATEMENTS                                                                 | 1      |
|--------------|--------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                               |   |
| ITEM 1.      | BUSINESS                                                                                                           | 2      |
|         |                                                                                                               |   |
| ITEM 1A.     | RISK FACTORS                                                                                                       | 11     |
|         |                                                                                                               |   |
| ITEM 2.      | PROPERTIES                                                                                                         | 20     |
|         |                                                                                                               |   |
| ITEM 3.      | LEGAL PROCEEDINGS                                                                                                  | 20     |
|         |                                                                                                               |   |
| ITEM 4.      | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                                               | 20     |
|         |                                                                                                               |   |
| PART II |                                                                                                               | 21     |
|         |                                                                                                               |   |
| ITEM 5.      | MARKET FOR REGISTRANT’S COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 21     |
|         |                                                                                                               |   |
| ITEM 6.      | SELECTED FINANCIAL DATA                                                                                            | 22     |
|         |                                                                                                               |   |
| ITEM  7.     | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        | 22     |
|         |                                                                                                               |   |
| ITEM 7A.     | QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK                                                        | 36     |
|         |                                                                                                               |   |
| ITEM 8.      | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                        | 36     |
|         |                                                                                                               |   |
| ITEM 9.      | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                              | 70     |
|         |                                                                                                               |   |
| ITEM 9A.     | CONTROLS AND PROCEDURES                                                                                            | 70     |
|         |                                                                                                               |   |
| ITEM 9B.     | OTHER INFORMATION                                                                                                  | 72     |
|         |                                                                                                               |   |
| PART III     |                                                                                                               | 73     |
|         |                                                                                                               |   |
| ITEM 10.     | DIRECTORS EXECUTIVE OFFICERS AND CORPORATE  GOVERNANCE                                                             | 73     |
|         |                                                                                                               |   |
| ITEM 11.     | EXECUTIVE COMPENSATION                                                                                             | 73     |
|         |                                                                                                               |   |
| ITEM 12.     | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    | 73     |
|         |                                                                                                               |   |
| ITEM 13.     | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                         | 73     |
|         |                                                                                                               |   |
| ITEM 14.     | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                             | 73     |

 

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| PART IV                                             |                                    | 73     |
|----------------------------------------------------------|-----------------------------------------|--------|
|                                                     |                                    |   |
| ITEM 15.                                                 | EXHIBITS, FINANCIAL STATEMENT SCHEDULES | 73     |
|                                                     |                                    |   |
| CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |                                    |

 

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**PART I**

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

ThisAnnual Report on Form 10-K contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. These forward-looking statements are subject to certain risks and uncertaintiesthat could cause actual results to differ materially from historical results oranticipated results, including those set forth under the heading “Risk Factors”and elsewhere in, or incorporated by reference into, this report.

 

Insome cases, you can identify forward looking statements by terms such as “may,”“intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “ believe, “ “anticipate, “ “estimate,” “predict,” “potential,” or the negative of theseterms, and similar expressions are intended to identify forward-lookingstatements.  Such statements are subjectto certain risks and uncertainties, which could cause actual results to differmaterially from those projected.  Theseforward-looking statements speak only as of the date hereof.  Except to the extent required by federalsecurities laws, we undertake no obligation to update any forward-lookingstatement to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated events. The forward-looking statements in this report are based upon management’scurrent expectations and belief, which management believes are reasonable.  These statements represent our estimates andassumptions only as of the date of this Annual Report on Form 10-K.  In addition, we cannot assess the impact ofeach factor on our business or the extent to which any factor or combination offactors, or factors we are aware of, may cause actual results to differmaterially from those contained in any forward looking statements.  You are cautioned not to place undue relianceon any forward-looking statements.

 

Youshould be aware that our actual results could differ materially from thosecontained in the forward-looking statements due to a number of factors,including:

 

·                  significant uncertainty inherent inthe renewable energy industry including, without limitation the currentscheduled expiration of the Federal Investment tax credit on December 31,2008;

·                  intense and increasing competitionfrom other “clean” renewable energy companies and conventional fossil fuelbased energy companies; new competitors are likely to emerge and newtechnologies may further increase competition;

·                  our operating costs may increasebeyond our current expectations and we may be unable to fully implement ourcurrent business plan;

·                  our ability to obtain futurefinancing or funds when needed;

·                  our ability to successfully obtain adiverse customer base;

·                  our ability to protect ourintellectual property through patents, trademarks, copyrights and confidentialityagreements;

·                  our ability to attract and retain aqualified employee base;

·                  our ability to respond to newdevelopments in technology and new applications of existing technology beforeour competitors;

·                  acquisitions, business combinations,strategic partnerships, divestures, and other significant transactions mayinvolve additional uncertainties;

·                  our ability to maintain and execute asuccessful business strategy; and

·                  we may face other risks describedfrom time to time in periodic and current reports we file with the UnitedStates Securities and Exchange Commission, or SEC.

 

Otherrisks and uncertainties include such factors, among others, as marketacceptance and market demand for the Company’s technologies and services,pricing, the changing regulatory environment, the effect of the Company’saccounting policies, potential seasonality, industry trends, adequacy of theCompany’s financial resources to execute its business plan, the Company’sability to attract, retain and motivate key technical, marketing and managementpersonnel, possible disruption in commercial activities occasioned by terroristactivity and armed conflict, and other risk factors detailed in the Company’sother SEC filings.  You also shouldconsider carefully the statements under “Risk Factors” and other sections ofthis report, which address additional factors that could cause our actualresults to differ from those set forth in the forward-looking statements andcould materially and adversely affect our business, operating results andfinancial condition.  All subsequentwritten and oral forward-looking statements attributable to us or personsacting on our behalf are expressly qualified in their entirety by theapplicable cautionary statements.

 

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Inthis report, unless the context indicates otherwise, the terms “Open Energy,” “Company,”“we,” “us,” and “our” refer to Open Energy Corporation, a Nevada corporation,and its subsidiaries.

 

**ITEM 1.****                             BUSINESS**

 

**Company History**

** **

OpenEnergy Corporation is a renewable energy company focused on the development andcommercialization of a portfolio of solar technologies for residential,commercial and industrial applications. The Company currently designs, manufactures and distributesbuilding-integrated photovoltaic (BIPV) roofing tiles, roofing membranes andarchitectural photovoltaic glass products under the SolarSave® tradename.  The Company maintains two facilities:  A corporate office in Solana Beach for seniormanagement, marketing, sales, customer service, legal and finance and afacility in Grass Valley, California for product design, project engineering,prototyping, custom glass manufacturing, and materials management.

 

Ourcompany was originally incorporated in the State of Nevada on April 11,2002 under the name Barnabus Enterprises Ltd., as a traditional oil and gasdeveloper.  By 2005, it had acquired gasleases and a number of existing and proposed gas wells, and a small refinery inAlberta, Canada.  This network tied intoa transport pipeline leading into the United States, where a premium forproduction could be obtained.  In June 2005,we made a strategic business decision to shift our focus to renewableenergy.  Motivated by the growth in wind,solar and other alternative technologies and believing that market forces andlegislative incentives were in place to support rapid growth of the domesticsolar industry, we decided to transform the Company.

 

In August 2005,we signed an exclusive international license for SunConeTM CSP (concentrating solar power)technology.  SunConeTM CSP was invented byDr. Melvin Prueitt, a physicist, inventor and former senior researchscientist at the Los Alamos National Laboratory.  SunConeTM CSP utilizes curved geometries and reflective surfaces to collectsolar thermal energy, which can then be used to perform work.  Potentially, this energy can drive a turbineto produce electricity, or purify water using multi-stage flash distillation ormembrane filtration devices.  The firstprototype was designed and built by Hytec Engineering of Los Alamos, NewMexico, and initial testing of this prototype system was successful.

 

In December 2005,we sold our oil and gas holdings.  In thefirst half of calendar 2006, we acquired Toronto-based Solar Roofing Systems, Inc.(SRS), which was engaged in the manufacture of SolarSave® photovoltaic(PV) roofing membrane, and California-based Connect Renewable Energy, Inc.(CRE)**,** which was engaged in themanufacture of PV integrated roofing tiles. Both companies’ products were light-weight, fire-rated,weather-resistant, building-integrated PV roofing materials, and theseacquisitions provided our company with proprietary, photoelectric products, andexpanded our manufacturing, marketing, sales and service capabilities.  In April 2006, we changed our name toOpen Energy Corporation to better reflect our mission, vision and strategicobjectives.

 

In December 2006,we acquired WaterEye, a Grass Valley, California based company withproprietary, web-enabled water monitoring software.  WaterEye provided ongoing revenues, watertreatment expertise and, potentially, a technology platform for monitoring anddisplaying our PV installations.

 

In April 2007,we signed a master distribution agreement with privately held Eagle RoofingProducts, one of the largest manufacturers of cement tiles in NorthAmerica.  This strategic allianceprovides our company with access to major home developers and roofingcontractors across the country.  We sellour residential tile products through this distribution pipeline, and utilizeroofing contractors, electricians, and other members of the traditionalbuilding trades as our installation and service providers.

 

Realizingthat the solar industry was quickly becoming commoditized and that we wouldnever be competitive as a low-cost manufacturer, in May of 2007, we signeda memorandum of understanding with Suntech Power Holdings (NYSE: STP) tomanufacture our tile and PV glass products in China.  We believe this relationship has thepotential to provide the production volume required to compete for asignificant share of the U.S. residential and commercial solar electricmarketplace.  We also hired Chris Gopalas our Executive Vice President of Worldwide Operations, a highly qualifiedexecutive in the field of supply chain management and outsourcing strategies.

 

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In November 2007,we signed a distribution agreement with Petersen-Dean Roofing Systems, one ofthe largest residential and commercial roofing contractors in the U.S., todistribute SolarSave® PV Tiles on homes across the country.  The agreement includes a minimum commitmentto purchase the Company’s products, including tiles, membranes and balance ofsystem equipment.

 

In December 2007,our board of directors approved a plan to shut down operations at our Aurora,Ontario, facility in Canada.  Existingoperations and specified assets at our Aurora facility were transferred to ourGrass Valley, California facility and, by January 31, 2008, substantiallyall of our employees at the Aurora facility were terminated.

 

**The Energy Industry**

** **

*Continued Growth in Global Energy Use IsProjected*

* *

Accordingto the Energy Information Administration’s “Annual Energy Outlook 2007,” overthe course of the next 22 years, the global consumption of electricity isexpected to increase from 3,660 billion kilowatt hours in 2005 to over 5,000billion kilowatt hours by 2030. Approximately 63% of this increase in demand is predicted to come fromthe commercial sector, 39% from the residential sector, and 17% from theindustrial sector.  Population growth,escalating demand for more electrical products and manufacturing equipment, thelighting, heating and cooling of our built environment, and a shift towardelectric powered vehicles will all contribute to this growth in electricityusage.

 

Approximately70% of the world’s electricity is generated by burning fossil fuels (coal, oiland natural gas) to create steam and turn turbines.  Nuclear reactors contribute about 21% of ourpower, hydroelectric dams account for 6%, with just over 3% of mankind’s energydemand currently being met by renewable resources such as solar, wind,geothermal, biofuels and biomass conversion, and small hydro.

 

*Expanding Global Demand for Renewable EnergyAlternatives*

* *

Anumber of factors are currently contributing to the rapid growth of renewableenergy (RE) alternatives.  The firstfactor is the recognition that fossil fuels are a limited, non-renewableresource.  The World Energy Council hasestimated that based on proven operable reserves, the world will run out of oilin approximately 44 years and burn through readily available natural gas in 63years.  Most of these resources exist inpolitically unstable territories, or environmentally sensitive regions such asthe polar circle or coastal waters. Finite fossil fuel availability coupled with dramatically rising energydemands from Asia have driven the cost of oil and gas to unprecedentedheights.  There are over 230 years ofcoal in the ground, but the environmental impacts of burning coal aredevastating, accounting for 51% of all green house gas (GHG) emissions.

 

At thesame time, there is a growing recognition by the scientific community and thepublic at large that GHG emissions from our power plants, motor vehicles,factories and buildings are contributing to global warming.  The United Nations Framework Convention onClimate Change (the Kyoto Protocol), signed into law by 154 nations, provided abasis for international cooperation on the issue of global warming.  The 2007 Stern Report on the Economics ofClimate Change concluded that if we do not collectively reduce the use offossil fuels, adopt energy efficiency technologies and slow deforestation, thecost impacts of global warming will exceed 5% of world GDP per year.  In contrast, taking action to reduce the levelsof CO2 in the atmosphere will cost less than 1% of GDP and will morelikely represent significant opportunities for economic growth and development.

 

Risingfuel and electricity prices, a desire for energy security, and concerns aboutglobal climate change have led to the rapid growth of alternative energytechnologies.  According to EricMartinot, senior research fellow at Worldwatch Institute, over $100 billion wasinvested in 2007 in renewable energy.

 

Installationsof photovoltaic systems connected to electrical grids experienced over 50%annual increases in both 2006 and 2007 on a worldwide basis.  Motivated by solid government subsidies, taxincentives and feed-in tariffs (requiring utilities to buy power generated byprivately owned PV systems), Germany and Japan have led the world in PVproduction capacity and solar installations. Germany accounted for fully half of the solar electric market in 2006,but now Spain, California, France, Greece, and Italy are gaining traction.  According to Renewable Energy World’s GlobalStatus Report, there is now an estimated 7.8 gigawatts of installed solarcapacity, or about 1.5 million homes.

 

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*Distributed Generation and the Growth ofDomestic Solar*

* *

Anunderlying consideration concerning the delivery of electricity is the locationof the generation source relative to the location of the end-useconsumption.  Over the past century, theeconomics of power plant construction supported larger and larger centralstation sites linked to transmission lines spanning great distances to reachthe ultimate consumer.  The economicconsiderations of centralized power plants have been altered by the advent ofsmaller scale technologies that can provide electricity at competitive pricesnear the place of consumption.  Thecombination of economic factors and of advances in generation technologiesopens the market to an opportunity for “distributed generation” of electricityin combination with traditional grid resources. Our PV products are directed at this renewable distributed generationenvironment.

 

Themarket for PV modules and cell shipments in the United States has undergonesignificant growth in the last several years. According to the U.S. Department of Energy, solar power productionexpanded from 48,664 peak kilowatts in 2003, to over 78,000 in 2004, and over134,000 kW in 2005.  Demand forresidential and commercial solar systems is dependent upon:  governmentpolicies and incentive programs; technological developments (i.e. higher cellefficiencies, lower system costs); investment in manufacturing capacity(particularly polysilicon plants); market development; and consumer behavior.

 

**U.S. Energy Policy &Pending Legislation**

** **

At thefederal level, the United States has been relatively slow to commit to solid,long-term support for renewable energy. The Federal Energy Policy Act signed into law by President Bush in January 2006,provided for 30% investment tax credits (capped for residential installationsat $2,000, but uncapped for corporations installing commercial systems), aswell as 5-year accelerated depreciation, and a modest renewable energyportfolio standard.  These investment taxcredits (ITC’s) have led to significant domestic investment in commercial PVinstallations.  Unfortunately, thesefederal solar incentives are set to expire at the end of 2008 and, as of thedate of this filing, Congress has failed to extend the ITC’s, creatinguncertainty in the solar energy industry, generally.

 

Fortunately,a number of U.S. states and cities have enacted a wide range of supportprograms including cash rebates, net metering policies, renewable energycredits, green building standards and other incentives to support theinstallation of solar electric systems. California’s 2007 $3.3 billion Solar Initiative, funded through theCalifornia Public Utilities Commission through 2017, leads the nation infinancial incentives, providing rebates of the cost of specified solargeneration systems for both residential and commercial systems.  California further strengthened itscommitment to develop a comprehensive approach to address climate change withthe passage of Assembly Bill 32, which requires a reduction in greenhouse gasemissions to 1990 levels by 2020.  Thescoping plan for this bill includes reduced dependence on oil, increases use ofsolar power, expansion of California’s renewable energy portfolio standards,and a cap-and-trade program which will monetize the value of reducing carbonemissions.

 

**Photovoltaic Systems**

** **

One ofthe most significant drawbacks of PV is the high initial system cost, which isdue almost entirely to the high cost of PV cells, which in turn is dependentupon the cost and availability of semi-conductor grade silicon.  Several new silicon processing plants arecurrently under construction, which are expected to ease the current siliconshortage.  In 2005, 76% of U.S. moduleshipments were based upon crystalline silicon cells, with the remaining 24%being thin-film.

 

Wecurrently utilize crystalline silicon PV cells in our products.  PV cells offer high power generation persquare foot.  They are also highlyreliable, with proven, long term, power output performance.  Despite billions of dollars pouring intosolar PV in the form of government incentive programs, subsidies and privateinvestments, the industry remains less than 1% of the electrical power utilizedglobally today.  Wide scale adoption ofsolar electric generation has been hampered by two important limiting factors:a shortage of silicon, and the high cost per watt of manufacturing traditionalPV.  Several new technologies showpromise of overcoming these barriers. One of our key strategies is to remain technology agnostic.  As these alternative technologies becomecommercially viable, we will incorporate them in products designed to providecustomers with better solutions for their energy needs.

 

**Our Strategy**

** **

Accordingto the U.S. Department of Energy, every hour of every day the earth receivesenough solar radiation to meet mankind’s entire energy requirements for ayear.  It is this power we intend toutilize in order to deliver safe, clean, cost competitive power to ourresidential, commercial and industrial customers.  We participate in a marketplace that, whilehighly competitive, is experiencing 

 

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significantgrowth.  We do so with superiorbuilding-integrated products, an experienced leadership team, and a unique goto market strategy that we believe will lead to growth and shareholder value.

 

Thefollowing three strategic initiatives distinguish our approach from others inan industry that is increasingly becoming commoditized and price-driven:

 

1.                                       We utilizethe roofing products industry as our primary channel partner, co-designing,co-marketing and distributing our solar products through this well establishedindustry.

 

Webelieve that the lowest cost per installed watt for rooftop solar applicationscan best be achieved by partnering with those already engaged in theproduction, distribution, installation and servicing of traditional roofingproducts.  The channel begins with ourestablished relationships with companies such as Eagle Roofing Products andPetersen-Dean and ends with trained roofers who seamlessly install ourbuilding-integrated products onto rooftops simultaneous with the installationof standard tile, membrane and shingle products.  This avoids the problems created whenmultiple trades are engaged in the installation process, which can actuallyvoid existing roof warranties, as well as create construction and serviceissues.

 

Ourfocus on customer needs includes co-designing products with our channelpartners to drive innovation, lower installation costs, and provide bundledservices.  Channel support servicesinclude system engineering and design, installation training, pre-sales and point-of-salestraining, post-sales support, on-line real-time monitoring and display,warranty registration, and rebate processing. We have participated with our channel partners in the training of over350 roofers and sales personnel to sell and install our products, which offerssignificant sales leverage at a relatively low cost to our company.

 

2.                                       We outsourceproduction in order to lower our costs, increase our capacity and betterbalance demand and supply of our proprietary best-in-class building integratedPV products.

 

Westrive to be a leading edge designer of innovative PV products.  We offer a suite of building-integratedphotovoltaic, or “BIPV” products designed to blend seamlessly into and form apart of building materials already in use. While we will continue to develop innovative products, we will alsoevaluate licensing and purchasing options to acquire technologies developed byothers.  As thin film, nano-materials,vapor deposition and other innovations become commercially viable, we intend touse them to develop commercial products and bring them to market.  We do not spend extensively on research, orcarry expensive overhead that typically accompanies such efforts.

 

Weoutsource most of the steps in our manufacturing process in order to deliverhigh quality products in very large volumes to meet the demands of ourcustomers.  Our outsourced supply chainstrategy matches supply and demand, while providing the lowest total installedcost to our customers.  We utilize ourGrass Valley, California facility to perform design, product development andspecialty manufacturing and assembly functions.

 

3.                                       We intend tooffer financed solutions to the residential market through long-term powerpurchase agreements that will contribute to increased product sales andgenerate recurring revenues from the sale of energy.

 

Ingeneral, homeowners, commercial tenants and industrial operations do not buypower generating systems.  They pay forpower through their monthly utility bills. Although state rebates, federal tax incentives and other programs havereduced the costs of solar generation systems, they remain expensive topurchase.  We have developed a plan webelieve will provide a financial solution that monetizes the full array of taxincentives for the ultimate benefit of the residential energy consumer.  Together with a tax equity partner, we willinstall solar generation systems in “solar communities.”  We will coordinate the engineering, equipmentprocurement and construction of each project. We will contract with third parties to maintain the rooftop systems, toread the meters, and to bill the customers. The tax equity partner will receive a secure internal rate of return andthe benefits of the 30% investment tax credit and 5-year accelerated depreciationunder the 2005 U.S. Energy Bill.  Thebuilders will reduce their construction costs and, hopefully, sell their homesmore quickly.  The residential consumerwill be guaranteed a reduced monthly utility bill and receive the benefits ofincremental home value at no additional expense or tax impact.  We believe we will sell more products andparticipate in the long term revenue streams associated with the sale ofenergy.

 

We arecurrently evaluating the possibility of licensing the intellectual propertyassociated with our tile and membrane products. A license of one or both of these products to one or more parties oneither a geographically limited or worldwide basis could have the effect ofdriving substantially greater sales volumes at substantially reduced overheadcosts.  We believe that a licensestrategy would 

 

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exchangerevenue growth for greater operational profitability.  We anticipate that our channel distributionstrategy would remain intact in a licensing scenario, and we would continue toprovide pre- and post-sale services to our channel partners and end users.

 

**Our Products**

** **

***SolarSave®Roofing Tiles***

*** ***

SolarSave®PV Roofing Tiles are primarily targeted for residential housing projects, wherethe use of slate or ceramic tiles is prevalent. We have developed a line of PV tiles that blend seamlessly with thecolors and edge profiles of the most commonly used cement tiles.  SolarSave®  Roofing Tiles arewaterproof, fire-rated building materials that require no external framing orroof penetration.  They can be safely andeasily installed by professional roofing contractors.  SolarSave®  Tiles have the followingfeatures and benefits:

 

·                  Easilyinstalled using Roof Tile Institute standards

 

·                  Class AFire Rated, Certified to UL 1703 standards

 

·                  25-yearwarranty to produce 80% power output

 

·                  Availablein colors that match traditional cement tiles

 

·                  Edgeprofiles naturally shed water

 

·                  Modular,expandable system

 

·                  200pound/foot snow load capacity

 

·                  125mph wind load rating with clips installed

 

Wehave recently introduced the first generation of brown and terra cotta tiles tomatch brown and red tile roofs, which we believe significantly enhances theaesthetic potential of rooftop solar applications.  Based on considerable feedback from ourchannel partners, we will soon be introducing brown and terra cotta tiles usingcolored solar cells into the market. Finally, we are presently designing and will soon be introducing anasphalt shingle product that is designed to provide a solar solution for thesubstantial majority of rooftops in the U.S. that are asphalt shingle-based.

 

***SolarSave®Roofing Membranes***

*** ***

SolarSave® RoofingMembranes are a frameless, weather tight, fire rated, low maintenance productwith superior aesthetics and power performance, generating between 400 and 450watts per panel.  Our membrane product isdesigned for flat or low slope commercial, industrial and institutional roofingapplications.  Our pre-sale marketfeedback has indicated that there is robust demand for the membrane productboth in the U.S. and European markets. The membrane product has been UL approved for use with Duro-last, IB,Fibertite, Sarnafil, Carlisle and Cooley roofing membranes.

 

We aredeveloping our next generation commercial membrane product.  We have temporarily suspended shipments ofour current membrane product due to a product corrosion issue.  The membrane product is exhibiting randomcorrosion post-installation.  Thecorrosion occurrence and rate of development may be exacerbated by heat,humidity, sunlight, and electrical current.

 

Wehave engaged Bodycote Testing Laboratories (a worldwide testing agency withmultiple facilities in Toronto and surrounding areas) to determine themetallurgical and chemical composition of the corrosion as well as conduct apolymer layer analysis, so that we can: (1) determine the cause; (2) implementappropriate changes to the manufacturing and distribution processes to preventfuture occurrences; (3) determine appropriate corrective action ifcorrosion is detected on a module; (4) initiate quality assuranceprocedures to evaluate our product including: work in process laminates in ourplant; finished goods on hand in our plant; finished goods on hand in ourcustomers’ warehouses; and membranes that have been installed on end userroofs.

 

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***SolarSave®Architectural Glass***

 

Wealso design and manufacture custom PV glass laminates to meet the aesthetic,performance and structural requirements of designers and architects.  Sizes, shapes and configurations can be builtto match virtually any specification available today, allowing for a directsubstitution for monolithic, laminated or insulated glass panels.  This product is ideally suited for LEEDcertification on green building projects.

 

SolarSave®Architectural Glass, or “Glass,” offers both shading and electrical powergeneration, and is geared towards glass canopies, skylights, atriums, verticalglass curtain walls, and other architectural applications.  It is often desirable to achieve translucencyin PV skylight applications.  While astandard PV cell is an opaque 125 mm or 156 mm square, our cells can bearranged within clear glass panels to provide appropriate light levels andshading coefficients.  A wide variety ofcolors, thickness, patterns, and shapes can be produced.

 

Ourfirst major architectural glass project was installed at the California Academyof Sciences Museum in Golden Gate Park, California in the fourth calendarquarter of 2007.  The PV glass laminatesfor this project were certified to UL 1703 standards using Sunpower cells.

 

**Manufacturing**

** **

In May 2007,we outsourced production of our tile laminate to Suntech, who produced the tilelaminate in China.  In addition, theassembly of the laminate into the frame was outsourced to a company inCalifornia.  We have also obtained UL1703 certification with an alternate supplier.

 

SolarSave®Architectural PV Glass is specified by architects and designers seeking toincorporate PV directly into skylights, glass canopies, or vertical glasscurtain walls.  Currently, we manufactureGlass at our Grass Valley facility, which provides us flexibility for short runproduction.

 

Historically,we manufactured SolarSave® Membranes in Aurora, Ontario, Canada.  We have temporarily suspended shipments ofour membrane product due to a corrosion issue that we are currently working toresolve.  Concurrently, we are working ona combination of product enhancements and incorporating PV cells from alternatemanufacturers.  In addition, we areevaluating additional alternatives in an effort to optimize our manufacturingprocesses on a company-wide basis.  Ourplan is to outsource the production of the membrane product once ULcertification of alternate PV cells is obtained.

 

Thereis currently an industry-wide shortage of semi-conductor grade silicon, anessential raw material in the production of certain of our primaryproducts.  Continued shortages of siliconused in the manufacture of our products may result in significant priceincreases in PV cells or our inability to obtain needed raw materials on atimely basis, which could result in delays in manufacturing and adverselyaffect gross margins and results of operations.

 

**Sales and MarketingStrategy**

** **

**Market Segmentation**

** **

Wedivide our marketing and sales strategy into two separate, yet complimentarycomponents.  The first is product salesof SolarSave® Tiles, Membrane and Glass, as well as balance of system (BOS)components such as inverters and SolarEye monitoring software.  The second component is our Solar Communitiesbusiness.  The Solar Communities businessrepresents the sale of both products and electricity under long term power purchaseagreements (PPAs) or leases wherein we develop, install, own and operatesystems in residential multifamily developments.  Both product sales and our Solar Communitiesbusinesses are aligned through the building products channel.

 

**Product Sales**

** **

Productsales are segmented by channel within the building products industry.  For example, SolarSave® Tiles arepredominantly sold through Eagle Roofing under a master distributionagreement.  Eagle is the largestmanufacturer of residential concrete tiles in North America, providing us withaccess to customers through Eagle’s relationships with national home buildersand roofing contractors.  We aredeveloping a similar business model for SolarSave® Membranes which, in additionto being sold directly to large solar 

 

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integrators,will be marketed and distributed through relationships with several of theleading manufacturers of traditional PVC roofing membrane.  Our SolarSave® Architectural PV Glassproducts are sold directly to architectural and design firms, or constructioncontractors.

 

**Solar Communities**

** **

Wehave developed an innovative strategy geared to builders and owners ofcondominium and town home communities. These developers are under increasing regulatory pressure to increaseenergy efficiency and incorporate renewable energy alternatives in theirproperties.  Utilizing a traditionalproject finance model and the legal structures of existing homeownersassociations, we plan to provide an opportunity for the installation of solarsystems at no or limited additional cost to the builder or the homeowner, andto finance these installations from the revenue streams generated under longterm power purchase agreements for the electricity generated by the solarsystems.

 

Wewill benefit from a development fee for each project, increased sales of oursolar tiles, and participation in the long term revenue streams.  The builder is anticipated to experiencereduced construction costs, an accelerated permitting process, and increasedsales velocity of new homes, particularly in this challenging housingmarket.  The homeowner will benefit froma reduced utility bill and an increase in the resale value of their property atno additional cost.  We believe it is acompelling value proposition.

 

Severalmembers of our management team have previous experience successfully developingand financing distributed generation projects, with related power purchaseagreements, engineering procurement and construction contracts, and operationand maintenance agreements.  Thisknowledge base is currently being deployed in the development of similarframeworks for project financing solar systems on multi-family dwellings.  Over the next five years, we anticipate enteringinto agreements with major residential builders and homeowners associations toprovide our unique “Solar Communities” package in a number of locations.

 

**Market Criteria**

** **

Wecurrently focus our domestic marketing and sales efforts in territories thatmeet the following criteria:

 

·                  Strongsolar incentives;

 

·                  Highretail electricity rates;

 

·                  Highelectrical consumption; and

 

·                  Significantservice volatility.

 

Californiais the dominant market in the United States for PV, and is the Company’sprimary market.  Arizona, Nevada, NewMexico and Florida are also significant potential markets for our PV products.

 

**Customer Profiles**

** **

Wehave identified a number of potential customers by industry, sector, andapplication.  We focus on high-profileopportunities within correlative industries and with the following sectorapplication demographics:

 

·                  Buildingproducts companies;

 

·                  Residentialdevelopers;

 

·                  Architectsand interior designers;

 

·                  Publicadministrators, city planners;

 

·                  Hotel andresort developers;

 

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·                  Educationalinstitutions; and

 

·                  Governmentpurchasing officers.

 

Currentmarket opportunities are being realized in the new residential home buildingmarket, where solar has recently become a competitive advantage for the sale ofnew homes by major national home builders. As an example, companies such as Lennar, Centex, and others arebeginning to offer solar rooftops as a standard feature in many Californiacommunities.

 

**Product Promotion**

** **

SolarSave®Tiles, Membranes and Glass are sold on the basis of their features andassociated benefits.  They are lighter,stronger, easier to install and maintain, and aesthetically superior to most PVproducts available in the market today. Through our web presence, public relations activities, industryadvertising and trade show attendance, we have established a strong brandwithin a very competitive market environment. Open Energy and its SolarSave® products have appeared in a number ofindustrial trade publications, in ads, articles, and product reviews.  This publicity generates sales leads, whichare entered into a database and circulated to our network of distributors andintegrators.

 

Wehave developed a sophisticated web site that includes corporate information andcompany profile, a complete product information section, a list of ourdistributors and sales relationships, pictures of our installations, as well asinvestor and public relations sections. We have invested in Website and Search Engine Optimization throughRenewableEnergyAccess.com, SolarBuzz.com, and links to numerous industry sitesand information sources.  Our websiteaddress is**www.openenergycorp.com**.  Information on our website is notincorporated into this report by reference.

 

**Research &Development**

** **

A corecompetency of ours is innovative design, engineering and development ofmarket-focused and next generation solar energy BIPV products.  We employ a team of mechanical, electricaland software engineers in Grass Valley, California who are responsible for thisdevelopment effort.  A number ofinitiatives are currently under way to develop and extend our product lines tocover:

 

·                  Asphalt/compositionroofs;

 

·                  Coloredtile roofs;

 

·                  Tileand membrane enhancements and certification for European markets; and

 

·                  Selectedadditional residential and commercial roofing materials.

 

**The Competition**

** **

Weface competition from domestic and international companies actively engaged inthe manufacturing and distribution of solar PV systems, as well as fromemerging solar technology companies that may become viable in the nearfuture.  The best funded and mostpowerful of these multi-national corporations are vertically integrated,producing PV cells as well as PV modules. These standard PV modules (framed arrays of PV cells) must berack-mounted externally to the building, creating penetrations in the roof,generating maintenance problems, and detracting from their visualappearance.  The manufacturers of thesemodules include: Sharp, Kyocera, Suntech, Sanyo, REC, Mitsubishi Electric andmany others.

 

Whilethe standard PV modules could be considered competition to our products, OpenEnergy targets the building-integrated marketplace.  In the residential arena, we compete withBIPV tile manufacturers that include Sharp, Kyocera, BP Solar, GE Solar andSunpower Corporation.  In the commercialarena, we compete with PV membrane manufacturer Solar Integrated Technologies,which utilizes less efficient flexible thin film PV products.

 

Withthe influx of capital, the expansion of global PV capacity, and the launch ofnew traditional and thin film manufacturers in Europe, Asia and here in theU.S., we expect to face increased competition, which may result in pricereductions or reduced margins.  The solarpower market in general competes with other sources of renewable energy (suchas wind turbines), as well as conventional electrical power generation fromcoal and natural gas combustion.  We mayalso face competition from some of our customers who 

 

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maydevelop products or technologies internally, or who may enter into strategicrelationships to acquire existing solar power product providers.

 

Ourcurrent and future competitors may have longer operating histories, greatername recognition and greater financial, technical and human resources than us,or may develop technologies superior to ours. Many of our competitors have well-established relationships with ourcurrent and potential dealers and their customers and have extensive knowledgeof our target markets.  As a result, ourcompetitors may be able to devote greater resources to the research,development, promotion and sale of their products and respond more quickly toevolving industry standards and changing customer requirements than we can.  Consolidation or strategic alliances amongour competitors may strengthen these advantages and may provide them greateraccess to customers or new technologies.

 

***SolarSave®Roofing Tile Competition***

*** ***

Ourprimary competitors for the SolarSaveTM Tile product are BP Solar, Sharp,Kyocera, GE Solar, and Sunpower Corporation/Powerlight, each of which has aversion of a building-integrated tile product. However, we believe that SolarSave® Tiles have a number of importantadvantages.  Because they are made frominjection molded composites, they can be made to match the colors and edgeprofiles of the most commonly used cement tiles used in the domestic markettoday.  Thus, their visual appearance issuperior to our competitors.  They are alight weight, Class A fire rated, UL certified roofing product that issafer and easier to install than the competition.  They can support a snow load up to 200 poundsper square foot, and winds up to 120 mph with clips.  The SolarSave® Tile is a true roof tile,designed to be installed by roofers with traditional roofing tools andmethods.  The BIPV products offered byour competition must generally be installed by an electrician which increasesinstallation costs.

 

***SolarSave®Architectural PV Glass Competition***

*** ***

In theUnited States, our primary competitors for manufacturing solar glass productsare Atlantis Energy and Spire Solar. Companies that market to the architectural community could be consideredcompetitors from the standpoint that they may market solely competingmanufacturers’ products; however, they could potentially become Open Energydealers as well.  Internationally, wecompete with solar glass manufacturers such as: GSS Solar (Germany), Schuko (Germany), Solar Nova (Germany), SwissSustainable Systems (“3S” in Switzerland), and MSK (a subsidiary of Suntech, inJapan).  Our current intention is tooutsource a substantial portion of the manufacture of our architectural glassproducts.

 

***SolarSave®Roofing Membrane Competition***

*** ***

Ourprimary competitors for the SolarSave® membrane product are: Solar IntegratedTechnologies (SIT) which integrates Uni-solar’s (United Solar Ovonic) thin-filmtechnology with a Sarnafil commercial roofing membrane; and NanosolarSolarPlyTM, a building-integrated CIGS (Copper Indium Gallium Diselenide) thinfilm product that is integrated with commercial roofing membranes.  The SolarSave® roofing membrane product hassignificantly higher energy production per square foot of roof space (i.e.higher efficiency), primarily due to our use of high-efficiency crystalline PVcells rather than thin-film technology. SIT’s product currently generates approximately 6 watts per square foot,as compared to approximately 14 watts per square foot for our membraneproduct.  In addition, the SolarSave®membrane has been UL approved for use with Duro-last, IB, Fibertite, Sarnafil,Carlisle and Cooley roofing membranes.

 

Forcommercial installations, we also compete with a number of companies thatmanufacture standard PV modules, as discussed above.  In addition, solar integrators and/orinstallers that market commercial solar products could be consideredcompetitors to the extent that they market solely competing manufacturers’products, such as:  Powerlight (Sunpower), Conergy Inc., Dome-Tech Group,Eastwood Energy, GE Energy (a subsidiary of General Electric Corporation),Global Solar Energy, Inc. (a subsidiary of Solon AG), SPG Solar, Inc.,and Sun Edison LLC.

 

**Intellectual Property**

** **

Werely on a combination of patent, copyright, trade secret, trademark andcontractual protection to establish and protect our intellectual property.  We have filed trademark registrationapplications in the U.S. for SolarSave® and for other trademarks.  We require our customers to enter intoconfidentiality and nondisclosure agreements before we disclose any sensitiveaspects of our solar technologies or strategic plans, and we typically enterinto proprietary information agreements with employees and consultants.  Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to copy or otherwiseobtain and use our technology.  It isdifficult to monitor unauthorized use of technology, particularly in foreigncountries where the laws may not protect 

 

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ourproprietary rights as fully as laws in the United States.  In addition, our competitors mayindependently develop products similar to ours. Our precautions may not prevent misappropriation or infringement of ourintellectual property.

 

In theUnited States we have three issued patents, seven U.S. patent applicationspending, and three foreign patent applications pending relating to our title,membrane and remote water monitoring products. Pursuant to an agreement with Dr. Melvin Prueitt, we are the exclusivelicensee of a U.S. patent application for the first version of Suncone thatconsisted of an inexpensive lightweight reflected film that is formed into oneor more cones that concentrate the sun’s rays to the base, and the collectedenergy can be used to heat a fluid.  Wehave redesigned SunconeTM CSP to achieve a cost effective design with a morewind-resistant cone and have submitted our own patent application.  Our issued patents will begin to expire in2018.  We intend to continue assessingappropriate opportunities for patent protection of those aspects of ourtechnology that we believe provide significant competitive advantages to us,and for licensing opportunities of new technologies relevant to our business.

 

Althoughwe apply for patents to protect our technology, our revenue is not dependent onany one patent we own, and we currently rely on trade secret rights to protectour proprietary information and know-how. We also employ proprietary processes and customized equipment inmanufacturing facilities.  We do not knowif our current or future patent applications will result in patents beingissued with the scope of the claims we seek, if at all, or whether any patentswe may receive will be challenged, invalidated or declared unenforceable.

 

**Environmental Regulations**

** **

We aresubject to a variety of foreign, federal, state and local governmental laws andregulations related to the purchase, storage, use and disposal of hazardousmaterials.  If we fail to comply withpresent or future environmental laws and regulations, we could be subject tofines, suspension of production or a cessation of operations.  In addition, under some foreign, federal,state and local statutes and regulations, a governmental agency may seekrecovery and response costs from operators of property where releases ofhazardous substances have occurred or are ongoing, even if the operator was notresponsible for the release or otherwise was not at fault.

 

Webelieve that we have all environmental permits necessary to conduct ourbusiness.  We believe that we haveproperly handled our hazardous materials and wastes and have appropriatelyremediated any contamination at any of our premises.  We are not aware of any pending or threatenedenvironmental investigation, proceeding or action by foreign, federal, state orlocal agencies, or third parties involving our current facilities.  Any failure by us to control the use of or torestrict adequately the discharge of, hazardous substances could subject us tosubstantial financial liabilities, operational interruptions and adversepublicity, any of which could materially and adversely affect our business,results of operations and financial condition.

 

**Employees**

** **

Ourcurrent full-time headcount is 37 employees. Of that number, 5 are in production-related positions in Grass Valley;22 are in corporate, marketing, and administrative; 4 are in productdevelopment; and 4 are in sales.

 

**ITEM 1A.**                                            RISKFACTORS

** **

*Investors should carefully consider the risks described below beforedeciding whether to invest in our common stock. The risks described below are not the only ones we face.  Additional risks not presently known to us orthat we currently believe are immaterial may also impair our businessoperations and financial results.  If anyof the following risks actually occurs, our business, financial condition orresults of operations could be adversely affected.  In such case, the trading price of our commonstock could decline and you could lose all or part of your investment.  Our other filings with the Securities andExchange Commission also contain forward-looking statements that involve risksand uncertainties.  Our actual resultscould differ materially from those anticipated in these forward-looking statementsas a result of certain factors, including the risks we face describedbelow.  See “Special Note RegardingForward-Looking Statements.”*

* *

***The executionof our business plan will require substantial funds.  If we are unable to acquire additionalfinancing, we may be forced to discontinue our operations.***

*** ***

Wewill need to raise additional funds in order to execute our business plan andcontinue operations.  No assurance can begiven that this additional financing will be available on terms satisfactory tous.  Any such financing will likelyresult in substantial additional dilution to our current stockholders.

 

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If weare unable to raise substantial funds, we may be unable to pay our debts asthey mature and we may be forced to discontinue our operations andliquidate.  In such event, holders of ourcommon stock would likely lose all or substantially all of their investment inour shares.

 

***Depending onour method of raising funds, now and in the future, your shares may be diluted.***

*** ***

If weraise additional funds by selling additional shares of our capital stock, orsecurities convertible into or exercisable for shares of our capital stock, theownership interest of our stockholders may be diluted.  It is likely that any financing will resultin substantial dilution to our existing stockholders.  For example, the financing described in Note22 - Subsequent Events - Securities Purchase Agreement, which has not closed asof the date of this report, would result in substantial dilution to existingstockholders.

 

***New homeconstruction in the U.S. is currently slowing, and doing so fairly dramaticallyin several areas where the Company’s products are offered.  This building slow-down could negativelyimpact our sales.***

*** ***

California,our most important market, represents a majority of all PV installations inNorth America, and new home construction in California has slowedsignificantly.  Arizona, Nevada, NewMexico and Florida are also significant potential markets for our PV productsand they too are experiencing a decline in new home construction activity.  In addition, these regions also have a highvolume of unsold new home inventory.  Ifthe residential home industry continues to have a high volume of unsoldinventory, the new home construction market is likely to continue todecline.  This could adversely affectsolar installations, particularly for our residential PV roofing tiles.

 

***Our auditorshave expressed substantial doubt regarding our ability to continue as a goingconcern.***

*** ***

As ofthe date of our most recent audit, which included the fiscal years ended May 31,2008 and May 31, 2007, we had not generated sufficient revenues to meetour cash flow needs.  As a result, ourauditors have expressed substantial doubt about our ability to continue as agoing concern.  Although we havegenerated revenue, we are still operating at a net loss, and may continue toincur losses for a period of time.  Weincurred a net loss of $34.9 million for the year ended May 31, 2008, anet loss of $39.6 million for the year ended May 31, 2007, and a net lossof $12.2 million for the year ended May 31, 2006.  We cannot assure you that we will be able toobtain sufficient funds from our operating or financing activities to supportour continued operations.  If we cannotcontinue as a going concern, we may need to substantially revise our businessplan or cease operations, which may reduce or negate the value of yourinvestment.

 

***We expect ouroperating results to fluctuate on a quarterly and annual basis, which couldcause our stock price to fluctuate or decline.***

*** ***

Webelieve that our operating results may fluctuate substantially fromquarter-to-quarter and year-to-year for a variety of reasons, many of which arebeyond our control.  Factors that couldaffect our quarterly and annual operating results include those listed below aswell as others listed in this “Risk Factors” section:

 

·                  our current reliance on large-volumeorders from only a few customers;

·                  the receipt and shipment of largeorders or reductions in these orders;

·                  variability between customer andproduct mix;

·                  changes in our pricing policies orthose of our competitors;

·                  the introduction of new products orproduct enhancements by us or our competitors;

·                  changes in the terms of ourarrangements with customers or suppliers;

·                  the ability of our customers toaccurately forecast demand for our products by their end users;

·                  the impact of changes in governmentregulation and rebate and similar incentive programs affecting our products;

·                  delays or failures to fulfill ordersfor our products on a timely basis;

·                  delays in the introduction of new orenhanced products by us or market acceptance of these products;

·                  our ability to finance our workingcapital needs;

·                  the availability and cost of rawmaterials and components for our products;

·                  an increase in product warrantyreturns or in our allowance for doubtful accounts; and

·                  operational disruptions, such astransportation delays or failures of our order processing system.

 

Asubstantial portion of our sales in a given quarter may depend on obtainingorders for products to be manufactured and shipped in the same quarter in whichthose orders are received.  As a resultof these factors, period-to-period comparisons of our operating results 

 

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maynot be meaningful, and you should not rely on them as an indication of ourfuture performance.  In addition, ouroperating results may fall below the expectations of public market analysts orinvestors.  In this event, our stockprice could decline significantly.

 

***Evaluating ourbusiness and future prospects may be difficult due to the rapidly changingtechnological and market landscape.***

*** ***

Thereis limited historical information available about our company upon which youcan base your evaluation of our business and prospects.  We first shipped renewable energy commercialproducts in December 2005.  Relativeto the entire solar industry, we have shipped only a very small number ofproducts.

 

Themarket we are addressing is rapidly evolving and is experiencing technologicaladvances and new market entrants.  Wehave recently begun to outsource substantially all of our manufacturing, andthere is no guarantee we can do this at a price that is competitive with ourcompetition, or that we can gain access to new, more cost effective solartechnologies that may be developed by our competitors.  Moreover, the SunConeTM CSP system is only inthe early stages of development and we have limited experience upon which topredict whether it can be successfully commercialized and limited capital tofund such development.

 

***We faceintense competition from other companies producing solar power and other energygeneration products.  If we fail tocompete effectively, we may be unable to increase our market share and sales.***

*** ***

Thesolar power market is intensely competitive and rapidly evolving.  Our competitors are better capitalized, haveestablished market positions more prominent than ours, and if we fail toattract and retain customers and establish a successful distribution networkfor our solar products, we may be unable to achieve adequate sales and marketshare.  There are a number of majormulti-national corporations that produce solar power products, including BPSolar, Kyocera, Sharp, GE, Mitsubishi, Solar World AG and Sanyo.  We also expect that future competition willinclude new entrants to the solar power market offering new technologicalsolutions.  Further, many of ourcompetitors are developing and currently producing products based on new solarpower technologies that may have costs similar to, or lower than, our projectedcosts.

 

Mostof our competitors are substantially larger than we are, have longer operatinghistories, and have substantially greater financial, technical, manufacturingand other resources than we do.  Ourcompetitors’ greater sizes in some cases provides them with competitiveadvantages with respect to manufacturing costs due to their ability to allocatefixed costs across a greater volume of production and purchase raw materials atlower prices.  Many also have far greatername recognition, an established distribution network and an installed base ofcustomers.  In addition, many of ourcompetitors have well-established relationships with current and potentialresellers, which have extensive knowledge of our target markets.  As a result, our competitors will be able todevote greater resources to research, development, promotion and sale of theirproducts and may be able to respond more quickly to evolving industry standardsand changing customer requirements than we can.

 

***There is ashortage of semi-conductor grade silicon and the PV cells made from thismaterial, upon which our products depend, that may constrain our revenuegrowth.  Additionally, we may not havesufficient financial resources to take advantage of supply opportunities asthey may arise.***

*** ***

Siliconis an essential raw material in the production of PV cells.  There is currently an industry-wide shortageof silicon ingots, which has resulted in significant price increases.  Increases in silicon prices may impact ourmanufacturing costs in the future.  Asdemand for PV cells has increased, a number of manufacturers have announcedplans to add additional capacity.  Asthis manufacturing capacity becomes operational, it will increase the demandfor silicon.  Polysilicon is also used inthe semiconductor industry generally, and any increase in demand from thatsector will compound the shortage.  Theproduction of silicon is capital intensive and adding additional capacityrequires significant lead time.  Weexpect that silicon demand will continue to outstrip supply in the near term.

 

***We depend on alimited number of suppliers for the laminates and cells necessary tomanufacture our products, and the loss or interruption of supply wouldnegatively impact sales and damage our reputation with our customers.***

*** ***

Wecurrently purchase laminate and cells from a small number of majorsolar suppliers.  There has been anindustry wide shortage of laminate which has resulted in shipment delays andprice increases.  Unlike some of ourcompetitors, we are not vertically integrated and do not control our supplychain.  We are evaluating alternatesuppliers for the critical parts of all of our products.  Any interruption or slow down in supply, orincrease in product costs, could cause a disruption or a complete stoppage ofour manufacturing operations and a corresponding loss of revenue.

 

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Inaddition, we have entered into agreements with our significant customers thatrequire that we provide them with certain volume commitments.  Any inability on our part to meet therequirements of those customers would damage our reputation with thosecustomers and negatively impact our operations.

 

***Our productsmay not gain market acceptance, which would prevent us from achieving sales andmarket share.***

*** ***

Thedevelopment of a successful market for our products may be adversely affectedby a number of factors, some of which are beyond our control, including:

 

·                  ourfailure to produce products that compete favorably against other solar powerproducts on the basis of cost, quality and performance;

·                  our failure to produce products thatcompete favorably against conventional energy sources and alternativedistributed-generation technologies, such as wind, biomass and solar thermal,on the basis of cost, quality and performance;

·                  whether customers will accept our newdesigns under development; and

·                  our failure to develop and maintainsuccessful relationships with distributors, systems integrators and otherresellers, as well as strategic partners.

 

If ourproducts fail to gain market acceptance, we will be unable to achieve sales andmarket share.

 

***Technologicalchanges in the solar power industry could render our products uncompetitive orobsolete, which could prevent us from achieving market share and sales.***

*** ***

Ourfailure to refine our technology and to develop and introduce new productscould cause our products to become uncompetitive or obsolete, which couldprevent us from achieving market share and sales.  The solar power industry is rapidly evolvingand highly competitive.  We will need toinvest significant financial resources in research and development to keep pacewith technological advances in the solar power industry and to compete in thefuture and we may be unable to secure such financing.  We believe that a variety of competing solarpower technologies may be under development by other companies that couldresult in lower manufacturing costs or higher product performance than thoseexpected for our products.  Ourdevelopment efforts may be rendered obsolete by the technological advances ofothers, and other technologies may prove more advantageous for thecommercialization of solar power products.

 

***The reductionor elimination of government economic incentives could prevent us fromachieving sales and market share.***

*** ***

Webelieve that the near-term growth of the market for “on-grid” applications,where solar power is used to supplement a customer’s electricity purchased fromthe utility network, depends in large part on the availability and size offederal and state government economic incentives.  The reduction or elimination of governmenteconomic incentives may adversely affect the growth of this market or result inincreased price competition, which could prevent us from achieving sales andmarket share.  In the United States, the30% federal investment tax credit is currently scheduled to expire on December 31,2008.  If Congress does not extend theinvestment tax credit, the Company and the industry in general will be severelyand negatively affected.  In December 2007,the Senate failed to get enough votes to pass the proposed clean energy billand its associated renewable electricity standard which would have extended theinvestment tax credit.  Similar attemptsin Congress during 2008 to extend the investment tax credit have failed.

 

Today,the cost of solar power exceeds the cost of power furnished by the electricutility grid in many locations.  As aresult, federal, state and local government bodies in many countries, mostnotably Germany and Japan, have provided incentives in the form of feed-intariffs, cash rebates, tax credits, permitting preferences and other incentivesto promote the use of solar energy and to reduce dependency on fossilfuels.  These government economicincentives could be reduced or eliminated altogether, which would significantlyharm our business and future prospects.

 

***Existingregulations and changes to such regulations may present technical, regulatoryand economic barriers to the purchase and use of solar power products, whichmay significantly reduce demand for our products.***

*** ***

Thetraditional energy and electrical utility industries are heavily regulated byforeign, federal, state and local governments. These regulations and policies often relate to electricity pricing andtechnical interconnection of customer-owned power generation systems.  In the United States and in a number of othercountries, these regulations and policies are being modified and may continueto be 

 

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modified.  Customer purchases of, or further investmentin the research and development of, alternative energy sources, including solarpower technology, could be deterred by these regulations and policies, whichcould result in a significant reduction in the potential demand for our solarpower products.  For example, utilitycompanies commonly charge fees to larger, industrial customers for having thecapacity to use power from the electric grid for back-up purposes.  These fees could increase the cost to ourcustomers of using our solar power products and make them less desirable, whichwould harm our business, prospects, results of operations and financialcondition.

 

Weanticipate that our solar power products and their installation will be subjectto oversight and regulation in accordance with national and local ordinancesrelating to building codes, health and safety standards, environmentalregulations, utility interconnection and metering and related matters.  There is also a burden in having to track therequirements of individual states and design equipment to comply with thevarying standards.  Any new governmentregulations or utility policies pertaining to our solar power products mayresult in significant additional expenses to us and our resellers and theircustomers and, as a result, could cause a significant reduction in demand forour solar power products.

 

***Problems withproduct quality or product performance may cause us to incur warranty expensesand prevent us from achieving sales and market share, particularly if weintroduce new technologies.***

*** ***

As isconsistent with standard practice in our industry, the duration of our productwarranties is lengthy.  Our currentroofing tile product warranty is for 25 years, and our roofing membrane productwarranty is for 20 years.  Due to thelong warranty period, we bear the risk of extensive warranty claims long afterwe have shipped product and recognized revenues.  Our products have not been installed longenough to allow us to evaluate their performance over a 20 to 25-year period.  We experienced a warranty claim with ourfirst tile installation.  Although webelieve the initial problem has been resolved, other warranty issues coulddevelop.  We also experienced warrantyclaims with some of our initial membrane installations, causing us totemporarily discontinue product shipments. There is no assurance that the membrane product warranty issues can beresolved.  Failure to resolve theseproduct warranty issues could force us to permanently discontinue productshipments, which would materially and negatively affect the Company’srevenues.  Please see “Description ofBusiness — Our Products — SolarSave® Roofing Membranes.”

 

***If solar powertechnology is not suitable for widespread adoption or sufficient demand forsolar power products does not develop or takes longer to develop than weanticipate, we would be unable to achieve sales and market share.***

*** ***

Themarket for solar power products is emerging and rapidly evolving, and itsfuture success is uncertain.  If solarpower technology proves unsuitable for widespread commercial deployment or ifdemand for solar power products fails to develop sufficiently, we would beunable to achieve sales and market share. In addition, demand for solar power products in the markets andgeographic regions we target may not develop or may develop more slowly than weanticipate.  Many factors will influencethe widespread adoption of solar power technology and demand for solar powerproducts, including:

 

·                  cost-effectiveness of solartechnologies as compared with conventional and competitive alternative energytechnologies;

·                  performance and reliability of solarproducts as compared with conventional and non-solar alternative energyproducts;

·                  success of alternative distributedgeneration technologies such as hydrogen fuel cells, wind turbines, bio-dieselgenerators and solar thermal technologies;

·                  public concern regarding energysecurity, the potential risks associated with global warming, the environmentaland social impacts of fossil fuel extraction and use;

·                  fluctuations in economic and marketconditions that impact the viability of conventional and competitivealternative energy sources;

·                  increases or decreases in the pricesof oil, coal and natural gas;

·                  capital expenditures by customers,which tend to decrease when the domestic or foreign economies slow;

·                  continued deregulation of theelectric power industry and broader energy industry; and

·                  availability of government subsidiesand incentives.

 

***If we areunable to protect our intellectual property adequately, we could lose ourcompetitive advantage in the solar power market.***

*** ***

Ourability to compete effectively against other solar power technologies willdepend, in part, on our ability to protect our current and future proprietarytechnology, product designs and manufacturing processes through a combinationof patent, copyright, trademark, 

 

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tradesecret and unfair competition laws.  Wemay not be able to protect our intellectual property and may need to defend ourproducts and services against infringement claims, either of which could resultin the loss of our competitive advantage in the solar power market andmaterially harm our business and profitability. We face the following risks in protecting our intellectual property andin developing, manufacturing, marketing and selling our products and services:

 

·                  we cannot be certain that our pendingpatent applications will result in issued patents or that the claims allowedare or will be sufficiently broad to protect our technology or processes;

·                  given the costs of obtaining patentprotection, we may choose not to protect certain innovations that later turnout to be important;

·                  third parties may design around ourpatented technologies or seek to challenge or invalidate our intellectualproperty rights and there is no assurance that our intellectual property rightswill deter infringement or misappropriation of our intellectual property;

·                  we may incur significant costs anddiversion of management resources in prosecuting or defending intellectualproperty infringement suits;

·                  we may not be successful in prosecutingor defending intellectual property infringement suits and, as a result, mayneed to seek to obtain a license of the third party’s intellectual propertyrights, which may not be available to us, whether on reasonable terms or atall; and

·                  the contractual provisions we rely onto protect our trade secrets and proprietary information, such as ourconfidentiality and non-disclosure agreements with our employees, consultantsand other third parties, may be breached and our trade secrets and proprietary informationmay be disclosed to competitors, strategic partners and the public.

 

***Failure toadequately protect our trademark rights could cause us to lose market share andcause our sales to decline.***

*** ***

Wesell our solar roofing, architectural glass and balance-of-system productsunder our brand names SolarSave® and we have branded our solar concentrating technologyunder the brand name SunConeTM CSP.  Weare also branding our company with the name Open EnergyTM.  We expect to expend significant resources promotingthese brand names, and we have applied for registered trademarks in the UnitedStates for SunConeTM CSP, the OE Logo, OpenEnergyTM andother trademarks.  However, registrationof our brand name trademarks could be denied, and if granted, such registrationwill not necessarily deter or prevent unauthorized use by others.  If other companies, including ourcompetitors, use our brand names, consumers may not recognize us as the sourceof our products.  This would reduce thevalue of goodwill associated with our brand names.  This consumer confusion and the resultingreduction in goodwill could cause us to lose market share and cause our salesto decline.

 

***Materialweaknesses in our disclosure controls and procedures and our internal controlover financial reporting, if not remedied effectively, could prevent usfrom reporting our financial results on a timely and accurate basis and resultin a decrease in the trading price of our common stock and otherwise seriouslyharm our business.***

*** ***

Managementhas concluded that our disclosure controls and procedures and our internalcontrol over financial reporting had material weaknesses as of May 31,2008.  We have not remedied allweaknesses at this time.  In addition,because of our limited financial resources and operating challenges, we havenot been able to complete the design, documentation and implementation of aninternal control system that meets the standards prescribed by Section 404of the Sarbanes-Oxley Act of 2002, as amended. These controls and procedures are designed to provide reasonableassurance that we can provide timely and accurate financial reporting of ourresults of operations.

 

Failureto achieve and maintain an effective internal control environment could preventus from reporting our financial results on a timely and accurate basis or causeinvestors to lose confidence in our reported financial information.  These effects could in turn result in adecrease in the trading price of our common stock.

 

***There are alarge number of shares underlying our convertible debentures and warrants thatmay be available for future sale.  Ourexisting stockholders may experience immediate and substantial dilutionresulting from the issuance of these shares and the sale of these shares maydepress the future market price of our common stock.***

*** ***

As of August 22,2008, we had (i) 127,952,397 shares of common stock issued andoutstanding; (ii) debentures outstanding that, including accrued interest,are convertible into 42,000,000 additional shares of common stock; and (iii) warrantsoutstanding to purchase up to 74,973,656 additional shares of our commonstock.  The number of shares of commonstock issuable upon conversion 

 

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orexercise of the foregoing securities may increase if we issue shares of commonstock or securities convertible into common stock at an effective price pershare less than the conversion and/or exercise prices of the foregoingsecurities.  See “Management’s Discussionand Analysis - Liquidity and Capital Resources – Debt Financings.”  If andwhen our outstanding debentures, notes and warrants are converted or exercisedfor shares of our common stock, our existing stockholders will bediluted.  In addition, the sale of a significant number of such shares ofcommon stock may depress the market price of our common stock.

 

***Our seniorlender has a general security interest in our inventory, specified accountsreceivable and our cash accounts, which collectively represent substantiallyall of our liquid assets.  If we were todefault under the terms of our loan agreement, our lender would have the rightto foreclose on these assets.***

*** ***

In April 2008,we entered into a loan and security agreement with The Quercus Trust pursuantto which Quercus loaned us $3.5 million based upon the availability ofspecified collateral.  The loan andsecurity agreement is collateralized by a general security interest in all ofour inventory, specified accounts receivable and our cash accounts.  If we were to default under the terms andconditions of the loan and security agreement, or if our collateral ratios fallbelow specified levels, Quercus would have the right to accelerate theoutstanding indebtedness under the loan and security agreement and foreclose onthe collateral.  Such a foreclosure wouldhave a material adverse effect on our business, liquidity, results ofoperations and financial position.

 

***Our failure towithhold for or pay federal and state employment and income taxes associatedwith the vesting or issuance of shares of restricted stock granted to ouremployees may result in significant liabilities for which we may not havesufficient cash to satisfy.***

*** ***

In thepast, we issued shares of restricted stock to certain employees.  We failed to withhold and pay taxes on suchrestricted shares upon vesting, which resulted in tax liability to theCompany.  We are obligated to pay allemployee federal and state withholding taxes as well as the employer’s portionof FICA.  As of August 29, 2008, wehave a remaining obligation to pay $207,000 in employment taxes incurred inconnection with the vesting of restricted stock.

 

Ourobligation to withhold for and pay federal and state employment and incometaxes associated with these restricted shares granted to employees is ongoingwith each new vesting date, and the level of tax obligation would besignificant if any of the vesting schedules were to accelerate in accordancewith the terms of the employment agreements upon a termination by the Companywithout cause or by the employee for good reason or upon a change of control ofthe Company.  We could therefore incursignificant additional liabilities for which we may not have sufficient cash tosatisfy, requiring us to raise additional funds or curtail or cease operations.

 

***Nevada law mayhave the effect of deterring hostile takeovers or delaying changes in controlof our management, which could depress the market price of our common stock.***

*** ***

*BusinessCombinations Act. *Wewill become subject to Sections 78.411 and 78.444 of the NGCL if we ever have200 or more stockholders of record.  Suchstatutes prohibit an “interested stockholder” from entering into a “combination”with the corporation, unless certain conditions are met.  An “interested stockholder” is a person who:

 

·                  Directlyor indirectly beneficially owns 10% or more of the voting power of theoutstanding voting shares of the corporation, or

 

·                  Isan affiliate or associate of the corporation and at any time within three yearsbefore the date in question was the beneficial owner, directly or indirectly,of 10% or more of the voting power of the then outstanding shares of thecorporation.

 

Undercertain circumstances, a corporation may not engage in a combination withinthree years after the interested stockholder first became an interestedstockholder, unless the combination or the transaction by which the personbecame an interested stockholder was approved by the board of directors beforethe date the interested stockholder first became an interestedstockholder.  If this approval was notobtained, then after the three year period expires, the combination may beconsummated if all the requirements in the corporation’s articles of incorporationare met and either the approval of the non-interested stockholders is obtainedor certain minimum price and other Nevada law requirements are met.

 

Businesscombinations encompass a wide variety of transactions with or caused by aninterested stockholder, including mergers, asset sales and other transactionsin which the interested stockholder receives or could receive a benefit onother than a pro rata basis with 

 

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otherstockholders.  Provisions of this lawhave an anti-takeover effect on transactions not approved in advance by theboard of directors.

 

*ControlShares Act*.  Nevada lawprovides that, in certain circumstances, a stockholder who acquires acontrolling interest in a corporation, defined in the statute as an interest inexcess of a 1/5, 1/3, or 1/2 interest in the voting power of the corporation inthe election of directors, has only such voting rights in the shares acquiredthat caused the stockholder to exceed any such threshold as are conferred by amajority vote of the corporation’s stockholders at an annual or specialstockholders’ meeting.

 

Thecontrol shares provision applies to Nevada corporations with at least 200stockholders, including at least 100 stockholders who have addresses in Nevadaappearing on the stock ledger of the corporation, and which do business directlyor indirectly in Nevada.  We do not haveat least 200 stockholders and do not have at least 100 stockholders who haveaddresses in Nevada; therefore the control shares provision does not currentlyapply to us.  If the control sharesprovision became applicable to us in the future, acquisition of us could becomemore difficult.

 

***Our successdepends on our ability to retain our key personnel.***

*** ***

Oursuccess is dependent upon the efforts of key members of our management,including our president and chief operating officer, David Field, our executivevice president of worldwide operations, Christopher Gopal, our chief financialofficer, Aidan Shields and our general counsel and senior vice president,Dalton W. Sprinkle.  The loss of thesepersons, or other key employees, could have a material adverse effect onus.  Our future success is likely todepend substantially on our continued ability to attract and retain highlyqualified personnel.  The competition forsuch personnel is intense, and our inability to attract and retain such personnelcould have a material adverse effect on us. We do not maintain life insurance on any of our personnel.

 

***Our growth maynot be manageable and our business could suffer as a result.***

*** ***

Evenif we are successful in obtaining new business, failure to manage the growthcould adversely affect our operations. We may experience extended periods of very rapid growth, which couldplace a significant strain on our management, operating, financial and otherresources.  Our future performance willdepend in part on our ability to manage growth effectively.  We must develop management informationsystems, including operating, financial, and accounting systems, improveproject management systems and expand, train, and manage employees to keep pacewith growth.  Our inability to managegrowth effectively could negatively affect results of operations and theability to meet obligations as they come due.

 

***We may notaddress successfully the problems encountered in connection with any recent andpotential future acquisitions.***

*** ***

In March andApril, 2006, we completed the acquisitions of Solar Roofing Systems, Inc.and Connect Renewable Energy, Inc. In December of 2006 we acquired WaterEye Corporation.  In addition, we expect to consider futureopportunities to acquire or make investments in other technologies, productsand businesses that could enhance our capabilities, complement our products, orexpand the breadth of our markets or customer base.  We have limited experience in acquiring otherbusinesses and technologies.  Potentialand completed acquisitions and strategic investments involve numerous risks,including:

 

·                  problemsassimilating the purchased technologies, products or business operations;

 

·                  problemsmaintaining uniform standards, procedures, controls and policies;

 

·                  unanticipatedcosts associated with the acquisition;

 

·                  diversionof management’s attention from our core business;

 

·                  adverseeffects on existing business relationships with suppliers and customers;

 

·                  risksassociated with entering new markets in which we have no or limited priorexperience;

 

·                  potentialloss of key employees of acquired businesses; and

 

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·                  increasedlegal and accounting costs as a result of the newly adopted rules andregulations related to the Sarbanes-Oxley Act of 2002.

 

***We have notpaid dividends on our common stock in the past and do not anticipate payingdividends on our common stock in the foreseeable future.***

*** ***

Wehave not paid common stock dividends since our inception and do not anticipatepaying dividends in the foreseeable future. Our current business plan provides for the reinvestment of earnings inan effort to complete development of our technologies and products, with thegoal of increasing sales and long-term profitability and value.  In addition, several of our financingagreements currently restrict, and any other credit or borrowing arrangementsthat we may enter into may restrict or limit, our ability to pay common stockdividends to our stockholders.

 

***We are subjectto significant corporate governance and internal control reportingrequirements, and our costs related to compliance with, or our failure tocomply with existing and future requirements, could adversely affect ourbusiness.***

*** ***

Weface significant corporate governance requirements under the Sarbanes-Oxley Actof 2002, as well as rules and regulations subsequently adopted by the SECand the Public Company Accounting Oversight Board.  These laws, rules and regulationscontinue to evolve and may become increasingly stringent in the future.  In particular, under rules adopted bythe SEC, we are required to include management’s report on internal controls aspart of this annual report pursuant to Section 404 of the Sarbanes-OxleyAct. Furthermore, an attestation report on our internal controls from ourindependent registered public accounting firm will be required as part of ourannual report for the fiscal year ending May 31, 2010.  We are in the process of evaluating ourcontrol structure to help ensure that we will be able to comply with Section 404of the Sarbanes-Oxley Act, but we have not completed such evaluation as of thedate of this annual report and we cannot assure you that we will be able tofully comply with these laws, rules and regulations that address corporategovernance, internal control reporting and similar matters.  The financial cost of compliance with theselaws, rules and regulations is substantial and our financial resources arelimited.  Failure to comply with theselaws, rules and regulations could materially adversely affect ourreputation, financial condition and the value of our securities.

 

***Our commonstock is subject to penny stock rules.***

*** ***

Ourcommon stock is subject to Rule 15g-1 through 15g-9 under the ExchangeAct, which imposes certain sales practice requirements on broker-dealers whichsell our common stock to persons other than established customers and “accreditedinvestors” (generally, individuals with net worths in excess of $1,000,000 orannual incomes exceeding $200,000 (or $300,000 together with theirspouses)).  For transactions covered bythis rule, a broker-dealer must make a special suitability determination forthe purchaser and have received the purchaser’s written consent to thetransaction prior to the sale.  This rule adverselyaffects the ability of broker-dealers to sell our common stock and purchasersof our common stock to sell their shares of such common stock. Additionally, our common stock is subject to the SEC regulations for “pennystock.”  Penny stock includes any equitysecurity that is not listed on a national exchange and has a market price ofless than $5.00 per share, subject to certain exceptions.  The regulations require that prior to anynon-exempt buy/sell transaction in a penny stock; a disclosure schedule setforth by the SEC relating to the penny stock market must be delivered to thepurchaser of such penny stock.  Thisdisclosure must include the amount of commissions payable to both thebroker-dealer and the registered representative and current price quotationsfor the common stock.  The regulationsalso require that monthly statements be sent to holders of penny stock whichdisclose recent price information for the penny stock and information of thelimited market for penny stocks.  Theserequirements adversely affect the market liquidity of our common stock.

 

***If a letteragreement with one of our investors were held to be in violation of Section 5of the Securities Act of 1933, we could be required to repurchase certainsecurities sold in a previous offering.***

*** ***

On March 30,2006, we entered into a securities purchase agreement pursuant to which weissued convertible debentures and warrants to Cornell Capital Partners,L.P.  In May of 2007, we enteredinto a letter agreement, or the May Letter, whereby Cornell elected towaive a condition of the convertible debentures then held by Cornell thatstated that Cornell could own no more than 4.99% of the Company.  The May Letter also stated that theCompany elected to waive a provision of the convertible debentures relating tothe conversion limitation in any thirty (30) day period.

 

Whilewe do not believe it to be the case, the May Letter may have resulted in aviolation of Section 5 of the Securities Act of 1933.  However, ifthe May Letter was held by a court to be in violation of the SecuritiesAct of 1933, we could be required to repurchase any shares held by Cornell andthe shares sold by Cornell in such offering at the original purchase price,less any amounts previously 

 

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paidby us to Cornell in partial redemption of the convertible debentures orreceived by Cornell from the sale of shares of our common stock into which theconvertible debentures were converted in part, plus statutory interest from thedate of purchase.  We sold an aggregateof $15 million in principal amount of convertible debentures to Cornell pursuantto the March 30, 2006 securities purchase agreement and we previouslyredeemed approximately $1.9 million in principal amount of such convertibledebentures, and paid approximately $864,000 in interest on such convertibledebentures.  In the event that we wererequired to repurchase shares our cash position would be reduced by theamount of shares we were required to repurchase.  There can be no assurance that we would havesufficient cash available to meet such obligation as well as our continuing operatingrequirements or that, if additional financing were required, that suchfinancing could be obtained on terms acceptable to us, if at all.  We would contest vigorously any claim that aviolation of the Securities Act of 1933 occurred.

 

**ITEM 2.****                             PROPERTIES**

# ** **

We ownno real property.  We lease facilities inSolana Beach, California totaling approximately 4,300 square feet for ourcorporate headquarters.  We lease anapproximately 8,000 square foot manufacturing facility in Grass Valley,California.  Additionally, we lease 2,400square feet related to warehouse space in Grass Valley for tile and glassrelated inventory.

 

Each of our facilities is covered by insurance and we believe them tobe suitable for their respective uses and adequate for our present needs. Webelieve that suitable additional or substitute space will be available toaccommodate the foreseeable expansion of our operations.

 

**ITEM 3.****                             LEGALPROCEEDINGS**

# ** **

We arenot involved in any material pending legal proceeding against us, nor are weinvolved as a plaintiff in any material pending litigation.  From time to time, we are a party to otherclaims and legal proceedings arising in the ordinary course of business.

 

**ITEM 4.****                             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

# ** **

On April 16,2008, we entered into an amendment of our 9/19/2007 Note and our 12/7/07 Notes(which collectively comprise our Series B Convertible Notes) with theholders thereof, which amendment:

 

·                  Permitsus to issue shares of our common stock that are not registered pursuant to theSecurities Act of 1933, as amended, in lieu of cash interest payments on the Series BConvertible Notes;

 

·                  Permitsus to issue warrants to acquire shares of our common stock, in lieu of cashinterest payments on the Series B Convertible Notes, which warrants willhave an exercise price per share equal to the greater of $0.506 per share or5-day weighted average price per share of our common stock and;

 

·                  Waivesany prior defaults or trigger events caused by our previous failure to payinterest on our Series B Convertible Notes when due, upon the issuance ofwarrants in lieu of such accrued interest.

 

Inconnection with the above amendment, we issued warrants to the holders of our Series BConvertible Notes to acquire a total of 3,092,704 shares of our common stockwith an exercise price of $0.506 per share in lieu of accrued and unpaidinterest that was in arrearage.  Theother terms of such warrants are substantially the same as the 9/19/07 Warrantsdescribed in “Management’s Discussion and Analysis of Financial Condition andResults of Operation—Liquidity and Capital Resources—Financings—9/19/07 Note.”

 

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**PART II**

** **
| **ITEM 5.** | **MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER  MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES** |
|-------------|------------------------------------------------------------------------------------------------------------------------|

 

Ourcommon stock is traded on the National Association of Securities Dealers, Inc.Over-the-Counter Bulletin Board, or the OTCBB. It has been quoted under thesymbol “OEGY.OB” since April 21, 2006. Before that, it was quoted underthe symbol “BBSE.OB.” The following is a summary of the high and low closingprices of our common stock on the OTCBB during the periods presented. Suchprices represent inter-dealer prices, without retail mark-up, mark down orcommissions, and may not necessarily represent actual transactions. Trading inour common stock has not been extensive in all the periods presented below, andsuch trades may not constitute an active trading market in all the periodspresented below.

 
| ** **                   | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------|------------|----------|------------|---------|------------|
| **Year  Ended May 31, 2008** |       |     |       |    |       |
| First Quarter                |       | $        | 0.77       |    | $          | 0.41 |   |
| Second Quarter               |       | 0.63     |       | 0.45    |       |
| Third Quarter                |       | 0.46     |       | 0.24    |       |
| Fourth Quarter               |       | 0.34     |       | 0.24    |       |
|                              |            |          |            |         |            |  |  |

 
| **Year  Ended May 31, 2007** |   |   |   |   |   |
|------------------------------|--------|--------|--------|--------|--------|
| First Quarter                |   | $      | 1.59   |   | $      | 0.60 |   |
| Second Quarter               |   | 0.95   |   | 0.48   |   |
| Third Quarter                |   | 0.66   |   | 0.30   |   |
| Fourth Quarter               |   | 0.59   |   | 0.30   |   |
|                              |        |        |        |        |        |  |  |

 

On August 22,2008, the closing sales price for our common stock was $0.125, as reported onthe website of the OTCBB. As of August 22, 2008, there were 59stockholders of record of the common stock (which does not include the numberof persons or entities holding stock in nominee or street name through variousbrokerage firms).

 

**Dividends**

** **

Sinceinception, we have not declared or paid any dividend on our common stock. We donot anticipate that any dividends will be declared or paid in the foreseeablefuture on our common stock. In addition, our security agreements with certainof our lenders currently restrict or limit our ability to enter into othercredit or borrowing arrangements and restrict or limit our ability to paycommon stock dividends to our stockholders.

 

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**Securitiesauthorized for issuance under equity compensation plans**

 

**Equity Compensation Plan Information**

 
| **Plan Category**                                      | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options  (a)** | ** ** | **Weighted-average  exercise price of  outstanding options  (b)** | ** ** | **Number of securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in column (a) (c)** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | 15,470,386                                                                                                            |       | 0.50                                                                             |       | 1,029,614                                                                                                                                                                                                                |       |
| Equity compensation plans not approved by  security holders |       | 2,100,000                                                                                                             |       | 0.44                                                                             |       | 9,432,017                                                                                                                                                                                                                | (1)        |
| Total                                                       |       | 17,570,386                                                                                                            |       | 0.50                                                                             |       | 10,461,631                                                                                                                                                                                                               |       |

 

----

(1) Reflectssecurities issuable under the Company’s 2004 Consultant Compensation Plan (the “**Plan**”). Under the Plan, the Company’s Board of Directors, ora designated committee of two or more members of the Board, is authorized toissue up to 9,771,000 shares of our common stock to consultants or advisors ofthe Company or its subsidiaries. Stock grants under the Plan are restricted toconsultant or advisors who, in the discretion of the Board of Directors ordesignated committee have provided or will provide significant bona fideservices to the Company or an affiliated entity (other than services inconnection with a capital raising transaction, investor relations or marketmaking services) pursuant to the terms of a written contract. The Board ofDirectors or designated committee, in its sole discretion, is empowered to makeall decisions with respect to stock grants under the Plan, including when tomake a grant, the number of shares, vesting of the grant or restrictions onfuture transferability of the shares issued pursuant to a grant under the Plan.The Company has issued 338,983 shares of common stock under the Plan and as of May 31,2008, a total of 9,432,017 shares issued pursuant to the plan were outstanding.

 
| **ITEM 6.** | **SELECTED FINANCIAL DATA** |
|-------------|-----------------------------|

# ** **

Disclosurenot required as a result of the Company’s status as a smaller reportingcompany.

 
| **ITEM 7.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

** **

**CompanyDescription and Overview**

** **

OpenEnergy Corporation is a renewable energy company focused on the development andcommercialization of a portfolio of solar electric technologies forresidential, commercial and industrial applications. The Company currentlydesigns, manufactures and distributes building-integrated photovoltaic (BIPV)roofing tiles, roofing membranes and architectural photovoltaic glass productsunder the SolarSave® trade name. The company maintains two facilities:  Acorporate office in Solana Beach for senior management, marketing, sales,customer service, legal and finance and an engineering facility in GrassValley, California for product design, project engineering, prototyping, customglass manufacturing, and materials management.

 

Thefollowing three strategic initiatives distinguish our approach from others inan industry that is increasingly becoming commoditized and price-driven:

 
| 1. |   | We  utilize the roofing products industry as our primary channel partner,  co-designing, co-marketing and distributing our solar products through this  well established industry. |
|----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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Duringthe fiscal year ended May 31, 2008, we participated with our channelpartners in the training of over 350 roofers and sales personnel to sell andinstall our proprietary products. In April 2008, we amended our jointmarketing and distribution agreement with Eagle Roofing Products whereby Eaglehas agreed to purchase at least 82,500 tiles in monthly increments from April 2008through December 2008. In November 2007 we signed a distributionagreement with Petersen-Dean Roofing systems to distribute SolarSave® productsacross the country.

 
| 2. |   | We  outsource production in order to lower our costs, increase our capacity and  better balance demand and supply of our proprietary best-in-class building  integrated PV products. |
|----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Duringthe year ended May 31, 2008, we implemented a new supply chain strategy,pursuant to which we transitioned our manufacturing model to a multi-source,outsourcing model resulting in the expansion of our supply of tiles from 2,000to 20,000 tiles per month. Our outsourced supply chain strategy providesflexibility, allowing us to match supply and demand, while providing the lowesttotal installed cost to our customers. In January 2008, we completed theshutdown of operations at our Aurora, Ontario, manufacturing facility inCanada. We continue to utilize the resources in our Grass Valley, Californiafacility to perform design and supplemental manufacturing and assemblyfunctions.

 
| 3. |   | We  intend to offer financed solutions to the residential market through  long-term power purchase agreements that will contribute to increased product  sales and generate recurring revenues from the sale of energy. |
|----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

In February 2008,we signed a development agreement for our first “solar community” project, a47-unit condominium project co-sited with a Whole Foods store and other mixedretail outlets in San Diego, California. The project is a LEED certified “green”development and construction commenced during the summer of 2008.

 

**CriticalAccounting Policies**

** **

***Use of Estimates***

 

Thepreparation of financial statements in conformity with United States generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the reportingperiods.

 

Managementroutinely makes judgments and estimates about the effects of matters that areinherently uncertain. As the number of variables and assumptions affecting theprobable future resolution of the uncertainties increase, these judgments becomeeven more subjective and complex. The Company has identified the followingaccounting policies, described below, as the most important to an understandingof the Company’s current financial condition and results of operations.

 

***RevenueRecognition***

*** ***

TheCompany recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104,*Revenue Recognition* (“SAB 104”). TheCompany generates revenue from the sale of photovoltaic roofing tiles,photovoltaic roofing membranes, balance of system products, water monitoringequipment and subscriptions and management system products to dealers and otherparties. The Company does not perform any installations of photovoltaicproducts. The Company does, however, install water monitoring systems andrecognizes corresponding license/subscription revenue consistent with AICPAStatement of Position (SOP) 97-2,*SoftwareRevenue Recognition* requirements.

 

SAB104 requires that four basic criteria be met before revenue can be recognized: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the seller’s price to the buyer is fixed and determinable;and (4) collectability is reasonably assured. Amounts billed or receivedfrom customers in advance of performance are recorded as deferred revenue. Inaddition, the Company records deferred revenue in connection with sales tocertain customers of products that qualify for state rebates that have beenassigned to the Company by the customer. Based on the assignment of the rebateto the Company, the Company bills the customer net of the anticipated rebateand assumes the responsibility for collection of the rebate. The rebateprocessing cycle involves a multi-step process in which the Company accumulatesand submits information required by the state agency necessary for

 

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thecollection of the rebate. The entire process can take up to 120 days or more tocomplete. Although title to the products sold have transferred to the customer,due to uncertainty relating to the collection of the rebate and thedetermination of the ultimate price to be received, the Company defers revenueon the portion of the selling price related to the rebate, until such time thatthe rebate claim is submitted to the state agency.

 

Costof sales related to revenue that has been deferred in connection with rebatecollection process is recorded as deferred charges until such time as therelated revenue is recognized.

 

***AccountsReceivable***

*** ***

TheCompany regularly evaluates the collectability of its accounts receivable. Anallowance for doubtful accounts is maintained for estimated credit losses, andsuch losses have been minimal and within management’s expectations. Whenestimating credit losses, the Company considers a number of factors includingthe aging of a customer’s account, creditworthiness of specific customers,historical trends and other information. Accounts receivable consist of tradereceivables and amounts due from state agencies or utilities for rebates onstate-approved solar systems installed. These rebate amounts are passed on tothe customer at the time the customer is billed and the rebate is assigned tothe Company. Generally, state agencies or utilities can take 120 days or moreto remit the rebate amounts to the Company.

 

***Inventories***

*** ***

Inventoriesare valued at lower of cost (first in, first out) or market. Managementprovides a reserve, as necessary, to reduce inventory to its net realizablevalue. Certain factors could impact the realizable value of inventory somanagement continually evaluates the recoverability based on assumptions aboutcustomer demand and market conditions. The evaluation may take intoconsideration expected demand, new product development, the effect new productsmight have on the sale of existing products, product obsolescence and otherfactors. The reserve or write down is equal to the difference between the costof inventory and the estimated market value based upon assumptions about futuredemand and market conditions. If actual market conditions are less favorablethan those projected by management, additional inventory reserves or writedowns may be required. If actual market conditions are more favorable, reservesor write-downs may be reversed.

 

***Goodwill andIntangible Assets***

*** ***

Goodwillrepresents the excess of costs over fair value of assets of businessesacquired. Per Statement of Financial Accounting Standards No. 142,*Goodwill and Other Intangible Assets* (“SFASNo.142”), goodwill and intangible assets acquired in a purchase businesscombination and determined to have an indefinite useful life are not amortized,but instead must be tested for impairment annually or more frequently ifcircumstances indicate that indicators of impairment may be present. Managementassesses goodwill for impairment at the reporting unit level on an annual basisat fiscal year-end or more frequently under certain circumstances. Suchcircumstances include (i) significant adverse change in legal factors orin the business climate, (ii) an adverse action or assessment by aregulator, (iii) unanticipated competition, (iv) a loss of keypersonnel, (v) a more-likely-than-not expectation that a reporting unit ora significant portion of that unit will be sold or otherwise disposed of, and (vi) recognitionof an impairment loss in a subsidiary that is a component of a reporting unit. Managementmust make assumptions regarding estimating the fair value of the Companyreporting unit. If these estimates or related assumptions change in the future,the Company may be required to record an impairment charge.

 

***Evaluation ofLong-lived Assets***

*** ***

TheCompany’s policy is to assess potential impairments to its long-lived assetswhen there is evidence that events or changes in circumstances have maderecovery of the assets carrying value unlikely and the carrying amount on theasset exceeds the estimated undiscounted future cash flows. If such evaluationwere to indicate a material non-recoverability of these long-lived assets, suchimpairment would be recognized by a write down of the applicable asset to itsestimated fair value under SFAS No. 144,*Accounting for the Impairment of Disposal of Long-Lived Assets*.

 

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***Income Taxes***

*** ***

Incometaxes are computed using the asset and liability method. Under the asset andliability method, deferred income tax assets and liabilities are determinedbased on the differences between the financial reporting and the tax bases ofassets and liabilities and are measured using the currently enacted tax ratesand laws. A valuation allowance is provided for the amount of deferred taxassets that, based on available evidence, are not expected to be realized.

 

***BeneficialConversion and Warrant Valuation***

*** ***

Inaccordance with EITF No. 98-5*,Accounting for Convertible Securities with Beneficial Conversion Features orContingently Adjustable Conversion Ratios* and EITF No. 00-27,*Application of Issue No. 98-5 to CertainConvertible Instruments*, the Company records a beneficial conversionfeature (“BCF”) related to the issuance of convertible debt instruments thathave conversion features at fixed rates that are in the money when issued, andthe fair value of warrants issued in connection with those instruments. The BCFfor the convertible instruments is recognized and measured by allocating aportion of the proceeds to warrants, based on their relative fair value, and asa reduction to the carrying amount of the convertible instrument equal to theintrinsic value of the conversion feature. The discounts recorded in connectionwith the BCF and warrant valuation are recognized as non-cash interest expenseover the term of the convertible debt, using the effective interest method.

 

**Limited OperatingHistory**

** **

Thereis limited historical financial information about our company upon which tobase an evaluation of our future performance. Our company has generated limitedrevenues from operations. We cannot guarantee that we will be successful in ourbusiness. We are subject to risks inherent in a fast growing company, includinglimited capital resources, possible delays in product development andmanufacturing, and possible cost overruns due to price and cost increases. Thereis no assurance that future financing will be available to our company onacceptable terms. Additional equity financing will likely result in substantialdilution to existing stockholders.

 

**Results ofOperations – Fiscal Year Ended May 31, 2008 compared to Fiscal Year Ended May 31,2007**

** **

Thefollowing table sets forth the Company’s consolidated statement of operationsdata for the years ended May 31, 2008 and 2007.

 

*Summary Statement of Operations (inthousands):*

 
| ** **                                          | ** ** | **Twelve Months Ended May 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Revenues, net**                                   |       | $                                                   | 6,938      |   | 100.0 | % | $ | 4,292 |   | 100.0 | % |
| **Gross profit (loss)**                             |       | (4,162                                              | )          | (60.0 | ) | (4,788 | ) | (111.6 | ) |
| **Operating expenses:**                             |       |                                                |       |   |   |   |   |   |   |
| **Selling, general and administrative**             |       | 18,747                                              |       | 270.2 |   | 17,084 |   | 398.0 |   |
| **Research and development**                        |       | 290                                                 |       | 4.2 |   | 513 |   | 12.0 |   |
| **Restructuring Costs**                             |       | 849                                                 |       | 12.2 |   | — |   | — |   |
| **Impairment of intangibles and goodwill**          |       | —                                              |       | — |   | 10,540 |   | 245.6 |   |
| **Impairment of note receivable**                   |       | —                                              |       | — |   | 683 |   | 15.9 |   |
| **Total operating expenses**                        |       | 19,886                                              |       | 286.6 |   | 28,820 |   | 671.5 |   |
| **Loss from operations**                            |       | (24,048                                             | )          | (346.6 | ) | (33,608 | ) | (783.0 | ) |
| **Total other income (expense)**                    |       | (12,339                                             | )          | (177.8 | ) | (9,206 | ) | 214.5 | ) |
| **Loss from operations before income tax  benefit** |       | (36,387                                             | )          | (524.5 | ) | (42,814 | ) | (997.5 | ) |
| **Income tax benefit**                              |       | 1,452                                               |       | 20.9 |   | 3,262 |   | 76.0 |   |
| **Net loss**                                        |       | $                                                   | (34,935    | ) | (503.5 | )% | $ | (39,552 | ) | (921.5 | )% |

 

**Revenues**

** **

Forthe years ended May 31, 2008 and 2007, revenues were $6,938,000 and$4,292,000, respectively.

 

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Duringthe year ended May 31, 2008, revenues of $6,938,000 primarily consisted of$4,448,000 in sales of SolarSave® Tiles for residential projects and$1,250,000 in sales of SolarSave® PV Glass for the remainder of theCalifornia Academy of Sciences Museum installation in Golden Gate Park, SanFrancisco, California, and to another PV Glass customer. SolarSave® Tile revenueshave increased by 280% from 2007 primarily as a result of our change indistribution strategy to utilization of the Eagle Roofing Products saleschannel.

 

At May 31,2008, we deferred revenue in the amount of $2,822,000, which was primarilyrelated to rebate claims submitted to state and federal agencies. The amount ofdeferred revenue was determined by assigning a declining factor to the rebate,based on the progress of the rebate application through the rebate processingcycle.

 

Forthe year ended May 31, 2007, revenues for SolarSave® Tile and SolarSave®Membrane products and WaterEye water monitoring subscriptions totaled$4,292,000. Revenues were significantly below our initial financial projectionsprimarily due to a manufacturing and cell procurement cost structure that wastoo high relative to the competition and which caused us to price our productsat a premium. In addition, our initial sales strategy for our SolarSave® Tileof selling through solar integrators resulted in a sales cost structure thatcompounded the price disadvantage.

 

**Cost of Sales**

** **

Forthe years ended May 31, 2008 and 2007, cost of sales was $11,100,000 and$9,080,000, respectively. Gross loss for the years ended May 31, 2008 and2007, was $4,162,000 and $4,788,000, respectively.

 

Thegross loss for the year ended May 31, 2008 of $4,162,000 reflects: thehigh cost of laminates for the SolarSave® Tile for low volume purchasequantities, higher than expected freight and manufacturing costs incurred as aresult of our need to satisfy tight delivery schedules, a $996,000 increase towarranty reserve related to diode failures of SolarSave® Membrane productshipments and a $372,000 increase to warranty reserve related to tiledelamination on a small percentage of early production Solar Save® Tiles.

 

Forthe year ended May 31, 2007, cost of sales was $9,080,000, resulting in agross loss of $4,788,000. The cost of sales includes charges for $1,370,000 ofinventory reserves for our membrane product, a $547,000 charge to adjust tileinventory to the lower of cost or market and a charge for membrane productwarranty reserves totaling $1,520,000. The remaining $5,643,000 of cost ofsales exceeded revenues due to an underutilization of manufacturing capacityand the resulting under-absorption of labor and overhead expenses due to lowerthan anticipated sales volume. The inventory and warranty reserves for themembrane product are primarily related to the estimated costs to correct thecorrosion issues with the membrane product for both on-hand inventories andexisting installations.

 

Ourindustry is still developing and the highly competitive environment continuesto put pressure on pricing. In addition, scarce resources of silicon haveincreased costs of sales. The combination of these factors is putting pressureon gross margins.

 

Wehave undertaken a number of initiatives to improve gross margin, the mostsignificant of which is moving from a 3 foot tile to a 4 foot standard tile,which is expected to be commercially available in the calendar-quarter ended December 31,2008. We believe that the redesign of our SolarSave® Membrane product scheduledfor release to market early in 2009 will address the previous product failureissues. We are negotiating with outsourced manufacturers on product pricing forour current and next generation SolarSave® roofing tiles and are alsoevaluating other cost effective supply options for our laminates and products. Aswe mature in our relationship with our suppliers and customers and improveforecasting, we expect to reduce costs. In addition, we are currentlyevaluating the potential of licensing the intellectual property associated withour tile and membrane products. We believe that such a licensing strategy wouldresult in greater operational profitability.

 

**Operating Expenses**

** **

*Selling, general and administrative*

* *

Forthe years ended May 31, 2008 and 2007, selling, general and administrativeexpenses (“SG&A”) were $18,747,000 and $17,084,000, respectively.

 

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Forthe year ended May 31, 2008, SG&A expenses of $18,747,000 included$9,645,000 in stock-based compensation, $1,006,000 of depreciation expense andintangible asset amortization expense, and $1,707,000 of legal and professionalfees associated primarily with SEC reporting, contractual matters, and effortsto protect the Company’s intellectual property.

 

SG&Aexpenses for the year ended May 31, 2007 were $17,084,000. SG&Aexpenses included $7,421,000 in non-cash compensation for stock grants to keymanagement, directors, and consultants. Cash-based management fees, wages andsalaries were approximately $3,536,000 for fiscal 2007. Legal, professional andconsulting fees were approximately $2,249,000 for fiscal 2007. The legal andprofessional fees were primarily related to our financing activities, ourregistration statement that went effective in October 2006, theacquisition of WaterEye, and SEC reporting. Depreciation and amortization were$151,000 and $1,350,000, respectively. General administrative, insurance,facilities, and travel for fiscal 2007 were $1,752,000. Advertising expenses,which include investor relations expenses, were $626,000 for fiscal 2007. Theseexpenses were related to the branding of the Open Energy name, participation intrade shows, and the marketing of the SolarSave ® Tiles, Membranes, and Glass.

 

***Research andDevelopment***

*** ***

Forthe years ended May 31, 2008 and 2007, research and development expenseswere $290,000 and $513,000, respectively.

 

Theresearch and development expenses incurred in both years were relatedto the ongoing development of the SolarSave® Tiles, SolarSave® Membranes,SolarSave® Glass and future product development. Future research anddevelopment efforts will be focused on improvements to ourSolarSave® Tiles and Membranes, as well as a suite of asphalt shingleproducts which we believe will contribute to increasing and retaining marketshare.

 

***Restructuringcosts***

*** ***

For theyear ended May 31, 2008, restructuring costs were $849,000. The Companydid not incur restructuring costs in 2007.

 

In December 2007,we adopted a plan to shut down operations at our Aurora, Ontario facility inCanada. The plan was substantially complete as of January 31, 2008. Inconnection with the plan, we terminated 28 of our 30 full-time employees at theAurora facility. Existing operations and specified assets at the Aurorafacility were transferred to our Grass Valley, California facility and we soldcertain of the other assets located at the Aurora facility. We recorded totalcosts associated with the plan of $849,000, of which $272,000 related toemployee termination costs, $210,000 related to asset impairment and relocationcosts, $171,000 pertained to lease and lease settlement costs and $196,000 wasincurred for legal and administrative costs. At May 31, 2008, $68,000 oflease settlement costs remained outstanding.

 

***Impairment ofintangibles and goodwill***

*** ***

TheCompany has performed annual impairment tests of the carrying value of goodwilland intangibles of its SRS and CRE acquisitions as required under SFAS NO. 142and SFAS NO. 144, respectively. The tests determined that indications ofimpairment did not exist for certain purchased intangible assets and goodwillassociated with the acquisitions. Based on these assessments, there were nowrite-offs for the year ended May 31, 2008.

 

Duringthe year ended May 31, 2007, the Company recorded an impairment charge of$10,540,000 that was related to the impairment of intangibles and goodwill inSRS of $3,500,000 and $2,731,000, respectively, and an impairment of goodwillin WaterEye of $2,525,000. In addition, the Company wrote-off the unamortizedamount of $1,694,000 of the SunCone TM CSP license agreement.

 

***Impairment ofnote receivable***

*** ***

In2007, the Company wrote off a note receivable of $683,000, including accruedinterest totaling $33,000, relating to the divestiture of its oil and gasinterests.

 

Therewere no such write-offs for the year ended May 31, 2008.

 

***Other income(expense)***

*** ***

Otherexpenses for year ended May 31, 2008 and 2007 were $12,339,000 and$9,206,000, respectively.

 

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Forthe year ended May 31, 2008, other expenses totaling $12,339,000 included$10,833,000 in non-cash interest from the amortization of the discountsrecorded in connection with warrants, beneficial conversion features andoriginal issue discounts, and non-cash deferred financing fees associated withconvertible debentures and notes payable.

 

Infiscal 2007, other expense was $9,206,000. Interest expense was $8,924,000 infiscal 2007, of which $8,211,000 was due to warrant repricings and non-cashinterest expense related to amortization of the warrants, beneficial conversionfeature and original issue discount associated with various debentures.

 

***Net Loss***

*** ***

Ournet loss for the year ended May 31, 2008 and 2007 was $34,935,000 and$39,552,000, respectively.

 

Forthe year ended May 31, 2008, the net loss of $34,935,000 included$9,645,000 in stock-based compensation, $1,006,000 in depreciation andamortization expense, and $10,833,000 in non-cash interest from theamortization of the discounts recorded in connection with warrants, beneficialconversion features and original issue discounts, and non-cash deferredfinancing fees associated with convertible debentures and notes payable.

 

Ournet loss was $39,552,000 for fiscal 2007, of which $10,540,000 was thewrite-off and impairment of intangibles and goodwill, $7,418,000 wasstock-based compensation, $1,594,000 was depreciation and amortization expense,and $8,211,000 was non-cash interest expense.

 

**Liquidity andCapital Resources**

** **

TheCompany has incurred losses since its inception totaling approximately$87,388,000 through May 31, 2008. The Company has been selling itsproducts at a negative margin to gain market share and is unsure if or when itwill become profitable.

 

Duringthe year ended May 31, 2008, we funded our operations primarily fromprivate sales of equity and debt securities. We have no unused sources ofliquidity. Thus, additional equity or debt financing will need to be raised inthe near future to continue operations and implement our business strategy. Asdiscussed below, in April 2008, we entered into a loan and securityagreement with The Quercus Trust pursuant to which Quercus agreed to loan us upto $3,500,000 based upon the availability of specified collateral. As of May 31,2008, we had borrowed $1,550,000 under this agreement and by June 10, 2008the remaining $1,950,000 had been funded. The loan and security agreement iscollateralized by a general security interest in all of our inventory,specified accounts receivable and our cash accounts. If we were to defaultunder the terms and conditions of the loan and security agreement, or if ourspecified collateral ratios fall below certain levels, Quercus would have theright to accelerate the outstanding indebtedness under the loan and securityagreement and foreclose on the collateral. Such a foreclosure would have amaterial adverse effect on our business, liquidity, results of operations andfinancial position.

 

As of May 31,2008, we had cash and cash equivalents of $327,000 and negative working capitalof $4,796,000. For the year ended May 31, 2008, we used $15,099,000 ofcash in operations. Investment activities used $145,000 of cash during theyear, which was related to the acquisition of property and equipment. Financingactivities provided $15,252,000 of cash during the year, with $24,500,000 ingross proceeds resulting from the sale of promissory notes and convertibledebentures with warrants.

 

Duringthe year ended May 31, 2008, we took steps to improve our debt structurein an effort to increase our ability to secure additional financing. We repaidour 8/31/2007 Note for $1,000,000 which matured on February 29, 2008. On February 25,2008, the Company redeemed all remaining amounts outstanding pursuant to the 5%Debentures (defined below) issued by the Company in 2006 to YA GlobalInvestments, L.P., and its affiliates (formerly known as Cornell CapitalPartners, L.P.). The redemption payment, which included principal, accruedinterest and a redemption premium, totaled approximately $3,100,000. TheCompany recognized an immaterial gain on the early extinguishment. While thescheduled maturity date of the 2006 Debentures was in March 2009, the 5%Debentures permitted the holder to demand redemption and a redemption premiumfor so long as the Company’s common stock was trading below $.50 per share. The2006 Debentures were the only remaining variably-priced convertible securitiesin the Company’s capital structure. YA Global Investments held one additional10% Debenture (defined below) in the principal amount of $3,000,000, which wasscheduled to mature in March 2008. YA Global Investments agreed to extendthe maturity date and on April 30, 2008, the Company repaid all remainingprincipal amounts outstanding pursuant to the series 10% Debenture. Thepayment, which included principal and accrued interest, totaled approximately$3,300,000. The 10% Debenture was the only remaining convertible debenture heldby YA Global Investments in the Company’s capital structure.

 

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On September 12, 2008, weentered into a definitive securities purchase agreement with The QuercusTrust.  The securities purchase agreement provides for the purchase byQuercus of warrants to acquire 235,000,000 shares of the Company’s common stockat a purchase price of $.02 per warrant share for a total of $4.2 million ofcash, $300,000 of forgiveness of accrued interest on the Series BConvertible Notes held by Quercus and a $200,000 restructuring fee for theamendment of certain terms of the $3.5 million secured loan previously extendedto the Company by Quercus. The warrants would have an exercise price equalto $0.067 per share. The $3.5 million secured loan would be amended to (1) extendthe maturity date of the secured loan from October 2008 to March 2009,(2) reduce the borrowing base collateral requirement to 100% of theoutstanding loan amount, and (3) eliminate the requirement that theCompany make prepayments of the secured loan with the proceeds of Californiastate solar rebates received by the Company. The warrants would have anexercise price equal to $0.067 per share. The closing of the financing under thesecurities purchase agreement is subject to customary conditions precedent thathave not been satisfied as of the date of this report.

 

On September 12, 2008, weentered into a forbearance and repayment agreement with Suntech, our largestsupplier. The forbearance agreement provides for a payment plan for theapproximately $3 million of payables currently due from us to Suntech withinterest at 12% per annum. Pursuant to the forbearance agreement, we agreed topay $1 million on or prior to September 19, 2008, $500,000 on or prior toJanuary 15, 2009, and six payments of $297,558 on a monthly basis beginning on March15, 2009 until the entire amount is paid in full.

 

As of May 31,2007, we had cash and cash equivalents of $319,000 and negative working capitalof $8,492,000. For the year ended May 31, 2007, we used $9,239,000 of cashin operations. Investment activities used $832,000 of cash during the year,which was primarily related to acquisition of property and equipment. Financingactivities provided $7,639,000 of cash during the year, with $8,000,000 ingross proceeds from convertible debentures with warrants and $500,000 inproceeds from warrants that were exercised.

 

Todate, the Company has been unable to meet forecasted sales and marginprojections and as a result has experienced significant negative cash flow foran extended period of time. Based on its current cash usage rate, the Companyestimates that it currently has adequate cash to fund operations only throughthe end of September 2008. The ability of the Company to continue as agoing concern is dependent on obtaining additional financing to support itsproduction and working capital requirements. Management is pursuing a number ofpossible debt and equity financing opportunities in an effort to address theserequirements. However, the Company cannot currently predict the likelihood ofbeing able to raise additional debt or equity financing in an amount, nature oron terms that would be acceptable to the Company and the Company currently doesnot have any commitments for future debt and/or equity financing. If theCompany is unable to obtain additional financing prior to the end of September 2008,the Company may not have sufficient cash to satisfy all ongoing capitalrequirements and previously incurred liabilities and will have to substantiallycurtail or cease operations.

 

***SignificantCapital Expenditures***

*** ***

Weanticipate that we will make limited capital expenditures over the next twelvemonths for manufacturing equipment and leasehold improvements.

 

***Contractualobligations***

*** ***

Thematurities of our long-term debt and future payments relating to our operatingleases and other purchase commitments as of May 31, 2008 are as follows(in thousands):

 
| ** **                      | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligation** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **More than  5 years** | ** ** |
| Long-Term Debt                  |       | $                                         | 21,000     |   | $ | — |   | $ | 21,000 |   | $ | — |   | $ | — |   |
| Operating Leases                |       | 476                                       |       | 294 |   | 169 |   | 13 |   | — |   |
| Purchase Commitments            |       | 3,024                                     |       | 3,024 |   | — |   | — |   | — |   |
|                            |       | $                                         | 24,500     |   | $ | 3,318 |   | $ | 21,169 |   | $ | 13 |   | $ | — |   |

** **

***Financings***

* *

*4/30/2008 Note*

* *

On April 30,2008, the Company entered into a Loan and Security Agreement and issued apromissory note for a loan of up to $3,500,000 (the “4/30/2008 Note”). Pursuant to the Loan Agreement, the Company mayborrow an amount equal to the lesser of 50% of the Company’s combinedinventory, accounts receivable and cash balances, and 100% of its qualifiedaccounts receivable (as defined in the Loan Agreement) (the “Borrowing Base”), up to a maximum of$3.5 million.

 

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On April 30,2008, the Company borrowed $1,550,000 under the Loan Agreement.  From April 30, 2008 through June 30,2008, the Company was permitted to request additional advances under the LoanAgreement in minimum amounts of at least $200,000, as the Company generatedadditional qualified accounts receivable and assuming the Borrowing Base wassatisfied.  All unpaid principal underthe 4/30/2008 Note is due in full on October 30, 2008, and the 4/30/2008Note may be prepaid in full at any time. The Company is required to make partial prepayments on the 4/30/2008Note upon receipt of any rebates included in the accounts receivable portion ofthe Collateral (defined below), and upon determination that the Borrowing Baseis not satisfied at specified intervals during the term of the 4/30/2008 Note.

 

Intereston the 4/30/2008 Note is payable in warrants to acquire shares of the Company’scommon stock at an exercise price of $.506 per share.  The total number of warrants that may beissued, assuming the maximum loan amount of $3.5 million is funded is1,389,096, which the parties agreed equates to an 18% per annum interest rateon the 4/30/2008 Note.  The warrants havea seven-year term.  On April 30,2008, the Company issued warrants to acquire 615,171 shares of the Company’scommon stock upon the receipt of the $1,550,000 described above.  The Company recorded prepaid interest of$137,589 in payment of interest in warrant shares.

 

The4/30/2008 Note is secured by a first priority security interest in all of theCompany’s inventory, accounts receivable and money and deposit accounts (the “Collateral”).  If any event of default occurs under the LoanAgreement, the lender may: (1) declare null and void its obligation tomake any additional advances under the 4/30/2008 Note, (2) require theCompany to immediately repay the 4/30/2008 Note in full, (3) foreclose onthe Collateral, and (4) assert all other rights and remedies of a lenderunder applicable law.

 

*12/7/2007 Notes*

* *

On December 7,2007, the Company entered into an amendment of a certain SecuritiesPurchase Agreement, dated as of September 19, 2007 between the Company andan accredited investor pursuant to which amendment the Company issued (i) convertiblenotes (the “12/7/07 Notes”) in the aggregate principal amount of $1,000,000 and(ii) warrants (the “12/7/07 Warrants”) to acquire up to 2,000,000 sharesof the Company’s common stock for an aggregate purchase price of $1,000,000.  The transaction resulted in net proceeds tothe Company of $913,000, which was used for the repayment of debt and generalcorporate and working capital purposes.

 

Thematurity date of the 12/7/07 Notes is three years from December 7, 2007,which may be accelerated at the option of the investors if (i) a triggerevent (as defined in the 12/7/07 Notes) has occurred and is continuing, and (ii) throughthe date that is ten business days after the consummation of a change ofcontrol in the event that a change of control is publicly announced.  The Company does not have the right to prepaythe 12/7/07 Notes in whole or in part without penalty prior to the maturitydate.  The 12/7/07 Notes are convertibleinto shares of the Company’s common stock at an initial price of $0.50 pershare, subject to adjustment, including anti-dilution protection, on the termsset forth in the 12/7/07 Notes.  The12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interestdue and payable quarterly in arrears.

 

The12/7/07 Warrants are exercisable for up to 2,000,000 shares of the Company’scommon stock at an exercise price of $0.506 per share, subject to adjustment,including anti-dilution protection, on the terms set forth in the 12/7/07Warrants.

 

Inconnection with the December 7, 2007 amendment and related transactions,the Company paid approximately $86,437 in placement agent fees and expenses andagreed to issue warrants to acquire 80,000 shares of common stock to itsplacement agents.

 

Inconnection with the 12/7/07 Notes and 12/7/07 Warrants, the Company recordeddebt discount in the aggregate amount of $487,500 in accordance with EITF98-05,*Accounting for Convertible Securitieswith Beneficial Conversion Features or Contingently Adjustable ConversionRatios* and EITF 00-27,*Applicationof Issue No. 98-05 to Certain Convertible Instruments*.  As a result of the debt discounts recorded inconnection with the 12/7/07 Notes, the effective interest rate on the date ofissuance was estimated to be approximately 22%.

 

Asdiscussed above, the 12/7/07 Notes accrue interest at a rate of 6% per annum,with accrued interest due and payable quarterly in arrears on each January 1,April 1, July 1 and October 1 beginning on the first such dateafter December 7, 2007.  The Companyhad not made the interest payments due on the following dates: January 1,2008 and April 1, 2008.  The totalpast due interest owed through March 31, 2008 was approximately$19,000.  The Company entered into anamendment of its 12/7/07 Notes effective as of April 17, 2008, which aremore fully described below under “9/19/07 Note.”  In connection with the amendment of the12/7/07 Notes, we issued warrants to acquire a total of 89,334 shares of ourcommon stock with an exercise price of $0.506 per share to the holders of 

 

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the12/7/07 Notes in lieu of accrued and unpaid interest that was in arrearage (44,667of such warrants were issued after May 31, 2008).  The other terms of such warrants aresubstantially the same as the warrants issued to the holders of the 12/7/07Note.

 

*9/19/2007 Note*

* *

On September 19,2007, the Company issued to an accredited investor (i) a convertiblenote in the principal amount of $20,000,000 (the “9/19/07 Note”) and (ii) awarrant to acquire up to 40,000,000 shares of common stock (the “9/19/07Warrant”) for an aggregate purchase price of $20,000,000.

 

Thematurity date of the 9/19/07 Note is three years from September 19, 2007,which may be accelerated at the option of the holder if (i) a triggerevent (as defined in the 9/19/07 Note) has occurred and is continuing on thematurity date, and (ii) through the date that is ten business days afterthe consummation of a change of control in the event that a change of controlis publicly announced.  The Company doesnot have the right to prepay the 9/19/07 Note in whole or part without penalty priorto the maturity date.  The Company maynot declare or pay any cash dividend or distribution on its capital stock whilethe 9/19/07 Note is outstanding without the prior express written consent ofthe holder.  The 9/19/07 Note isconvertible at the option of the holder into shares of the Company’s commonstock at an initial price of $0.50 per share, subject to adjustment asspecified in the 9/19/07 Note.  The9/19/07 Note accrues interest at a rate of 6% per annum with accrued interestdue and payable quarterly in arrears.

 

The9/19/07 Warrant is exercisable for up to 40,000,000 shares of common stock atan exercise price of $0.506, which is subject to adjustment as described in the9/19/07 Warrant.  The 9/19/07 Warrantexpires 84 months after the initial closing date of September 19,2007.  In addition, warrants to purchase1,600,000 shares at $0.50 per share were issued to an investment banker forservices rendered in connection with the financing.

 

Inconnection with the 9/17/07 Note and 9/17/07 Warrant, the Company recorded debtdiscount in the aggregate amount of $16,910,000 in accordance with EITF 98-05,*Accounting for Convertible Securities withBeneficial Conversion Features or Contingently Adjustable Conversion Ratios*and EITF 00-27,*Application of Issue No. 98-05to Certain Convertible Instruments*. As a result of the debt discounts recorded in connection with the9/17/07 Note, the effective interest rate on the date of issuance was estimatedto be approximately 64%.

 

Asdiscussed above, the 9/19/07 Note accrues interest at a rate of 6% per annum,with accrued interest due and payable quarterly in arrears on each January 1,April 1, July 1 and October 1 beginning on the first such dateafter September 17, 2007.  TheCompany had not made the interest payments due on the following dates: October 1,2007, January 1, 2008 and April 1, 2008.  The total past due interest owed through March 31,2008 was approximately $641,000.  On April 16,2008, we entered into amendments of our 9/19/2007 Note and our 12/7/07 Notes(collectively, our “Series B Convertible Notes”) with the holders thereof,which amendments:

 

·                  Permitus to issue shares of our common stock that are not registered pursuant to theSecurities Act of 1933, as amended, in lieu of cash interest payments on the Series BConvertible Notes;

 

·                  Permit us to issue warrants toacquire shares of our common stock, in lieu of cash interest payments on the Series BConvertible Notes, which warrants will have an exercise price per share equalto the greater of $0.506 per share or 5-day weighted average price per share ofour common stock and ; and

 

·                  Waive any prior defaults or triggerevents caused by our previous failure to pay interest on our Series BConvertible Notes when due, upon the issuance of warrants in lieu of suchaccrued interest.

 

On April 17,2008, we issued warrants to acquire a total of 3,003,390 shares of our commonstock with an exercise price of $0.506 per share to the holder of our 9/19/2007Note in lieu of accrued and unpaid interest that was in arrearage.  The other terms of such warrants aresubstantially the same as the 9/19/07 Warrants.

 

*8/31/07 Note*

* *

On August 31,2007, the Company entered into a Securities Purchase Agreement with anaccredited investor for the private placement of (i) a convertiblenote in the principal amount of $1,000,000 (the “8/31/07 Note”) and (ii) awarrant to acquire up to 1,200,000 shares of common stock (the “8/31/07 Warrant”)for an aggregate purchase price of $950,000. The maturity date of the 8/31/07 Note was February 29, 2008, atwhich time the Company repaid the 8/31/07 Note in full.  The 8/31/07 Note accrued interest at a rateof 10% per annum, with accrued interest due and payable February 29,2008.  The 8/31/07 Note was convertibleinto shares of the 

 

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Company’scommon stock at the option of the holder at an initial price of $0.50 pershare, subject to adjustment as specified in the 8/31/07 Note.

 

The8/31/07 Warrant is exercisable for up to 1,200,000 shares of common stock at anexercise price of $0.709, subject to adjustment according to the anti-dilutionprovisions in the 8/31/07 Warrant, provided that, in no event shall theexercise price be reduced to less than five cents ($0.05) per share (such floorprice to be adjusted in the same manner that the exercise price is adjusted),and is exercisable through August 31, 2012.  In addition, a warrant to purchase 72,000shares at $0.709 per share and expiring on August 31, 2012 was issued toan investment banker for services rendered in connection with the financing.

 

TheCompany and the investor also executed a Registration Rights Agreement pursuantto which the Company has agreed to provide certain registration rights withrespect to the 8/31/07 Note and the 8/31/07 Warrant.

 

Inconnection with the 8/31/07 Note and 8/31/07 Warrant, the Company recorded debtdiscount in the aggregate amount of $1,000,000 in accordance with EITF 98-05,Accounting for Convertible Securities with Beneficial Conversion Features orContingently Adjustable Conversion Ratios and EITF 00-27, Application of Issue No. 98-05to Certain Convertible Instruments.

 

Thecarrying value of the 8/31/07 Note will accrete to the face value over the lifeof the debt, as the value of the discounts is expensed.  As a result of the debt discounts recorded inconnection with the 8/31/07 Note, the effective interest rate on the date ofissuance was estimated to be approximately 147%.

 

*6/15/2007 Note*

* *

On June 15,2007, the Company entered into a Note and Warrant Purchase Agreement withan accredited investor for the private placement of a $950,000 promissory note(the “6/15/07 Note”) and a related warrant to acquire up to 4,000,000 shares ofcommon stock (the “6/15/07 Warrant”) for a purchase price of $750,000.  The maturity date of the 6/15/07 Note was October 15,2007, and it was paid in full on October 5, 2007.  The 6/15/07 Warrant is exercisable for threeyears, and is subject to anti-dilution provisions and a floor exercise price of$0.05 per share.

 

Inaddition to the purchase discount of $200,000, debt discount in the amount of$590,000 was recorded based on the estimated fair value of the 6/15/07Warrant.  In addition, a warrant topurchase 400,000 shares of common stock at the rate of $0.50 per share thatexpires on June 15, 2012, was issued to an investment banker for servicesrendered in connection with the financing.

 

*5% Secured Convertible Debentures and RelatedWarrants*

* *

On February 25,2008, the Company redeemed all remaining principal amounts outstanding pursuantto the 5% Debentures issued by the Company in 2006 to YA Global Investments,L.P., and its affiliates (formerly known as Cornell Capital Partners, L.P.)(the “5% Debenture”).  The totalredemption payment, which included principal, accrued interest and a redemptionpremium, amounted to approximately $3.1 million and the Company recognized animmaterial gain on the early extinguishment.

 

*0% Convertible Debentures and Related Warrants*

* *

As of May 31,2008 all of the 0% Debentures, originally issued in February 2006, havebeen converted and are no longer outstanding.

 

As of February 29,2008, 1,475,010 warrants issued in connection with the 0% Debentures wereoutstanding at an exercise price of $0.2419 per share.  The exercise price is subject to furtheradjustment upon the occurrence of certain specified events including, but notlimited to, the issuance of securities at a deemed price below the currentexercise price, stock dividends, stock splits, mergers or reorganizations, andour failure to meet certain revenue milestones.

 

*10% Secured Convertible Debentures andRelated Warrants*

* *

On March 30,2007, we issued to YA Global Investments (formerly Cornell Capital Partners,L.P.): (i) a Convertible Secured Debenture in the original principalamount of $3,000,000 (the “10% Debenture”) and (b) a Warrant to purchaseup to 6,000,000 shares of our common stock, which were issued and sold for anaggregate purchase price of $3,000,000. The 2007 Debenture accrued interest at a rate of 10% per annum and wasoriginally scheduled to mature on March 30, 2008.  The maturity date was extended to April 30,2008.  No payments of interest orprincipal were due under the 10% Debenture until maturity.  Subject to specified 

 

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limitations,the 10% Debenture was convertible at any time at Cornell’s option into shares ofour common stock at a conversion price of $0.50 per share, subject toadjustment as set forth in the 10% Debenture. The warrant issued to Cornell has an initial exercise price of $0.50 pershare, subject to adjustment, and a term of five years from the issuancedate.  On April 30, 2008, theCompany repaid all remaining principal amounts outstanding pursuant to the 10%Debenture.  The total payment, whichincluded principal and accrued interest, totaled approximately $3,300,000.  The 10% Debenture was the only remainingconvertible debenture held by YA Global Investments in the Company’s capitalstructure.

 

***PayrollWithholding Taxes***

*** ***

Asdiscussed in Note 13 of the Consolidated Financial Statements, during thefiscal years ended May 31, 2006 and 2007, we did not withhold for or payfederal or state employment or income taxes associated with the vesting datesfor restricted stock set forth in certain officers’ and employees’employment agreements, or associated with the grants of shares to officers andemployees during their employment periods for consulting and/or directorservices.  We also did not withhold orpay employment or income taxes for shares of common stock issued to anon-executive employee during the fiscal year ended May 31, 2006, andanother employee during the fiscal year ended May 31, 2007.

 

Theshares of stock subject to all of these awards were registered for the firsttime with the registration statement that went effective October 27,2006.  At this time, we cannot predictwhen shares may be sold by the employees as a means of generating funds tosatisfy withholding obligations.  Marketconditions and SEC regulations may also limit the number of shares that may besold and the proceeds to the employees from such sales.  We may be obligated to pay such taxliabilities before the employees have been able to sell their shares, and thesales prices the employees receive may be less than the tax liability.

 

Totalaccrued liabilities at May 31, 2008 and 2007 associated with the employees’and employer’s combined portion of required withholding, which is an obligationof our company to the extent not satisfied by the employees, are $190,000 and$2,417,000, respectively.  We also may besubject to penalties and interest, estimated to be approximately $9,000 and$324,000 for the fiscal years ended May 31, 2008 and 2007, respectively,which has been recorded as other expense. In January 2008, the Company paid past-due taxes related to theserestricted stock grants, as well as related estimated interest and penaltiesassociated with previously unpaid taxes.

 

TheCompany has recorded corresponding amounts due from the officers and employeesat May 31, 2008 and 2007 totaling $397,000 and $1,993,000,respectively.  These amounts areclassified as due from related parties on the accompanying balance sheets andrepresent the amount of the liability that is owed by the individuals to theCompany for the required withholdings not made on their behalf.  In December 2007, the Company received$1,498,770 from its chairman and chief executive officer to satisfy theemployee portion of the required withholding taxes on his restricted stockgrants.  The May 31, 2008 balancerepresents the remaining obligation for one employee and one former employee torepay the Company for taxes to be paid on their behalf.

 

On March 30,2008, we entered into an amendment to the employment agreement between us andDavid Saltman, our chairman and chief executive officer, which provides thatall restricted shares granted to Mr. Saltman that were scheduled to veston March 31, 2008 would vest on April 20, 2008.  On April 18, 2008, we entered into anadditional amendment to Mr. Saltman’s employment agreement which providesthat all restricted shares granted to Mr. Saltman that were scheduled tovest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30,2008 would vest on August 20, 2009, and (3) September 30, 2008would vest on November 20, 2009.

 

**Recent AccountingPronouncements**

 

*Adoption of New Accounting Pronouncement*

* *

In July 2006,the Financial Accounting Standards Board (“FASB”) issued FIN 48,*Accounting for Uncertainty in Income Taxes — anInterpretation of FASB No. 109* (“FIN 48”) which prescribes a recognition threshold and measurementprocess for recording in the financial statements uncertain tax positions takenor expected to be taken in a tax return. Additionally, FIN 48 provides guidance on recognition, classification,accounting in interim periods and disclosure requirements for uncertain taxpositions.  The Company adoptedFIN 48 at the beginning of fiscal year 2007.  The adoption of FIN 48 did not impact ourconsolidated financial position, results of operations and cash flows (seeNote 20).

 

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*RecentAccounting Pronouncements*

 

In September 2006,the FASB issued Statements of Financial Accounting Standards (“SFAS”) No. 157,*Fair Value Measurements* (“SFAS 157”).  SFAS No. 157 defines fair value,established a framework for measuring fair value under generally acceptedaccounting principles (“GAAP”) and expands disclosures about fair valuemeasurements.  SFAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007.  On November 14, 2007, theFASB provided a one-year deferral for implementation of SFAS No. 157 forother nonfinancial assets and liabilities. The Company is currently evaluating the impact of this guidance on itsconsolidated financial position, results of operations and cash flows.

 

In December 2006,the FASB issued FASB Staff Position (“FSP”) on Emerging Issues Task Force (“EITF”)00-19-2*Accounting for Registration PaymentArrangements* (“FSP EITF 00-19-2”) which specifies that thecontingent obligation to make future payments or otherwise transferconsideration under a registration payment arrangement should be separatelyrecognized and measured in accordance with SFAS No. 5,*Accounting for Contingencies*. Adoption of FSP EITF 00-19-02 is required for fiscal years beginning after December 15,2006.  The adoption of FSP EITF 00-19-2did not have a material impact on the Company’s consolidated financialposition, results of operations and cash flows.

 

In February 2007,the FASB issued SFAS No. 159,*The FairValue Option for Financial Assets and Financial Liabilities—Including anamendment of FASB Statement No. 115*, which permits entities tochoose to measure many financial instruments and certain other items at fairvalue.  The fair value option establishedby this Statement permits all entities to choose to measure eligible items atfair value at specified election dates. A business entity shall report unrealized gains and losses on items forwhich the fair value option has been elected in earnings at each subsequentreporting date.  Adoption is required forfiscal years beginning after November 15, 2007.  Early adoption is permitted as of thebeginning of a fiscal year that begins on or after November 15, 2007,provided the entity also elects to apply the provisions of SFAS No. 157.  The Company is currently evaluating theimpact of this guidance on its consolidated financial position, results ofoperations and cash flows.

 

In March 2007,the FASB issued FASB Staff Position EITF 07-03 (“FSP 07-03”),*Accounting for Nonrefundable Advance Payments forGoods or Services to Be Used in Future Research and Development Activities*.  FSP 07-03 addresses whether nonrefundableadvance payments for goods or services that will be used or rendered forresearch and development activities should be expensed when the advance paymentis made or when the research and development activity has been performed.  FSP 07-03 will be effective for fiscal yearsbeginning after December 15, 2007, and interim periods within those fiscalyears.  The Company is currentlyevaluating the impact of this guidance on its consolidated financial position,results of operations and cash flows.

 

In December 2007,the FASB issued SFAS No. 141(R),*Business Combinations* (“SFAS No. 141R”).  SFAS 141R retains the fundamentalrequirements in SFAS 141 that the acquisition method of accounting (which SFAS141 called the*purchase method*)be used for all business combinations and for an acquirer to be identified foreach business combination.  SFAS 141Ralso establishes principles and requirements for how the acquirer: (a) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any non-controlling interest in the acquiree; (b) improvesthe completeness of the information reported about a business combination bychanging the requirements for recognizing assets acquired and liabilitiesassumed arising from contingencies; (c) recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and (d) determines what information to disclose to enable usersof the financial statements to evaluate the nature and financial effects of thebusiness combination.  SFAS No. 141Rapplies prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  Earlyapplication is not permitted.  TheCompany has not yet determined the impact, if any, SFAS No. 141R willhave on its consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 160,*Non-controlling Interests in Consolidated Financial Statements* (“SFASNo. 160”).  SFAS No. 160 amendsARB 51 to establish accounting and reporting standards for the non-controlling(minority) interest in a subsidiary and for the deconsolidation of asubsidiary.  It clarifies that anon-controlling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statements and establishes a single method of accounting for changesin a parent’s ownership interest in a subsidiary that do not result indeconsolidation.  SFAS No. 160 iseffective for fiscal years beginning on or after December 15, 2008.  The Company has not yet determined theimpact, if any, that SFAS No. 160 will have on its consolidated financialstatements.

 

In December 2007,the FASB ratified the Emerging Issues Task Force consensus on EITF Issue No. 07-1,*Accounting for Collaborative Arrangements*thatdiscusses how parties to a collaborative arrangement (which does not establisha legal entity within such arrangement) should account for variousactivities.  The consensus indicates thatcosts incurred and revenues generated from transactions with third parties(i.e., parties outside of the collaborative arrangement) should be reported bythe collaborators on the respective line items in their income statementspursuant to EITF Issue No. 99-19, *Reporting Revenue Gross asa Principal Versus Net as an Agent*. Additionally, the consensus provides that income statementcharacterization of payments between the participants in a 

 

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collaborativearrangement should be based upon existing authoritative pronouncements; analogyto such pronouncements if not within their scope; or a reasonable, rational,and consistently applied accounting policy election.  EITF Issue No. 07-1 is effectivebeginning January 1, 2009 and is to be applied retrospectively to allperiods presented for collaborative arrangements existing as of the date ofadoption.  The Company is currentlyevaluating the impacts and disclosures of this standard, but would not expectEITF Issue No. 07-1 to have a material impact on the Company’sconsolidated results of operations or financial condition.

 

InMarch, 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments and Hedging Activities*.  The new standard is intended to improvefinancial reporting about derivative instruments and hedging activities byrequiring enhanced disclosures to enable investors to better understand theireffects on an entity’s financial position, financial performance, and cashflows.  The new standard also improvestransparency about the location and amounts of derivative instruments in anentity’s financial statements; how derivative instruments and related hedgeditems are accounted for under SFAS No. 133; and how derivative instrumentsand related hedged items affect its financial position, financial performance,and cash flows.  It is effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2008, with early application encouraged.  The Company does not believe that theadoption of the disclosure provisions required under SFAS No. 161 willhave a material impact on the Company’s consolidated financial position,results of operations and cash flows.

 

In April 2008,the FASB issued FASB Staff Position No. FAS 142-3, *Determiningthe Useful Life of Intangible Assets* (*“*FSP142-3”).  FSP 142-3 amends the factors tobe considered in determining the useful life of intangible assets.  Its intent is to improve the consistencybetween the useful life of an intangible asset and the period of expected cashflows used to measure its fair value. FSP 142-3 is effective for fiscal years beginning after December 15,2008.  The Company is currentlyevaluating the impact of this guidance on its consolidated financial position,results of operations and cash flows.

 

On May 9,2008, the FASB issued FASB Staff Position No. APB 14-1, *Accounting for Convertible Debt Instruments That May Be Settled inCash Upon Conversion (Including Partial Cash Settlement*(“FSP APB14-1”).  FSP APB 14-1 requires issuers ofconvertible debt that may be settled wholly or partly in cash when converted toaccount for the debt and equity components separately.  FSP APB 14-1 is effective for fiscal yearsbeginning after December 15, 2008 and must be applied retrospectively toall periods presented.  The Company iscurrently evaluating the impact of this guidance on its consolidated financialposition, results of operations and cash flows.

 

InMay 2008, the FASB issued SFAS No. 162, “The Hierarchy of GenerallyAccepted Accounting Policies” (“SFAS No. 162”), which reorganizes the GAAPhierarchy. The purpose of the new standard is to improve financial reporting byproviding a consistent framework for determining what accounting principlesshould be used when preparing the U.S. GAAP financial statements. The standardis effective 60 days after the SEC’s approval of the PCAOB’s amendments to AU Section 411.The adoption of SFAS No. 162 is not expected to have an impact on ourconsolidated financial statements.

 

InMay 2008, the FASB issued SFAS No. 163, “Accounting for FinancialGuarantee Insurance Contracts—an interpretation of FASB Statement No. 60”(“SFAS No. 163”). SFAS 163 interprets Statement 60 and amends existingaccounting pronouncements to clarify their application to the financialguarantee insurance contracts included within the scope of that Statement. SFASNo. 163 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and all interim periods within thosefiscal years. The Company does not expect that SFAS No. 163 will have amaterial impact on its consolidated financial statements.

 

InJune 2008, the FASB issued FSP No. EITF 03-6-1, “Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities” (“FSP EITF 03-6-1”), which requires entities to apply the two-classmethod of computing basic and diluted earnings per share for participatingsecurities that include awards that accrue cash dividends (whether paid orunpaid) any time common shareholders receive dividends and those dividends donot need to be returned to the entity if the employee forfeits the award. FSPEITF 03-6-1 will be effective for the Company on January 1, 2009 and willrequire retroactive disclosure. The Company is currently evaluating the impactof adopting FSP EITF 03-6-1 on its financial position, cash flows, and resultsof operations.

 

**Off-Balance SheetArrangements**

** **

TheCompany does not have any off-balance sheet arrangements, as defined in Item303(a)(4)(ii) of Regulation S-K promulgated under the Securities Act of1933.

 

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**ITEM 7A.****                                            QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Disclosurenot required as a result of the Company’s status as a smaller reportingcompany.

 

# **ITEM 8.**                                                     FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

 

Report ofIndependent Registered Public Accounting Firm

ConsolidatedBalance Sheets as of May 31, 2008 and 2007

ConsolidatedStatements of Operations for the years ended May 31, 2008 and 2007

ConsolidatedStatements of Changes in Stockholders’ Equity for the years ended May 31,2008 and 2007

ConsolidatedStatements of Cash Flows for the years ended May 31, 2008 and 2007

Notes to theConsolidated Financial Statements

 

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**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

** **

To the Boardof Directors and Stockholders of

Open EnergyCorporation

SolanaBeach, California

 

We haveaudited the accompanying consolidated balance sheets of Open Energy Corporationand its subsidiaries as of May 31, 2008 and 2007, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows forthe years then ended.  These consolidatedfinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audits toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. The Company was not required to have, nor were weengaged to perform, an audit of its internal control over financial reporting.Our audits included consideration of internal control over financial reportingas a basis for designing audit procedures that were appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Open EnergyCorporation as of May 31, 2008 and 2007, and the results of its operationsand its cash flows for the years then ended in conformity with accountingprinciples generally accepted in the United States of America.

 

Theaccompanying financial statements have been prepared assuming that the Companywill continue as a going concern.  Asdiscussed in Note 2 to the financial statements, the Company’s recurring lossesfrom operations and working capital deficiency raise substantial doubt aboutits ability to continue as a going concern. Management’s plans as to these matters are described in Note 2.  The accompanying financial statements do notinclude any adjustments that might result from the outcome of this uncertainty.

 
| /s/  Squar, Milner, Peterson, Miranda & Williamson, LLP |   |
|------------------------------------------------------------------|--------|
|                                                             |   |
| San Diego, California                                            |   |
| September 15,  2008                                         |   |

 

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**OPEN ENERGY CORPORATIONCONSOLIDATED BALANCE SHEETS(In thousands, except share data)**

 
| ** **                                                                                                                                                                    | ** ** | **May 31, 2008** | ** ** | **May 31, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Current assets:**                                                                                                                                                           | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Cash and  cash equivalents**                                                                                                                                                |       | $                          | 327        |                       | $          | 319 |   |
| **Accounts  receivable, net of allowance for doubtful accounts of $232 and $138 at  May 31, 2008 and 2007, respectively**                                                |       | 3,834                      |       | 415                        |       |
| **Inventories**                                                                                                                                                               |       | 2,221                      |       | 1,857                      |       |
| **Deferred  charges**                                                                                                                                                         |       | 2,617                      |       | —                     |       |
| **Prepaid  expenses and other current assets**                                                                                                                                |       | 367                        |       | 380                        |       |
| **Total  current assets**                                                                                                                                                     |       | 9,366                      |       | 2,971                      |       |
| ** **                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Fixed  assets, net**                                                                                                                                                        |       | 757                        |       | 1,298                      |       |
| **Due from  related parties**                                                                                                                                                 |       | 397                        |       | 1,993                      |       |
| **Deferred  financing costs, net**                                                                                                                                            |       | 1,644                      |       | 93                         |       |
| **Intangible  assets, net**                                                                                                                                                   |       | 4,196                      |       | 4,889                      |       |
| **Goodwill**                                                                                                                                                                  |       | 10,221                     |       | 10,221                     |       |
| **Total  assets**                                                                                                                                                             |       | $                          | 26,581     |                       | $          | 21,465 |   |
| ** **                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Current  liabilities:**                                                                                                                                                     | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Accounts  payable**                                                                                                                                                         |       | $                          | 5,283      |                       | $          | 1,687 |   |
| **Notes  payable, current maturities**                                                                                                                                        |       | 1,516                      |       | 325                        |       |
| **Current  portion of convertible debentures, net**                                                                                                                           |       | —                     |       | 1,778                      |       |
| **Advances  from related parties**                                                                                                                                            |       | 67                         |       | 312                        |       |
| **Other  accrued liabilities**                                                                                                                                                |       | 4,474                      |       | 6,164                      |       |
| **Deferred  revenue**                                                                                                                                                         |       | 2,822                      |       | 1,197                      |       |
| **Total  current liabilities**                                                                                                                                                |       | 14,162                     |       | 11,463                     |       |
| ** **                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Notes  payable, net of current maturities**                                                                                                                                 |       | —                     |       | 14                         |       |
| **Long-term  portion of convertible debentures, net**                                                                                                                         |       | 5,351                      |       | 4,178                      |       |
| **Deferred  tax liability**                                                                                                                                                   |       | 3,943                      |       | 1,752                      |       |
| **Total  liabilities**                                                                                                                                                        |       | 23,456                     |       | 17,407                     |       |
| ** **                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Commitments  and contingencies (Note 17)**                                                                                                                                  | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| ** **                                                                                                                                                                    | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Stockholders’  equity**                                                                                                                                                | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| **Common  stock, $0.001 par value; 1,125,000,000 shares authorized; 127,952,400 and  103,801,854 shares issued and outstanding at May 31, 2008 and 2007,  respectively** |       | 128                        |       | 104                        |       |
| **Additional  paid—in capital**                                                                                                                                          |       | 90,385                     |       | 56,407                     |       |
| **Accumulated  deficit**                                                                                                                                                      |       | (87,388                    | )          | (52,453                    | )          |
| **Total  stockholders’ equity**                                                                                                                                          |       | 3,125                      |       | 4,058                      |       |
|                                                                                                                                                                          |       |                       |       |                       |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                          |       | $                          | 26,581     |                       | $          | 21,465 |   |

 

**The accompanying notesare an integral part of these consolidated financial statements.**

 

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**OPEN ENERGY CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data)**

 
| ** **                                                   | ** ** | **Twelve Months Ended May 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Revenues,  net**                                           |       | $                                                   | 6,938      |   | $ | 4,292 |   |
| **Cost of  sales**                                           |       | 11,100                                              |       | 9,080 |   |
| **Gross  profit (loss)**                                     |       | (4,162                                              | )          | (4,788 | ) |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Operating  expenses:**                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Selling,  general and administrative**                     |       | 18,747                                              |       | 17,084 |   |
| **Research  and development**                                |       | 290                                                 |       | 513 |   |
| **Restructuring  Costs**                                     |       | 849                                                 |       | — |   |
| **Impairment  of intangibles and goodwill**                  |       | —                                              |       | 10,540 |   |
| **Impairment  of note receivable**                           |       | —                                              |       | 683 |   |
| **Total  operating expenses**                                |       | 19,886                                              |       | 28,820 |   |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Loss  from operations**                                    |       | (24,048                                             | )          | (33,608 | ) |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Other  income (expense):**                                 | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Interest  income**                                         |       | 314                                                 |       | 70 |   |
| **Interest  expense**                                        |       | (12,391                                             | )          | (8,924 | ) |
| **Other  income (expense)**                                  |       | (188                                                | )          | (237 | ) |
| **Loss on  foreign exchange**                                |       | (74                                                 | )          | (115 | ) |
| **Total  other income (expense)**                            |       | (12,339                                             | )          | (9,206 | ) |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Loss  before income tax benefit**                          |       | (36,387                                             | )          | (42,814 | ) |
| **Income  tax benefit**                                      |       | 1,452                                               |       | 3,262 |   |
| **Net loss**                                                 |       | $                                                   | (34,935    | ) | $ | (39,552 | ) |
| ** **                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Net loss  per share – basic and diluted**             |       | $                                                   | (0.29      | ) | $ | (0.49 | ) |
|                                                         |       |                                                |       |   |   |
| **Weighted  average shares outstanding - basic and diluted** |       | 121,527,253                                         |       | 81,085,056 |   |

 

**The accompanying notesare an integral part of these consolidated financial statements.**

 

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** **

**OPEN ENERGY CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYYears Ended May 31, 2008 and 2007(In thousands, except stock shares)**

 
| ** **                                                               | ** ** | **Common  Stock Shares** | ** ** | **Common  Stock  Amount** | ** ** | **Additional  Paid in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Income** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------|------------|---------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
| **Balance,  May 31, 2006**                                          |       | 69,131,663                    |       | 69                        |       | 30,589                                |       | (12,901                  | )          | 7                                |       | 17,764                                |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Restricted  stock amortization**                                       |       | —                        |       | —                    |       | 6,420                                 |       | —                   |       | —                           |       | 6,420                                 |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of stock for services**                                      |       | 421,483                       |       | 1                         |       | 233                                   |       | —                   |       | —                           |       | 234                                   |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of stock and warrants for licensing rights**                 |       | 100,000                       |       | —                    |       | 1,787                                 |       | —                   |       | —                           |       | 1,787                                 |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Cancellation  of stock issued for licensing rights**                   |       | (100,000                      | )          | —                    |       | —                                |       | —                   |       | —                           |       | —                                |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Issuance  of warrants in connection with debt financing**              |       | —                        |       | —                    |       | 1,801                                 |       | —                   |       | —                           |       | 1,801                                 |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Beneficial  conversion feature - convertible debt, net of income tax** |       | —                        |       | —                    |       | 229                                   |       | —                   |       | —                           |       | 229                                   |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Conversion  of convertible debentures**                                |       | 26,261,997                    |       | 26                        |       | 10,029                                |       | —                   |       | —                           |       | 10,055                                |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of stock in legal settlement**                               |       | 75,000                        |       | —                    |       | 70                                    |       | —                   |       | —                           |       | 70                                    |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Issuance  of stock in connection with acquisitions**                   |       | 6,911,711                     |       | 7                         |       | 2,905                                 |       | —                   |       | —                           |       | 2,912                                 |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Stock  based compensation expense**                                    |       | —                        |       | —                    |       | 765                                   |       | —                   |       | —                           |       | 765                                   |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Issuance  of stock upon warrant exercise**                             |       | 1,000,000                     |       | 1                         |       | 499                                   |       | —                   |       | —                           |       | 500                                   |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Foreign  currency translation adjustments**                            |       | —                        |       | —                    |       | —                                |       | —                   |       | (7                               | )          | (7                                    | )          |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Warrant  repricing**                                                   |       | —                        |       | —                    |       | 1,080                                 |       | —                   |       | —                           |       | 1,080                                 |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Net loss**                                                             |       | —                        |       | —                    |       | —                                |       | (39,552                  | )          | —                           |       | (39,552                               | )          |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Balance,  May 31, 2007**                                          |       | 103,801,854                   |       | $                         | 104        |                                  | $          | 56,407                   |       | $                                | (52,453    | )                                     | $          | — |   | $ | 4,058 |   |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Restricted  stock amortization**                                       |       | —                        |       | —                    |       | 5,489                                 |       | —                   |       | —                           |       | 5,489                                 |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of stock for services**                                      |       | 6,250                         |       | —                    |       | 3                                     |       | —                   |       | —                           |       | 3                                     |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of warrants in connection with debt financing**              |       | —                        |       | —                    |       | 10,577                                |       | —                   |       | —                           |       | 10,577                                |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Beneficial  conversion feature - convertible debt, net of income tax** |       | —                        |       | —                    |       | 7,975                                 |       | —                   |       | —                           |       | 7,975                                 |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Tax  benefit on beneficial conversion feature**                        |       | —                        |       | —                    |       | (3,643                                | )          | —                   |       | —                           |       | (3,643                                | )          |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Conversion  of convertible debentures**                                |       | 22,897,003                    |       | 23                        |       | 8,273                                 |       | —                   |       | —                           |       | 8,296                                 |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Issuance  of stock in connection with SRS settlement**                 |       | 368,040                       |       | 0                         |       | 110                                   |       | —                   |       | —                           |       | 110                                   |       |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Stock  based compensation expense**                                    |       | —                        |       | —                    |       | 4,154                                 |       | —                   |       | —                           |       | 4,154                                 |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Issuance  of stock upon warrant exercise**                             |       | 879,251                       |       | 1                         |       | 252                                   |       | —                   |       | —                           |       | 253                                   |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Warrants  issued in payment of interest**                              |       | —                        |       | —                    |       | 788                                   |       | —                   |       | —                           |       | 788                                   |       |
| ** **                                                               | ** ** | ** **                    | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                       | ** ** | ** **                            | ** ** |
| **Net loss**                                                             |       | —                        |       | —                    |       | —                                |       | (34,935                  | )          | —                           |       | (34,935                               | )          |
|                                                                     |       |                          |       |                      |       |                                  |       |                     |       |                             |       |                                  |       |
| **Balance,  May 31, 2008**                                          |       | 127,952,398                   |       | $                         | 128        |                                  | $          | 90,385                   |       | $                                | (87,388    | )                                     | $          | — |   | $ | 3,125 |   |

** **

**The accompanying notesare an integral part of these consolidated financial statements.**

 

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**OPEN ENERGY CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS**(In thousands)

 
| ** **                                                                            | ** ** | **Twelve Months Ended May 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                             | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net loss                                                                              |       | $                                                   | (34,935    | ) | $ | (39,552 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:          |       |                                                |       |   |   |
| Depreciation and amortization                                                         |       | 1,005                                               |       | 1,593 |   |
| Interest from amortization of warrants and  beneficial conversion feature, net of tax |       | 8,800                                               |       | 6,507 |   |
| Amortization of deferred financing costs                                              |       | 820                                                 |       | 51 |   |
| Amortization of original issue discount                                               |       | 1,189                                               |       | 573 |   |
| Warrant repricing                                                                     |       | —                                              |       | 1,080 |   |
| Stock issued in SRS settlement                                                        |       | 110                                                 |       | — |   |
| Stock issued in legal settlement                                                      |       | —                                              |       | 70 |   |
| Stock based compensation                                                              |       | 9,646                                               |       | 7,418 |   |
| Increase in allowance for doubtful accounts                                           |       | 94                                                  |       | 138 |   |
| Reduction to inventory reserves                                                       |       | (1,232                                              | )          | 1,917 |   |
| Loss on disposition of fixed assets                                                   |       | 297                                                 |       | — |   |
| Impairment of fixed assets                                                            |       | 119                                                 |       | — |   |
| Impairment of intangibles and goodwill                                                |       | —                                              |       | 10,541 |   |
| Reserve for note receivable and accrued  interest receivable                          |       | —                                              |       | 683 |   |
| Deferred taxes                                                                        |       | (1,452                                              | )          | (3,236 | ) |
| Change in operating assets and liabilities,  net of effects of acquisitions:          |       |                                                |       |   |   |
| Accounts receivable                                                                   |       | (3,513                                              | )          | (228 | ) |
| Due from related parties                                                              |       | 1,596                                               |       | (853 | ) |
| Inventories                                                                           |       | 825                                                 |       | (842 | ) |
| Deferred Charges                                                                      |       | (2,617                                              | )          | — |   |
| Other current assets                                                                  |       | 13                                                  |       | 124 |   |
| Accounts payable                                                                      |       | 3,596                                               |       | 545 |   |
| Advances from related parties                                                         |       | (245                                                | )          | — |   |
| Other accrued liabilities                                                             |       | (840                                                | )          | 3,177 |   |
| Deferred revenue                                                                      |       | 1,625                                               |       | 1,055 |   |
| Net cash used in operating activities                                                 |       | (15,099                                             | )          | (9,239 | ) |
|                                                                                  |       |                                                |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES**                                             | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                   |       | (145                                                | )          | (852 | ) |
| Additions to intangible assets                                                        |       | —                                              |       | (2 | ) |
| Acquisitions, net of cash acquired                                                    |       | —                                              |       | 22 |   |
| Net cash used in investing activities                                                 |       | (145                                                | )          | (832 | ) |
|                                                                                  |       |                                                |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES**                                             | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of notes payable                                               |       | 2,500                                               |       | — |   |
| Proceeds from issuance of convertible debt                                            |       | 22,000                                              |       | 8,000 |   |
| Proceeds from warrant exercise                                                        |       | —                                              |       | 500 |   |
| Payments on convertible debt                                                          |       | (6,279                                              | )          | — |   |
| Payments on notes payable                                                             |       | (1,133                                              | )          | (149 | ) |
| Payments on advances from related parties                                             |       | —                                              |       | (2 | ) |
| Payment of debt issuance costs                                                        |       | (1,836                                              | )          | (710 | ) |
| Net cash provided by financing activities                                             |       | 15,252                                              |       | 7,639 |   |
|                                                                                  |       |                                                |       |   |   |
| Effect of foreign currency translation                                                |       | —                                              |       | (7 | ) |
|                                                                                  |       |                                                |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                 |       | 8                                                   |       | (2,439 | ) |
|                                                                                  |       |                                                |       |   |   |
| Cash and cash equivalents at beginning of  period                                     |       | 319                                                 |       | 2,758 |   |
|                                                                                  |       |                                                |       |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                            |       | $                                                   | 327        |   | $ | 319 |   |
|                                                                                  | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION                                    | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| ** **                                                                            | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **Cash  paid during the year for:**                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Interest                                                                              |       | $                                                   | 33         |   | $ | 13 |   |
| Income taxes                                                                          |       | $                                                   | —     |   | $ | — |   |
|                                                                                  |       |                                                |       |   |   |
| **Non-cash  investing and financing activities:**                                     | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Stock issued and to be issued in connection  with acquisition                         |       | $                                                   | 110        |   | $ | 3,643 |   |
| Liabilities assumed in connection with  acquisition                                   |       | $                                                   | —     |   | $ | 24 |   |
| Assets acquired in connection with  acquisition                                       |       | $                                                   | —     |   | $ | 2,873 |   |
| Payment of convertible note and accrued  interest with warrant exercise               |       | $                                                   | (253       | ) | $ | — |   |
| Stock issued upon exercise of warrants                                                |       | $                                                   | 253        |   | $ | 1,801 |   |
| Warrants issued in payment of interest                                                |       | $                                                   | 788        |   | — |   |
| Warrants issued in connection with debt  financing                                    |       | $                                                   | 10,579     |   | $ | 229 |   |
| Beneficial conversion feature associated  with convertible debt                       |       | $                                                   | 9,145      |   | $ | — |   |
| Stock issued upon conversion of debt                                                  |       | $                                                   | 8.296      |   | $ | 10,055 |   |
| Stock and warrants issued for technology  license                                     |       | $                                                   | —     |   | $ | 1,787 |   |
| Acquisition of fixed assets pursuant to  notes payable agreement                      |       | $                                                   | —     |   | $ | 91 |   |
| Acquisition of fixed assets pursuant to  capital lease                                |       | $                                                   | —     |   | $ | 16 |   |

 

**The accompanying notesare an integral part of these consolidated financial statements.**

 

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**Open Energy Corporation**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTSFor the Years Ended May 31, 2008 and 2007**

** **

### **Note 1 – Description of Business**

### ** **

OpenEnergy Corporation, a Nevada corporation (the “Company” or “OEC”), is arenewable energy company focused on the development and commercialization of aportfolio of solar electric technologies for residential, commercial andindustrial applications.  The Companycurrently designs, manufactures and distributes building-integratedphotovoltaic (BIPV) roofing tiles, roofing membranes and architecturalphotovoltaic glass products under the SolarSave® trade name.  The company currently maintains two facilities: a corporate office in Solana Beach, California for senior management,marketing, sales, customer service, legal and finance; an engineering facilityin Grass Valley, California for product design, project engineering,prototyping, customer glass manufacturing, and materials management.  In addition, the Company is planning to opena sales and logistics office in Sacramento, adjacent to one of OEC’s majorchannel partner facilities.

 

Sharesof the Company’s common stock currently trade on the OTC Bulletin Board underthe symbol “OEGY.OB” (formerly BBSE.OB). In April 2006, the Company effected a corporate name change fromBarnabus Energy, Inc. to Open Energy Corporation.  (In May 2005, the Company had effected acorporate name change from Barnabus Enterprises, Ltd. to Barnabus Energy, Inc).

 

### **Note 2 – Going Concern**

### ** **

Theaccompanying financial statements have been prepared assuming the Company willcontinue as a going concern, which contemplates the realization of assets andsatisfaction of liabilities in the normal course of business.  The Company has incurred losses since itsinception totaling approximately $87,388,000 through May 31, 2008.  As of May 31, 2008, we had cash and cashequivalents of $327,000, and negative working capital of $4,796,000.  During the year ended May 31, 2008, we fundedour operations from private sales of equity and debt securities and as ofMay 31, 2008, have no unused sources of liquidity.  We believe our current cash will only providesufficient working capital to fund our operations through September 2008.  Our current cash requirements are significantdue to significant inventory purchases; the need to bring in additionalpersonnel to support our sales efforts; delays in product shipments as a resultof the shift to outsourcing and the suspension of membrane product shipments;research and development expenses; and other operational expenses.  We expect to continue to use significantsources of cash to fund our operations during fiscal 2009.  Thus, additional equity or debt financingwill need to be raised in the near future to implement our business strategy.

 

Theability of the Company to continue as a going concern is dependent on theCompany obtaining adequate capital or it could be forced to ceaseoperations.  In order to continue as agoing concern, the Company will also need to develop and grow its customer baseand revenues and achieve a profitable level of operations.  Management’s plans to obtain such resourcesfor the Company include raising additional capital through sales of debt andequity, the proceeds of which will be used to support its production andworking capital requirements.  InSeptember 2008 the Company entered into a securities purchase agreementpursuant to which it expects to receive initial gross cash proceeds of $4.2million (see Note 22). The financial statements included herein do not includeany adjustments that might be necessary if the Company is unable to continue asa going concern.

 

### **Note 3 - Summary ofSignificant Accounting Policies**

### ** **

*Basis of Presentation and Principles of Consolidation*

* *

Theaccompanying consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States ofAmerica.  The consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries.  All significantinter-company accounts and transactions have been eliminated.

 

*Reclassification*

* *

Certainamounts in the prior periods presented have been reclassified to conform to thecurrent period financial statement presentation.

 

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*Foreign Currency*

* *

Thefunctional currency for the Company’s Canadian subsidiary is the United Statesdollar.  Gains and losses from foreignexchange transactions are included in the consolidated statements of operationsand have not been significant. Translation adjustments resulting from the process of translating theCompany’s former oil and gas operations into U.S. dollars are included indetermining comprehensive loss and have not been significant.

 

*Use of Estimates*

* *

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and also requires disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting periods. Actual results could differ from those estimates.  Significant estimates made by managementinclude revenue recognition estimates, the viability of recognizing deferredtax assets, valuation of intangibles and goodwill, valuation of equityinstruments, reserves for inventory, allowance for uncollectible amounts duefrom related parties and the allowance for doubtful accounts receivable.  Significant changes in these estimates mayhave a material impact on the financial statements.

 

*Revenue Recognition*

* *

TheCompany recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104,“Revenue Recognition” (“SAB 104”).  TheCompany generates revenue from the sale of PV roofing tiles, PV roofingmembranes, balance of system products, and management system products to ourdealers or other parties.  The Companydoes not perform any installations of PV products.  The Company does, however, install watermonitoring systems and recognizes corresponding license/subscription revenueconsistent with the requirements of AICPA Statement of Position (SOP) 97-2,*Software Revenue Recognition* .  SAB 104 requires that four basic criteriamust be met before revenue can be recognized: (1) persuasive evidence ofan arrangement exists; (2) delivery has occurred or services rendered; (3) theseller’s price to the buyer is fixed and determinable; and (4) collectabilityis reasonably assured.  Amounts billed orreceived from customers in advance of performance are recorded as deferredrevenue.

 

*Deferred Revenue and Deferred Charges - SalesSubject to State Rebates*

* *

TheCompany records deferred revenue in connection with sales to certain customersof products that qualify for state rebates that have been assigned to theCompany by the customer.  Based on theassignment of the rebate to the Company, the Company bills the customer net ofthe anticipated rebate and assumes the responsibility for collection of therebate.  The rebate processing cycleinvolves a multi-step process in which the Company accumulates and submitsinformation required by the state agency necessary for the collection of therebate.  The entire process can take upto 120 days or more to complete. Although title to the products sold have transferred to the customer,due to uncertainty relating to the collection of the rebate and thedetermination of the ultimate price to be received, the Company defers revenueon the portion of the selling price related to the rebate, until such time thatthe rebate claim is submitted to the state agency.

 

Costof sales related to revenue that has been deferred in connection with rebatecollection process is recorded as deferred charges until such time as therelated revenue is recognized.

 

*Cash and Cash Equivalents*

* *

Cashand cash equivalents consist primarily of cash on deposit, certificates ofdeposit with original maturities of three months or less and money marketaccounts that are readily convertible into cash.

 

*Fair Value of Financial Instruments*

* *

Cash,accounts receivable and accounts payable are stated at their respectivecarrying values, which approximate their fair values. The carrying value ofnotes payable approximates their estimated fair values as these obligationsbear interest at rates which approximate current market rates.

 

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*Concentration of Credit Risk*

* *

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of temporary cash investments and trade accountsreceivable.  The Company maintains cashbalances at various financial institutions primarily located in California.  Accounts at these institutions are secured bythe Federal Deposit Insurance Corporation up to $100,000.  At times, balances may exceed federallyinsured limits.  The Company has notexperienced any losses in such accounts. Management believes that the Company is not exposed to any significantcredit risk with respect to its cash and cash equivalents.

 

*Accounts Receivable*

* *

TheCompany carries its accounts receivable at their face amounts less an allowancefor doubtful accounts.  On a periodicbasis, the Company evaluates its accounts receivable and establishes an allowancefor doubtful accounts based on a combination of specific customer circumstancesand credit conditions and based on a history of write-offs andcollections.  The Company evaluates itemson an individual basis when determining accounts receivable write-offs.  The Company’s policy is generally to notcharge interest on trade receivables after the invoice becomes past due.

 

*Inventories*

* *

Inventoriesconsist of PV cells and other component material for specific customer ordersand spare parts, and are valued at lower of cost (first-in, first-out) ormarket.  Management provides a reserve toreduce inventory to its net realizable value. Certain factors could impact the realizable value of inventory, somanagement continually evaluates its recoverability based on assumptions aboutcustomer demand and market conditions. The evaluation may take into consideration expected demand, new productdevelopment, the effect new products might have on the sale of existingproducts, product obsolescence, and other factors.  The reserve or write-down is equal to thedifference between the cost of inventory and the estimated market value basedupon assumptions about future demand and market conditions.  If actual market conditions are lessfavorable than those projected by management, additional inventory reserves orwrite-downs may be required.  If actualmarket conditions are more favorable, reserves or write-downs may be reversed.

 

*Warranty Reserves*

* *

It iscustomary in the Company’s business and industry to warrant or guarantee theperformance of PV roofing products at certain levels of conversion efficiencyfor extended periods, often as long as 25 years.  It is also customary to warrant or guaranteethe functionality of inverters and balance of systems for 10 years.  The Company therefore maintains warrantyreserves based on an estimated percentage of revenues upon shipment of productsto customers as a component of cost of sales to cover the potential liabilitythat could arise from these guarantees. The Company’s potential liability is generally in the form of productreplacement.  As necessary, the Company’swarranty reserve will also include specific accruals for known product issuesand an accrual for an estimate of incurred but not reported product issuesbased on industry loss information.

 

*Property and Equipment*

* *

Propertyand equipment is recorded at cost and depreciated using the straight-linemethod over estimated useful lives of the assets, generally ranging from threeto seven years.  Leasehold improvementsare amortized over the lesser of the lease term or useful life of theasset.  Expenditures for ordinary repairsand maintenance are expensed as incurred while major additions and improvementsare capitalized.

 

*Goodwill and Intangible Assets*

* *

Goodwillrepresents the excess of costs over fair value of assets of businessesacquired.  Per Statement of FinancialAccounting Standards (“SFAS”) No. 142,*Goodwill and Other Intangible Assets*, goodwill and intangible assetsacquired in a purchase business combination and determined to have anindefinite useful life are not amortized, but instead must be tested forimpairment annually or more frequently if circumstances indicate thatindicators of impairment may be present. Management assesses goodwill for impairment at the reporting unit levelon an annual basis at fiscal year-end or more frequently under certaincircumstances.  Such circumstancesinclude (i) significant adverse change in legal factors or in the businessclimate, (ii) an adverse action or assessment by a regulator, (iii) unanticipatedcompetition, (iv) a loss of key personnel, (v) a more-likely-than-notexpectation that a reporting unit or a significant portion of a reporting unitwill be sold or otherwise disposed of, and (vi) recognition of animpairment loss in a subsidiary that is a component of a reporting unit.  Management must make assumptions regardingestimating the fair value of the company 

 

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reportingunit.  If these estimates or relatedassumptions change in the future, the Company may be required to record animpairment charge.  For the year ended May 31,2007, the Company tested its goodwill for impairment under the provisions ofSFAS No. 142, and recorded the charges described in Note 5.

 

Intangibleassets with finite lives are amortized over their estimated useful lives, whichrange from five to ten years.  Intangibleassets are reviewed for impairment whenever events or circumstances indicateimpairment might exist in accordance with SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-lived Assets.*  Theprojected undiscounted net cash flows expected to be derived from the use ofthose assets are compared to the respective net carrying amounts to determinewhether any impairment exists. Impairment, if any, is based on the excess of the carrying amount overthe fair value of those assets.

 

Factorsthe Company considers important which could trigger an impairment reviewinclude:

 

·                                          Significantunderperformance relative to historical or projected future operating results;

 

·                                          Significantchanges in the manner of use of the acquired assets or the strategy for theCompany’s overall business; and

 

·                                          Significantnegative industry or economic trends.

 

*Deferred Financing Costs*

* *

Costsrelated to the issuance of debt are capitalized and amortized to interestexpense over the life of the related debt on a straight line basis which is notmaterially different from the results obtained using the effective interestmethod.

 

*Income Taxes*

* *

Incometaxes are computed using the asset and liability method.  Under the asset and liability method,deferred income tax assets and liabilities are determined based on thedifferences between the financial reporting and tax bases of assets andliabilities and are measured using the currently enacted tax rates andlaws.  A valuation allowance is providedfor the amount of deferred tax assets that, based on available evidence, arenot expected to be realized.

 

*Derivative Financial Instruments*

* *

TheCompany accounts for derivative instruments in accordance with the provisionsof SFAS No. 133,*Accounting forDerivative Instruments and Hedging Activities (“SFAS No. 133”)*,and its related interpretations, and complies with SFAS No. 138,*Accounting for Certain Derivative Instruments andHedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 133”)*..  SFAS No. 133 and SFAS No. 138establish accounting and reporting standards for derivative instruments,including certain derivative instruments embedded in other contracts and forhedging activities.

 

TheCompany does not use derivative instruments to hedge exposures to cash flow,market or foreign currency risk.  Termsof convertible debt and equity instruments are reviewed to determine whether ornot they contain embedded derivative instruments that are required under SFAS No. 133to be accounted for separately from the host contract, and recorded on thebalance sheet at fair value.  The fairvalue of derivative liabilities is required to be revalued at each reportingdate, with corresponding changes in fair value recorded in current periodoperating results.

 

Freestandingwarrants issued by the Company in connection with the issuance or sale of debtand equity instruments are considered to be derivative instruments, and areevaluated and accounted for in accordance with the provisions of the EmergingIssues Task Force Issue (“EITF”) No. 00-19,*Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock (“EITF No. 00-19”)*.  Pursuant to EITF No. 00-19, anevaluation of specifically identified conditions is made to determine whetherthe fair value of warrants issued is required to be classified as equity or asa derivative liability.

 

*Beneficial Conversion and Warrant Valuation*

* *

Inaccordance with EITF No. 98-5, Accounting for Convertible Securities withBeneficial Conversion Features or Contingently Adjustable Conversion Ratios andEITF No. 00-27, Application of Issue No. 98-5 to Certain ConvertibleInstruments, the Company records a beneficial conversion feature (“BCF”)related to the issuance of convertible debt instruments that have conversionfeatures at fixed rates that are in-the-money when issued, and the fair valueof warrants issued in connection with those instruments. The BCF for 

 

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theconvertible instruments is recognized and measured by allocating a portion ofthe proceeds to warrants, based on their relative fair value, and as areduction to the carrying amount of the convertible instrument equal to theintrinsic value of the conversion feature. The discounts recorded in connection with the BCF and warrant valuationare recognized as non-cash interest expense over the term of the convertibledebt, using the effective interest method.

 

*Stock-Based Compensation*

* *

Beginningin fiscal year 2007, the Company accounts for share-based compensationarrangements in accordance with the provisions of Statement of FinancialAccounting Standards No. 123R (“SFAS 123R”)  Share-Based Payment, which requires themeasurement and recognition of compensation expense for all share-based paymentawards to employees and directors based on estimated fair values.  The Company uses the Black-Scholes optionvaluation model to estimate the fair value of its stock options at the date ofgrant.  The Black-Scholes optionvaluation model requires the input of subjective assumptions to calculate thevalue of stock options.  The Company useshistorical data among other information to estimate the expected pricevolatility, the expected option life and the expected forfeiture rate.

 

Inaccordance with SFAS 123R, the Company records compensation expense forRestricted Stock Awards based on the estimated fair value of the award on thedate of grant.  The estimated fair valueis determined based on the closing price of the Company’s Common Stock on theaward date multiplied by the number of awards expected to vest.  The number of awards expected to vest isbased on the number of awards granted adjusted by estimated forfeiturerates.  The total compensation cost isthen recognized ratably over the vesting period.

 

*Litigation*

* *

Fromtime to time, the Company is involved in disputes, litigation and other legalactions.  The Company estimates the rangeof liability related to pending litigation where the amount and range of losscan be estimated.  The Company recordsits best estimate of a loss when the loss is considered probable.  Where a liability is probable and there is arange of estimated loss with no best estimate in the range, the Company recordsa charge equal to at least the minimum estimated liability for a losscontingency when both of the following conditions are met: (i) informationavailable prior to issuance of the financial statements indicates that it isprobable that an asset had been impaired or a liability had been incurred atthe date of the financial statements and (ii) the range of loss can bereasonably estimated.

 

*Basic and Diluted Net Loss per Share*

* *

Basicnet loss per share is computed by dividing the loss for the period by theweighted average number of common shares outstanding for the period.  Fully diluted loss per share reflects thepotential dilution of securities by including other potential issuances ofcommon stock, including shares to be issued upon exercise of stock options andwarrants, in the weighted average number of shares of common stock outstandingfor a period and is not presented where the effect is anti-dilutive.

 

Forthe year ended May 31, 2008, a total of 42,000,000 shares underlyingconvertible debt, 74,973,656 shares underlying warrants and 17,570,386outstanding stock options to purchase shares of our common stock have beenexcluded from the calculation because they are deemed to be anti-dilutive.

 

*Segment Reporting*

 

TheCompany has determined it operates in one operating segment. Operating segmentsare components of an enterprise for which separate financial information isavailable and is evaluated regularly by the Company in deciding how to allocateresources and in assessing performance. The Company’s chief operating decisionmaker assesses the Company’s performance, and allocates its resources as asingle operating segment.

 

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### **Note 4 – Recent Accounting Pronouncements**

### ** **

*Adoption of New Accounting Pronouncement*

* *

In July 2006,the Financial Accounting Standards Board (“FASB”) issued FIN 48, Accounting forUncertainty in Income Taxes — an Interpretation of FASB No. 109 (“FIN 48”)which prescribes a recognition threshold and measurement process for recordingin the financial statements uncertain tax positions taken or expected to betaken in a tax return.  Additionally, FIN48 provides guidance on recognition, classification, accounting in interimperiods and disclosure requirements for uncertain tax positions.  The Company adopted FIN 48 at thebeginning of fiscal year 2007.  Theadoption of FIN 48 did not impact our consolidated financial position, resultsof operations and cash flows (see Note 11).

 

*Recent Accounting Pronouncements*

* *

In September 2006,the FASB issued Statements of Financial Accounting Standards (“SFAS”) No. 157,Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, established a framework formeasuring fair value under generally accepted accounting principles (“GAAP”)and expands disclosures about fair value measurements.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007.  On November 14, 2007, the FASB provideda one-year deferral for implementation of SFAS No. 157 for othernonfinancial assets and liabilities.  The Company is currently evaluatingthe impact of this guidance on its consolidated financial position, results ofoperations and cash flows.

 

In December 2006,the FASB issued FASB Staff Position (“FSP”) on Emerging Issues Task Force (“EITF”)00-19-2  Accounting for RegistrationPayment Arrangements (“FSP EITF 00-19-2”) which specifies that the contingentobligation to make future payments or otherwise transfer consideration under aregistration payment arrangement should be separately recognized and measuredin accordance with SFAS No. 5, Accounting for Contingencies. Adoption of FSP EITF 00-19-02 is required for fiscal years beginning after December 15,2006.  The adoption of FSP EITF 00-19-2did not have a material impact on the Company’s consolidated financialposition, results of operations and cash flows.

 

In February 2007,the FASB issued SFAS No. 159, The Fair Value Option for Financial Assetsand Financial Liabilities—Including an amendment of FASB Statement No. 115,which permits entities to choose to measure many financial instruments andcertain other items at fair value.  Thefair value option established by this Statement permits all entities to chooseto measure eligible items at fair value at specified election dates.  A business entity shall report unrealizedgains and losses on items for which the fair value option has been elected inearnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15,2007.  Early adoption is permitted as ofthe beginning of a fiscal year that begins on or before November 15, 2007,provided the entity also elects to apply the provisions of SFAS No. 157.  The Company is currently evaluating theimpact of this guidance on its consolidated financial position, results ofoperations and cash flows.

 

In March 2007,the FASB issued FASB Staff Position EITF 07-03 (“FSP 07-03”), Accounting forNonrefundable Advance Payments for Goods or Services to Be Used in FutureResearch and Development Activities.  FSP07-03 addresses whether nonrefundable advance payments for goods or servicesthat will be used or rendered for research and development activities should beexpensed when the advance payment is made or when the research and developmentactivity has been performed.  FSP 07-03will be effective for fiscal years beginning after December 15, 2007, andinterim periods within those fiscal years.  The Company is currentlyevaluating the impact of this guidance on its consolidated financial position,results of operations and cash flows.

 

In December 2007,the FASB issued SFAS No. 141(R), Business Combinations (“SFAS No. 141R”). SFAS 141R retains the fundamental requirements in SFAS 141 that the acquisitionmethod of accounting (which SFAS 141 called the purchase method) be used forall business combinations and for an acquirer to be identified for eachbusiness combination.  SFAS 141R alsoestablishes principles and requirements for how the acquirer: (a) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any non-controlling interest in the acquiree; (b) improvesthe completeness of the information reported about a business combination bychanging the requirements for recognizing assets acquired and liabilitiesassumed arising from contingencies; (c) recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and (d) determines what information to disclose to enable usersof the financial statements to evaluate the nature and financial effects of thebusiness combination. SFAS No. 141R applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15,2008.  Early application is notpermitted.  The Company has not yetdetermined the impact, if any, SFAS No. 141R will have on itsconsolidated financial statements.

 

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In December 2007,the FASB issued SFAS No. 160, Non-controlling Interests in ConsolidatedFinancial Statements (“SFAS No. 160”). SFAS No. 160 amends ARB 51 to establish accounting and reportingstandards for the non-controlling (minority) interest in a subsidiary andfor the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is anownership interest in the consolidated entity that should be reported as equityin the consolidated financial statements and establishes a single method ofaccounting for changes in a parent’s ownership interest in a subsidiary that donot result in deconsolidation.  SFAS No. 160is effective for fiscal years beginning on or after December 15,2008.  The Company has not yet determinedthe impact, if any, that SFAS No. 160 will have on its consolidatedfinancial statements.

 

In December 2007,the FASB ratified the Emerging Issues Task Force consensus on EITF Issue No. 07-1,Accounting for Collaborative Arrangements that discusses how parties to acollaborative arrangement (which does not establish a legal entity within sucharrangement) should account for various activities.  The consensus indicates that costs incurredand revenues generated from transactions with third parties (i.e., partiesoutside of the collaborative arrangement) should be reported by thecollaborators on the respective line items in their income statements pursuantto EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Netas an Agent.  Additionally, the consensus provides that income statementcharacterization of payments between the participants in a collaborativearrangement should be based upon existing authoritative pronouncements; analogyto such pronouncements if not within their scope; or a reasonable, rational,and consistently applied accounting policy election.  EITF Issue No. 07-1 is effectivebeginning January 1, 2009 and is to be applied retrospectively to allperiods presented for collaborative arrangements existing as of the date ofadoption.  The Company is currentlyevaluating the impacts and disclosures of this standard, but would not expectEITF Issue No. 07-1 to have a material impact on the Company’sconsolidated results of operations or financial condition.

 

InMarch, 2008, the FASB issued SFAS No. 161, Disclosures about DerivativeInstruments and Hedging Activities.  Thenew standard is intended to improve financial reporting about derivativeinstruments and hedging activities by requiring enhanced disclosures to enableinvestors to better understand their effects on an entity’s financial position,financial performance, and cash flows. The new standard also improves transparency about the location andamounts of derivative instruments in an entity’s financial statements; howderivative instruments and related hedged items are accounted for under SFAS No. 133;and how derivative instruments and related hedged items affect its financialposition, financial performance, and cash flows.  It is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008, with early application encouraged. The Company does not believe that the adoption of the disclosureprovisions required under SFAS No. 161 will have a material impact on theCompany’s consolidated financial position, results of operations and cashflows.

 

In April 2008,the FASB issued Staff Position No. 142-3, Determining the Useful Life ofIntangible Assets (“FSP 142-3”).  FSP142-3 amends the factors to be considered in determining the useful life ofintangible assets.  Its intent is toimprove the consistency between the useful life of an intangible asset and theperiod of expected cash flows used to measure its fair value.  FSP 142-3 is effective for fiscal yearsbeginning after December 15, 2008. The Company is evaluating the effect the implementation will have on itsconsolidated financial statements.

 

InMay, 2008, the FASB issued FASB Staff Position No. APB 14-1, Accountingfor Convertible Debt Instruments That May Be Settled in Cash UponConversion (Including Partial Cash Settlement) (“FSP APB 14-1”).  FSP APB 14-1 requires issuers of convertibledebt that may be settled wholly or partly in cash when converted to account forthe debt and equity components separately. FSP APB 14-1 is effective for fiscal years beginning after December 15,2008 and must be applied retrospectively to all periods presented.  The Company is evaluating the effect theimplementation will have on its consolidated financial statements.

 

InMay 2008, the FASB issued SFAS No. 162, “The Hierarchy of GenerallyAccepted Accounting Policies” (“SFAS No. 162”), which reorganizes the GAAPhierarchy. The purpose of the new standard is to improve financial reporting byproviding a consistent framework for determining what accounting principlesshould be used when preparing the U.S. GAAP financial statements. The standardis effective 60 days after the SEC’s approval of the PCAOB’s amendments to AU Section 411.The adoption of SFAS No. 162 is not expected to have an impact on ourconsolidated financial statements.

 

InMay 2008, the FASB issued SFAS No. 163, “Accounting for FinancialGuarantee Insurance Contracts—an interpretation of FASB Statement No. 60”(“SFAS No. 163”). SFAS 163 interprets Statement 60 and amends existingaccounting pronouncements to clarify their application to the financialguarantee insurance contracts included within the scope of that Statement. SFASNo. 163 is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and all interim periods within thosefiscal years. The Company does not expect that SFAS No. 163 will have amaterial impact on its consolidated financial statements.

 

InJune 2008, the FASB issued FSP No. EITF 03-6-1, “Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities” (“FSP EITF 03-6-1”), which requires entities to apply the two-classmethod of computing 

 

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basicand diluted earnings per share for participating securities that include awardsthat accrue cash dividends (whether paid or unpaid) any time commonshareholders receive dividends and those dividends do not need to be returnedto the entity if the employee forfeits the award. FSP EITF 03-6-1 will beeffective for the Company on January 1, 2009 and will require retroactivedisclosure. The Company is currently evaluating the impact of adopting FSP EITF03-6-1 on its financial position, cash flows, and results of operations.

 

### **Note 5 – Accounts Receivable**

 

Accountsreceivable consisted of the following (in thousands):

 
| ** **                            | ** ** | **May 31,  2008** | ** ** | **May 31,  2007** | ** ** |
|---------------------------------------|------------|------------------------|------------|------------------------|------------|
| Assigned rebates                      |       | $                      | 2,734      |                   | $          | 106 |   |
| Trade accounts                        |       | 1,332                  |       | 447                    |       |
| Less: Allowance for doubtful accounts |       | (232                   | )          | (138                   | )          |
| Total                                 |       | $                      | 3,834      |                   | $          | 415 |   |

 

Assignedrebates represent uncollected rebates from the California Energy Commissionthat have been assigned to the Company from its customers.  The Company records deferred revenue in connection with sales to certaincustomers of products that qualify for state rebates that have been assigned tothe Company by the customer.  Based onthe assignment of the rebate to the Company, the Company bills the customer netof the anticipated rebate and assumes the responsibility for collection of therebate.  The rebate processing cycleinvolves a multi-step process in which the Company accumulates and submitsinformation required by the state agency necessary for the collection of therebate.  The entire process can take upto 120 days or more to complete.

 

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### **Note 6 – Inventories**

### ** **

Inventoriesconsisted of the following (in thousands):

 
| ** **      | ** ** | **May 31,** | ** ** |
|-----------------|------------|------------------|------------|
| ** **      | ** ** | **2008**         | ** ** | **2007** | ** ** |
| Raw materials   |       | $                | 2,181      |   | $ | 2,532 |   |
| Work-in-process |       | —           |       | 540 |   |
| Finished goods  |       | 724              |       | 702 |   |
| Less reserves   |       | (684             | )          | (1,917 | ) |
| Total           |       | $                | 2,221      |   | $ | 1,857 |   |

### ** **

### **Note 7 – Deferred Charges**

### ** **

At May 31,2008, the Company had deferred charges of $2,617,000.  These chargesrepresent the cost of sales related to revenue that has been deferred in connectionwith the rebate collection process.

 

### **Note 8 –Fixed Assets**

### ** **

Fixedassets are stated at cost less accumulated depreciation and amortization.  Depreciation and amortization of fixed assetsare provided over the estimated useful lives of the assets, or the relatedlease terms if shorter, by the straight-line method.  Useful lives range as follows:

 
| Computers and networks  |   | 3 years                                                |   |
|-------------------------|--------|--------------------------------------------------------|--------|
| Machinery and equipment |   | 5-7 years                                              |   |
| Furniture and fixtures  |   | 5-7 years                                              |   |
| Leasehold improvements  |   | Lesser of lease term or useful life of the improvement |   |

 

Fixedassets consisted of the following (in thousands):

 
| ** **                     | ** ** | **May 31,** | ** ** |
|--------------------------------|------------|------------------|------------|
| ** **                     | ** ** | **2008**         | ** ** | **2007** | ** ** |
| Computers and Networks         |       | $                | 336        |   | $ | 310 |   |
| Machinery and Equipment        |       | 683              |       | 735 |   |
| Furniture and fixtures         |       | 137              |       | 89 |   |
| Leasehold improvement          |       | 13               |       | 59 |   |
| Construction in progress       |       | 0                |       | 369 |   |
| Subtotal                       |       | 1,169            |       | 1,562 |   |
| Less: accumulated depreciation |       | (412             | )          | (264 | ) |
| Fixed assets, net              |       | $                | 757        |   | $ | 1,298 |   |

 

Depreciationexpense was $312,000 and $243,000 for the years ending May 31, 2008 and2007, respectively.

 

### **Note 9 – Due from Related Parties**

### ** **

Amountsdue from related parties as of May 31, 2008 and 2007 of $397,000 and$1,993,000, respectively, consist of estimated balances owed by certainofficers and other employees to the Company for income tax withholding inconnection with previously issued restricted stock grants (see Notes 12 and13).  In December 2007, the Company received $1,498,770 from itsChairman and Chief Executive Officer to satisfy the employee portion of therequired withholding taxes on restricted stock grants to him that have vestedto date.  In January 2008, the Company paid past-due federal andstate employment taxes, as well as related estimated interest 

 

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andpenalties associated with previously unpaid taxes.  The May 31, 2008balance represents the remaining obligation for one employee and one formeremployee to repay the Company for taxes paid and to be paid on their behalf.

 

### **Note 10 – DeferredFinancing Costs, net**

### ** **

TheCompany capitalizes costs directly related to financing agreements and certainqualified debt restructuring costs, and amortizes these costs as additionalinterest expense over the terms of the related debt.

 

Netdeferred financing costs are comprised of the following (in thousands):

 
| ** **                    | ** ** | **May 31, 2008** | ** ** | **May 31, 2007** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Deferred financing costs      |       | $                          | 2,159      |                       | $          | 152 |   |
| Accumulated amortization      |       | (515                       | )          | (59                        | )          |
| Deferred financing costs, net |       | $                          | 1,644      |                       | $          | 93 |   |

 

Forthe year ended May 31, 2008 and 2007, the Company recognized amortizationexpense of $820,000 and $51,000, respectively, related to deferred financingfees.

 

### **Note 11 – Goodwill and Intangible Assets**

### ** **

As of May 31,2008 and 2007, goodwill and intangible assets consisted of the following (inthousands):

 
| ** **  | ** ** | **May 31,** | ** ** |
|-------------|------------|------------------|------------|
| ** **  | ** ** | **2008**         | ** ** | **2007** | ** ** |
| *Goodwill:* |       |             |       |   |   |
| * *    |       |             |       |   |   |
| CRE         |       | $                | 6,097      |   | $ | 6,097 |   |
| SRS         |       | 3,846            |       | 3,846 |   |
| WaterEye    |       | 278              |       | 278 |   |
|        |       | $                | 10,221     |   | $ | 10,221 |   |

 
| ** **                      | ** ** | **Weighted**                   | ** ** | ** **       | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------|------------|------------------|------------|------------|------------|
| ** **                      | ** ** | **average**                    | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **amortization  period ** | ** ** | **May 31,** | ** ** |
| ** **                      | ** ** | **(years)**                    | ** ** | **2008**         | ** ** | **2007**   | ** ** |
| *Amortized  intangible assets:* |       |                           |       |             |       |       |       |
| * *                        |       |                           |       |             |       |       |       |
| Patented technologies           |       | (8                             | )          | $                | 5,699      |       | $          | 5,699 |   |
| Customer relationships          |       | (8                             | )          | 462              |       | 462        |       |
| Backlog                         |       | (0.5                           | )          | —           |       | 300        |       |
| Subtotal                        |       |                           |       | 6,161            |       | 6,461      |       |
| Less: accumulated amortization  |       |                           |       | (2,075           | )          | (1,682     | )          |
| Total amortized intangibles     |       |                           |       | 4,086            |       | 4,779      |       |
|                            |       |                           |       |             |       |       |       |
| Unamortized intangible assets:  |       |                           |       |             |       |       |       |
| Trademarks                      |       |                           |       | 110              |       | 110        |       |
| Total unamortized intangibles   |       |                           |       | 110              |       | 110        |       |
|                            |       |                           |       |             |       |       |       |
| Total intangibles               |       |                           |       | $                | 4,196      |       | $          | 4,889 |   |

 

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Aggregateamortization expense for all intangible assets for the years ended May 31,2008 and 2007 totaled $694,000 and $1,350,000, respectively.  Estimated amortization of intangible assetsis $699,000 annually for fiscal 2009 through 2012 and $1,290,000 thereafter.

 

### **Note 12 – Advances from Related Parties**

### ** **

TheCompany assumed advances from various related parties, including shareholders,in connection with the acquisition of SRS. These advances are due on demand and bear interest as of May 31,2008 and 2007, at 18% and 6% per annum respectively.

 

On March 7, 2008, the Company entered into a settlement andgeneral release agreement (the “Settlement Agreement”) with the formerstockholders (the “SRS Stockholders”) of Solar Roofing Systems, Inc. The Settlement Agreement was entered into to settle certain disagreementsrelated to the rights and liabilities of the Company and the SRS Stockholdersunder the terms of the stock purchase agreement the Company entered with SolarRoofing Systems, Inc. and the SRS Stockholders in February 2006.  Under the terms of the Settlement Agreement,among other things, in exchange for mutual releases given by the Company andthe SRS Stockholders in favor of the other, the Company agreed to pay offprincipal and interest of approximately $436,000 for certain loans owed to theSRS Stockholders.

 

As of May 31,2008 and 2007, balances due to related parties totaled $67,000 and $312,000,respectively, and related accrued interest totaled $3,000 and $81,000,respectively.

 

### **Note 13 – Other Accrued Liabilities**

### ** **

Otheraccrued liabilities consisted of the following (in thousands):

 
| ** **                  | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
|-----------------------------|------------|------------------|------------|------------------|------------|
| ** **                  | ** ** | **2008**         | ** ** | **2007**         | ** ** |
| Accrued warranty            |       | $                | 2,403      |             | $          | 1,520 |   |
| Payroll liabilities         |       | 406              |       | 2,533            |       |
| Accrued interest            |       | 351              |       | 879              |       |
| Common stock issuable       |       | 746              |       | 734              |       |
| Accrued legal fees          |       | 74               |       | —           |       |
| Accrued restructuring costs |       | 68               |       | —           |       |
| Other                       |       | 426              |       | 498              |       |
| Total                       |       | $                | 4,474      |             | $          | 6,164 |   |

 

*Accrued warranty.*  Changes in the warranty reserve for the yearended were the following (in thousands):

 
| ** **           | ** ** | **May 31, 2008** | ** ** | **May 31, 2007** | ** ** |
|----------------------|------------|----------------------------|------------|----------------------------|------------|
| Beginning balance    |       | $                          | 1,520      |                       | $          | 16 |   |
| Provisions           |       | 1,578                      |       | 1,504                      |       |
| Warranty settlements |       | (695                       | )          | —                     |       |
| Ending balance       |       | $                          | 2,403      |                       | $          | 1,520 |   |

 

Includedin the accrued warranty reserve is $943,000 related to warranty work to repairdiodes on the Company’s SolarSave® membrane product that was shippedin prior quarters, $987,000 related to a product corrosion issue on the Company’sSolarSave® membrane product shipped in prior quarters, $277,000related to tile delamination, and $196,000 related to a general reserve onproducts sold to date.

 

*Payroll liabilities.*  Included inpayroll liabilities at May 31, 2008 and 2007 are liabilities totaling$190,000 and $2,417,000, respectively, representing estimated employer andemployee taxes, employee withholding, interest and penalties related tostock-based compensation resulting from the vesting through February 29,2008 and May 31, 2007 of previous issuances of restricted common stock tocertain officers and employees of the Company.  In connection with theissuance of these shares, the Company failed to withhold the required amountsrelated to the individuals’ federal and state income and payroll taxliabilities, pay the related employer tax liabilities associated with theissuances, and did not remit the amounts to the appropriate federal and stategovernment agencies associated with amounts vested at the times required bylaw.  In January 2008, the Company paid past-due taxes related tothese restricted stock grants, as well as related estimated interest andpenalties associated with previously unpaid taxes.  The Company has 

 

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recordedcorresponding amounts due from the officers and employees at May 31, 2008and 2007 totaling $397,000 and $1,993,000, respectively.  These amountsare classified as due from related parties on the accompanying balance sheetsand represent the amount of the liability that is owed by the individuals tothe Company for the required withholdings not made on their behalf.  In December 2007,the Company received $1,498,770 from its Company’s Chairman and Chief ExecutiveOfficer to satisfy the employee portion of the required withholding taxes onhis restricted stock grants.  The May 31, 2008 balance represents theremaining obligation for one employee and one former employee to repay theCompany for taxes to be paid on their behalf.

 

*Common stock issuable. * Common stockissuable represented the liability to former shareholders of Solar RoofingSystems, Inc. (“SRS”) under the terms of the stock purchase agreement theCompany entered into with SRS and SRS stockholders in February 2006.  On March 7, 2008, the Company enteredinto a settlement and general release agreement with the former stockholders ofSRS to settle certain disagreements related to the rights and liabilities ofthe Company and the SRS Stockholders. The Company agreed to issue an aggregate of 2,202,594 shares of commonstock under the terms of the settlement agreement, of which 1,834,554 sharesremain to be issued.

 

*Accrued restructuring costs.*  TheCompany has remaining accrued restructuring costs related to the settlement ofits Canadian facility lease of $68,000 (see Note 21).

 

### **Note 14 – Deferred Revenue**

### ** **

Deferredrevenue consisted of the following (in thousands):

 
| ** **        | ** ** | **May 31,  2008** | ** ** | **May 31,  2007** | ** ** |
|-------------------|------------|------------------------|------------|------------------------|------------|
| Rebate processing |       | $                      | 2,617      |                   | $          | — |   |
| Other             |       | 205                    |       | 1,197                  |       |
|              |       |                   |       |                   |       |
| Total             |       | $                      | 2,822      |                   | $          | 1,197 |   |

### ** **

### **The Company records deferred revenue in connection withsales to certain customers of products that qualify for state rebates that havebeen assigned to the Company by the customer. Although title to the products sold have transferred to the customer,due to uncertainty relating to the collection of the rebate, the Company defersrevenue on a portion of the selling price related to the rebate.  As the rebate processing advances through thevarious stages of the processing cycle, revenue is deferred until such timethat the rebate claim is submitted to the state agency, at which point, anydeferred revenue relating to that specific transaction is recognized.**

### ** **

### **Note 15 – Notes Payable**

### ** **

Notespayable consisted of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                      | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                      | ** ** | **2008**         | ** ** | **2007**         | ** ** |
| Secured loan agreement for borrowings up to  $3,500,000, bearing interest at 18% payable at funding in warrant shares,  matures October 30, 2008, secured by accounts, including but not limited  to qualified accounts receivable, all inventory, money and deposit accounts,  cash and non-cash proceeds of any and all of the foregoing |       | $                | 1,511      |             | $          | — |   |
| Unsecured demand promissory note payable to  an unrelated party, bearing interest at 18% per annum calculated annually  with no fixed term of repayment                                                                                                                                                                                         |       | —           |       | 190              |       |
| Promissory note in connection with the  purchase of computer software bearing interest at 8%, due in six monthly  installments of $15,000 through April 2007                                                                                                                                                                               |       | —           |       | 77               |       |
| Secured credit facility agreement for  borrowings up to CDN $250,000, bearing interest at prime plus 3% (11.5% at  May 31, 2007), matured March 2008, secured by equipment and  personally guaranteed by certain shareholders of the Company                                                                                          |       | —           |       | 62               |       |
| Other                                                                                                                                                                                                                                                                                                                                           |       | 5                |       | 10               |       |
| Total                                                                                                                                                                                                                                                                                                                                           |       | 1,516            |       | 339              |       |
| Notes payable, current maturities                                                                                                                                                                                                                                                                                                               |       | 1,516            |       | 325              |       |
| Notes payable, long term maturities                                                                                                                                                                                                                                                                                                             |       | $                | —     |             | $          | 14 |   |

 

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On April 30,2008, the Company entered into a Loan and Security Agreement and issued apromissory note for a loan of up to $3,500,000 (the “4/30/2008 Note”).  Pursuantto the Loan Agreement, the Company may borrow an amount equal to the lesser of50% of the Company’s combined inventory, accounts receivable and cash balances,and 100% of its qualified accounts receivable (as defined in the LoanAgreement) (the “Borrowing Base”),up to a maximum of $3,500,000.  On April 30,2008, the Company was funded $1,550,000 under the Loan.  From April 30, 2008 through June 30,2008, the Company was entitled to make additional advances under the LoanAgreements in minimum amounts of at least $200,000, as the Company generatesadditional qualified accounts receivable and assuming the Borrowing Base issatisfied.  All unpaid principal underthe Loan is due in full on October 30, 2008, and the Loan may be prepaidin full at any time.  The Company isrequired to make partial prepayments on the Loan upon receipt of any rebatesincluded in the accounts receivable portion of the Collateral (defined below),and upon determination that the Borrowing Base is not satisfied at specifiedintervals during the term of the Loan. Through June 30, 2008, the Company borrowed a total of $3,500,000under this facility.

 

Intereston the Loan is payable in warrants to acquire shares of the Company’s commonstock at an exercise price of $.506 per share. The total number of warrants that may be issued, assuming the maximumLoan amount of $3.5 million is funded is 1,389,096, which the parties agreedequates to an 18% per annum interest rate on the Loan.  The warrants have a seven-year term.  On April 30, 2008, the Company issuedwarrants to acquire 615,171 shares of the Company’s common stock upon thereceipt of the $1,550,000 described above. The Company recorded prepaid interest of $137,589 in payment of interestin warrant shares.

 

TheLoan is secured by a first priority security interest in all of the Company’sinventory, accounts receivable and money and deposit accounts (the “Collateral”).  If any event of default occurs under the LoanAgreements, the lender may: (1) declare null and void its obligation tomake any additional advances under the Loan, (2) require the Company toimmediately repay the Loan in full, (3) foreclose on the Collateral, and (4) assertall other rights and remedies of a lender under applicable law.

 

On September 14,2007, the Company agreed to apply the principal and interest due under the 18%unsecured demand promissory notes to Coach Capital, LLC (for the three DemandNotes dated August 4, November 9, and December 2, 2005) to theexercise price of certain warrants held by them as payment in full of theCompany’s obligations under the 18% unsecured demand promissory notes. The Company applied an aggregate amount of $252,785 to the exercise pricepursuant to the Warrant Exercise Notices received from Coach Capital.  The amount of $193,386 at $0.2875 per warrantshare for a total of 672,646 common shares was applied to the Coach Capitalexercise, and $59,399 at $0.2875 per warrant share for a total of 206,605common shares was applied to the Nadelson Internacional S.A. exercise.  After this exercise, Coach Capital has nofurther warrants outstanding and Nadelson has 129,718 warrants stilloutstanding at May 31, 2008.

 

On June 15,2007, the Company entered into a Note and Warrant Purchase Agreement with anaccredited investor for the private placement of a $950,000 promissory note(the “6/15/07 Note”) and a related warrant to acquire up to 4,000,000 shares ofcommon stock for a purchase price of $750,000.  The maturity date of the6/15/07 Note was October 15, 2007, and it was paid in full on October 5,2007.  The warrant is exercisable forthree years, and was subject to anti-dilution provisions and a floor exerciseprice of $0.05 per share.  In addition tothe purchase discount of $200,000, debt discount in the amount of $590,000 wasrecorded based on the estimated fair value of the warrants.  In addition, a warrant to purchase 400,000shares of common stock at the rate of $0.50 per share that expires on June 15,2012, was issued to an investment banker for services rendered in connectionwith the financing.

 

Accruedinterest related to notes payable at May 31, 2008 and 2007 totaled $0 and$55,000, respectively.

 

### **Note 16 – Convertible Debentures and Warrants**

### ** **

*12/7/2007 Notes*

* *

On December 7,2007, the Company entered into an amendment of a certain SecuritiesPurchase Agreement, dated as of September 19, 2007 between the Company andan accredited investor pursuant to which amendment the Company issued (i) convertiblenotes (the “12/7/07 Notes”) in the aggregate principal amount of $1,000,000 and(ii) warrants (the “12/7/07 Warrants”) to acquire up to 2,000,000 sharesof the Company’s common stock for an aggregate purchase price of$1,000,000.  The transaction 

 

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resultedin net proceeds to the Company of $913,000, which was used for the repayment ofdebt and general corporate and working capital purposes.

 

Thematurity date of the 12/7/07 Notes is three years from December 7, 2007,which may be accelerated at the option of the investors if (i) a triggerevent (as defined in the 12/7/07 Notes) has occurred and is continuing, and (ii) throughthe date that is ten business days after the consummation of a change of controlin the event that a change of control is publicly announced.  The Company does not have the right to prepaythe 12/7/07 Notes in whole or in part without penalty prior to the maturitydate.  The 12/7/07 Notes are convertibleinto shares of the Company’s common stock at an initial price of $0.50 pershare, subject to adjustment, including anti-dilution protection, on the termsset forth in the 12/7/07 Notes.  The12/7/07 Notes accrue interest at a rate of 6% per annum, with accrued interestdue and payable quarterly in arrears.

 

The12/7/07 Warrants are exercisable for up to 2,000,000 shares of the Company’scommon stock at an exercise price of $0.506 per share, subject to adjustment,including anti-dilution protection, on the terms set forth in the 12/7/07Warrants.

 

Inconnection with the December 7, 2007 amendment and related transactions,the Company paid approximately $86,437 in placement agent fees and expenses andagreed to issue warrants to acquire 80,000 shares of common stock to itsplacement agents.

 

Inconnection with the 12/7/07 Notes and 12/7/07 Warrants, the Company recordeddebt discount in the aggregate amount of $487,500 in accordance with EITF98-05,*Accounting for Convertible Securitieswith Beneficial Conversion Features or Contingently Adjustable ConversionRatios* and EITF 00-27,*Applicationof Issue No. 98-05 to Certain Convertible Instruments* .  As a result of the debt discounts recorded inconnection with the note, the effective interest rate on the date of issuancewas estimated to be approximately 22%.

 

Asdiscussed above, the 12/7/07 Notes accrue interest at a rate of 6% per annum,with accrued interest due and payable quarterly in arrears on each January 1,April 1, July 1 and October 1 beginning on the first such dateafter December 7, 2007.  The Companyhad not made the interest payments due on the following dates: January 1,2008 and April 1, 2008.  The totalpast due interest owed through March 31, 2008 was approximately$19,000.  The Company entered into anamendment of its Series B Convertible Notes issued on September 19,2007, the (“9/19/07” Note) and the 12/7/07 Notes, which notes collectivelyconstitute the Series B Convertible Notes. In connection with theamendment of the Series B Convertible Notes, we issued warrants to acquirea total of 89,334 shares of our common stock with an exercise price of $0.506per share to the holders in lieu of accrued and unpaid interest that was inarrearage (see Note 22).  The other termsof such warrants are substantially the same as the warrants issued to theholders of the 12/7/07 Note.

 

*9/19/2007 Note*

* *

On September 19,2007, the Company issued to an accredited investor (i) a convertiblenote in the principal amount of $20,000,000 (the “9/19/07 Note”) and (ii) awarrant to acquire up to 40,000,000 shares of common stock (the “9/19/07Warrant”) for an aggregate purchase price of $20,000,000.

 

Thematurity date of the 9/19/07 Note is three years from September 19, 2007,which may be accelerated at the option of the holder if (i) a triggerevent (as defined in the 9/19/07 Note) has occurred and is continuing on thematurity date, and (ii) through the date that is ten business days afterthe consummation of a change of control in the event that a change of controlis publicly announced.  The Company doesnot have the right to prepay the 9/19/07 Note in whole or part without penaltyprior to the maturity date.  The Companymay not declare or pay any cash dividend or distribution on its capital stockwhile the 9/19/07 Note is outstanding without the prior express written consentof the holder.  The 9/19/07 Note isconvertible at the option of the holder into shares of the Company’s commonstock at an initial price of $0.50 per share, subject to adjustment asspecified in the 9/19/07 Note.  The9/19/07 Note accrues interest at a rate of 6% per annum with accrued interestdue and payable quarterly in arrears.

 

The9/19/07 Warrant is exercisable for up to 40,000,000 shares of common stock atan exercise price of $0.506, which is subject to adjustment as described in the9/19/07 Warrant.  The 9/19/07 Warrantexpires 84 months after the initial closing date of September 19,2007.  In addition, a separate warrant topurchase 1,600,000 shares at $0.50 per share was issued to an investment bankerfor services rendered in connection with the financing.

 

Inconnection with the 9/19/07 Note and 9/19/07 Warrant, the Company recorded debtdiscount in the aggregate amount of $16,910,000 in accordance with EITF 98-05,*Accounting for Convertible Securities with BeneficialConversion Features or*

 

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*Contingently Adjustable Conversion Ratios* andEITF 00-27,*Application of Issue No. 98-05to Certain Convertible Instruments* . As a result of the debt discounts recorded in connection with the note,the effective interest rate on the date of issuance was estimated to beapproximately 64%.

 

Asdiscussed above, the 9/19/07 Note accrues interest at a rate of 6% per annum,with accrued interest due and payable quarterly in arrears on each January 1,April 1, July 1 and October 1 beginning on the first such dateafter September 17, 2007.  TheCompany had not made the interest payments due on the following dates: October 1,2007, January 1, 2008 and April 1, 2008.  The total past due interest owed through March 31,2008 was approximately $641,000.  On April 16,2008, we entered into amendments of our 9/19/2007 Note with the holder thereof,which amendments:

 

·                  Permitus to issue shares of our common stock that are not registered pursuant to theSecurities Act of 1933, as amended, in lieu of cash interest payments on the9/19/2007 Note;

·                  Permit us to issue warrants toacquire shares of our common stock, in lieu of cash interest payments on the9/19/2007  Note, which warrants will have an exercise price per shareequal to the greater of $0.506 per share or 5-day weighted average price pershare of our common stock; and

·                  Waive any prior defaults or triggerevents caused by our previous failure to pay interest on our 9/19/2007 Notewhen due, upon the issuance of warrants in lieu of such accrued interest.

 

*On April 17,2008, we issued warrants to acquire a total of 3,003,370 shares of our commonstock with an exercise price of $0.506 per share to the holder of our 9/19/2007Note in lieu of accrued and unpaid interest that was in arrearage.  The other terms of such warrants aresubstantially the same as the 9/19/07 Warrants.*

* *

*8/31/07 Note*

* *

On August 31,2007, the Company entered into a Securities Purchase Agreement with anaccredited investor for the private placement of (i) a convertiblenote in the principal amount of $1,000,000 (the “8/31/07 Note”) and (ii) awarrant to acquire up to 1,200,000 shares of common stock (the “8/31/07 Warrant”)for an aggregate purchase price of $950,000. The maturity date of the 8/31/07 Note was February 29, 2008, atwhich time the Company repaid the 8/31/07 Note in full.  The 8/31/07 Noteaccrued interest at a rate of 10% per annum, with accrued interest due andpayable February 29, 2008.  The8/31/07 Note was convertible into shares of the Company’s common stock at theoption of the holder at an initial price of $0.50 per share, subject toadjustment as specified in the 8/31/07 Note.

 

The8/31/07 Warrant is exercisable for up to 1,200,000 shares of common stock at anexercise price of $0.709, subject to adjustment according to the anti-dilutionprovisions in the 8/31/07 Warrant, provided that, in no event shall theexercise price be reduced to less than five cents ($0.05) per share (such floorprice to be adjusted in the same manner that the exercise price is adjusted),and is exercisable through August 31, 2012.  In addition, a warrant to purchase 72,000shares at $0.709 per share and expiring on August 31, 2012 was issued toan investment banker for services rendered in connection with the financing.

 

TheCompany and the investor also executed a Registration Rights Agreement pursuantto which the Company has agreed to provide certain registration rights withrespect to the 8/31/07 Note and the 8/31/07 Warrant.

 

Inconnection with the 8/31/07 Note and 8/31/07 Warrant, the Company recorded debtdiscount in the aggregate amount of $1,000,000 in accordance with EITF 98-05, *Accounting for Convertible Securities with Beneficial ConversionFeatures or Contingently Adjustable Conversion Ratios* and EITF00-27, *Application of Issue No. 98-05 to CertainConvertible Instruments*.  As aresult of the debt discounts recorded in connection with the note, theeffective interest rate on the date of issuance was estimated to beapproximately 147%.

 

*0% Subordinated Convertible Debentures*

* *

In February andMarch 2006, the Company completed a private placement pursuant to which itissued five-year warrants and $5.25 million 0% subordinated convertibledebentures due July 31, 2008 (“0% Debentures”) at par to Coach CapitalLLC, Eversource Group Limited, Bank Sal. Oppenheim jr. & Cie.(Schweiz) AG and Nadelson Internacional S.A. The warrants are exercisable into 2,354,261 shares of the Company’scommon stock.  The warrant exercise priceand 0% Debenture conversion price, which were initially set at $2.23 per shareand $1.46, respectively, both became $0.2875 per share on December 22,2006, and are subject to further adjustment upon the occurrence of certainspecified events including, but not limited to, the issuance of securities at adeemed price below the 

 

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currentexercise price, stock dividends, stock splits, mergers or reorganizations, andthe Company’s failure to meet certain revenue milestones.  A previous reduction in the warrant exerciseprice from $2.23 to $0.5833 per share on August 22, 2006 resulted in anon-cash interest charge of $447,000 for the year ended May 31, 2007 dueto the change in the estimated fair value of the warrants before and after theexercise price reduction as determined by the Black Scholes option pricingmodel using the following assumptions:  estimated volatility of 87%; riskfree interest rate of 4.82%; an estimated life of 4.58 years and no dividendyield. A reduction in the warrant exercise price from $0.5833 to $0.2875 pershare on December 22, 2006 resulted in a non-cash interest charge of$104,000 for the year ended May 31, 2007 due to the change in theestimated fair value of the warrants before and after the exercise pricereduction as determined by the Black Scholes option pricing model using thefollowing assumptions:  estimated volatility of 94%; risk free interestrate of 4.53%; an estimated life of 4.25 years and no dividend yield.

 

As of March 30,2006, the 0% Debentures and warrants were amended and restated to provide thatthe anti-dilution adjustments will occur only upon a future exercise orconversion of a convertible security, rather than upon the issuance of aconvertible security, and will be calculated based upon the actual price usedfor the exercise or conversion.  In July 2006,the 0% Debentures and warrants were further amended to provide for a minimumconversion price and exercise price, respectively, of $0.05 per share.  The warrants were also amended to fix theaggregate number of warrant shares that are issuable to the number of shares ofcommon stock for which the warrants were exercisable at the time the warrantswere originally granted, or 2,354,261 shares.

 

On September 25,2006, Coach Capital LLC, Eversource Group Limited and Nadelson InternacionalS.A. converted an aggregate of $3,750,000 principal amount of 0% Debentures,representing the entire principal amount of 0% Debentures that were issued tothem at $0.5833 per share, and the Company correspondingly issued 2,571,576shares of its common stock to Coach Capital LLC, 2,571,576 shares of its commonstock to Eversource Group Limited and 1,285,788 shares of its common stock toNadelson Internacional S.A. On February 22, 2007, Bank Sal. Oppenheim jr. &Cie. (Schweiz) AG converted the remaining $1,500,000 principal amount of 0%Debentures into 5,217,391 shares of common stock at $0.2875 per share.

 

*5% Convertible Debentures*

* *

In March 2006,the Company entered into a securities purchase agreement with Cornell CapitalPartners, L.P. (“Cornell”), pursuant to which, as subsequently amended, theCompany agreed to issue and sell to Cornell up to an aggregate of $15.0 millionof secured convertible debentures (“5% Debentures) and warrants to purchase upto an aggregate of 13,250,000 shares of the Company’s common stock.  On March 31, 2006, Cornell purchased$10,000,000 of the 5% Debentures and the Company issued to Cornell warrants topurchase up to an aggregate of 7,000,000 shares of common stock.  Cornell also agreed to purchase an additional$5,000,000 of 5% Debentures and warrants to purchase up to 3,000,000 shares ofcommon stock on the date the Company’s registration statement covering theshares issuable upon conversion of the 5% Debentures and exercise of thewarrants was declared effective. Initially, the warrants were to have an exercise price of $1.50 pershare and a term of five years.  Each 5%Debenture matures three years from its date of issuance and bears interest atfive percent (5%) per annum.

 

Theconversion price of the 5% Debentures is the lower of (i) a fixedconversion price (initially $1.50) or (ii) 95% of the lowest volumeweighted average price of the common stock during the 30 trading daysimmediately preceding the conversion date. The 5% Debentures are secured pursuant to the terms of (1) a pledgeand escrow agreement among the Company, Cornell and David Gonzalez, Esq.,as escrow agent, and (2) security agreements among the Company, Cornelland two of the Company’s subsidiaries. In accordance with the pledge and escrow agreement, the Company deposited44,117,647 newly issued shares of the Company’s common stock into escrow, andgranted to Cornell a security interest in those shares to secure the Company’sobligations to Cornell under the 5% Debentures and related agreements.

 

Underthe security agreements, the Company and its subsidiaries granted to Cornell ablanket security interest in the Company’s consolidated assets.  The 5% Debentures holders agreed tosubordinate their security interests for certain transactions occurring in thenormal course of business.

 

TheCompany agreed to file with the SEC by May 15, 2006, which date theCompany refers to as the filing date, a registration statement including theshares underlying the 5% Debentures and warrants, and to use its best effortsto have such registration statement declared effective by July 29, 2006,which date the Company refers to as the effectiveness date.  If a registration statement was not filed bythe filing date or declared effective by the effectiveness date, as applicable,the Company would have become obligated to pay to Cornell, either in cash or inshares of common stock, liquidated damages equal to 1% of the liquidated valueof the 5% Debentures outstanding for each 30 day period (pro-rated for partial periods)that the registration statement was not filed or declared effective, asapplicable.  The Company is obligated tokeep the registration statement effective until all the shares have been soldor are eligible for sale without volume restrictions pursuant to Rule 144(k) promulgatedunder the Securities Act of 1933.

 

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In July 2006,the Company and Cornell agreed to amend the investment agreements describedabove, effective as of their original date, as follows:

 

·                                          Provide for afloor price of $0.05 per share on the adjustable conversion price of the 5%Debentures;

·                                          Provide for afloor price of $0.05 per share on the exercise price of the warrants applicableto adjustments with respect to certain future issuances of securities by theCompany, and upon certain distributions of assets and similar recapitalizationevents;

·                                          Extend thedeadline for having a registration statement declared effective until August 12,2006; and

·                                          Capliquidated damages payable in respect of failure to have an effectiveregistration statement at 15% of the liquidated value of the debenturesoutstanding.

 

In addition, on August 17, 2006 theCompany and Cornell agreed to further amend the investment agreements describedabove, as follows:

 

·                                          Provide forthe purchase by Cornell of $1,500,000 of the remaining 5% Debentures as of thedate of the amendment, with the remaining $3,500,000 to be purchased by Cornellupon the effectiveness of the registration statement;

·                                          Waive anybreaches of the investment agreements with Cornell related to the Company’s taxwithholding liabilities as described in Note 8 to the financial statements;

·                                          Furtherextend the deadline for having a registration statement declared effectiveuntil September 5, 2006; and

·                                          Reduce theexercise price of the warrant to be issued in connection with Cornell’spurchase of the remaining $5,000,000 of 5% Debentures to $0.80 from $1.50 pershare and increase the total number of warrant shares underlying such warrantsto 6,250,000 from 3,000,000.  Thesewarrants were issued on the date of the amendment.

 

Inaddition, Cornell granted the Company a waiver of certain of the restrictivecovenants contained in the investment agreements to permit the Company to takecertain remedial actions relative to the Company’s tax withholding liabilitiesdescribed in Note 8, including the following with respect to any officer oremployee: repurchasing vested shares, canceling any unvested shares, grantingsubstitute equity awards, or permitting such persons to sell, pledge ortransfer their shares.

 

Effectiveas of September 15, 2006, Cornell agreed to further extend the deadlinefor having the registration statement declared effective until October 31,2006, and waived the event of default set forth in each of the 5% Debentures,provided that the registration statement was declared effective on or before October 31,2006.  On October 25, 2006, Cornellagreed to reduce the aggregate number of shares of common stock that theCompany was required to register on Cornell’s behalf from 54,117,647 to18,730,000 shares.

 

On August 30,2006, the Company filed a registration statement on Form SB-2 covering,among others, the shares issuable upon conversion of the debentures andexercise of the warrants, which was declared effective on October 27, 2006(the “SB-2 registration statement”).  On October 30,2006, the Company completed the sale of the 5% $3,500,000 debenture toCornell.  We evaluated the embeddedconversion feature in the March 2006, August 2006 and October 2006debentures in accordance with the provisions of SFAS 133 and EITF 00-19, andconcluded that bifurcation of the conversion feature is not required.

 

ThroughFebruary 22, 2008, Cornell converted a total of $13,100,700 principalamounts of 5% Debentures, and the Company correspondingly issued a total of37,512,669 shares of common stock to Cornell.

 

On February 25,2008, the Company redeemed all remaining principal amounts outstanding pursuantto the 5% Debentures issued by the Company in 2006 to YA Global Investments,L.P., and its affiliates (formerly known as Cornell Capital Partners,L.P.).  The total redemption payment,which included principal, accrued interest and a redemption premium, totaledapproximately $3,143,000.  While the scheduled maturity date of the 5%Debentures was in March 2009, the 5% Debentures permitted redemption forso long as the Company’s common stock was trading below $0.05 per share, withthe payment of a redemption premium.  The Company recognized an immaterialgain on the early extinguishment.

 

*10% Debenture*

* *

On March 30,2007, the Company entered into an agreement with Cornell Capital Partners, L.P.for the private placement of (i) a Convertible Secured Debenture in theoriginal principal amount of $3,000,000 (“10% Debenture”) and (b) warrantsto purchase up to 6,000,000 shares of our common stock, which were issued andsold for an aggregate purchase price of $3,000,000.  We received gross 

 

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proceedsof $3,000,000 (before expenses) from the financing transaction, which were usedfor general corporate and working capital purposes.

 

The10% Debenture accrued interest at a rate of 10% per annum and matured one yearfrom the issuance date.  No payments ofinterest or principal are due under the 10% Debenture until maturity.  Subject to limitations contained in the 10%Debenture for the maximum amount that may be converted, the 10% Debenture isconvertible at any time at Cornell’s option into shares of our common stock atthe conversion price of $0.50 per share. The conversion price was subject to adjustment in the event we issuedshares of common stock for a consideration per share less than the conversionprice in effect immediately prior to such issuance or sale, except forissuances in connection with an approved stock plan, the conversion, exchangeor exercise of an outstanding security, an acquisition, or conversion of the10% Debenture.  The warrants issued toCornell also have an initial exercise price of $0.50 per share, subject toadjustment, and a term of five years from the issuance date.  We evaluated the embedded conversion featurein the March 2006 debenture in accordance with the provisions of SFAS 133and EITF 00-19, and concluded that bifurcation of the conversion feature is notrequired.

 

Theissuance of the March 30, 2007 debentures and warrants caused a reductionin the warrant exercise price for the previously issued Cornell warrants to$0.50 per share, and resulted in a non-cash interest charge for the year ended May 31,2007 in the amount of $396,000 for the first two warrants issued and $132,000for the third warrant issued due to the change in the estimated fair value ofthe warrants before and after the exercise price reduction as determined by theBlack Scholes option pricing model using the following assumptions: estimated volatility of 111%; risk free interest rate of 4.48%; an estimatedlife of 4 years and 4.42 years respectively, and no dividend yield.

 

On May 21,2007, the Company entered into a Letter Agreement (the “Amendment”) withCornell Capital Partners, L.P. which amended certain terms of the securedconvertible debentures issued by the Company to Cornell pursuant to aSecurities Purchase Agreement dated March 30, 2006, as amended.  Pursuant to the Amendment: (i) theownership cap set forth in Section 3(b)(i) of each debenture, whichlimits the holder’s ability to convert the debenture or receive shares ofcommon stock as payment of interest on the debenture, was increased from 4.99%to 9.99%, and (ii) the Company permanently waived the conversionlimitation set forth in Section 3(b)(ii) of each debenture, whichwould have limited the principal amount of the debenture that could beconverted at the market conversion price in any 30-day period.

 

On March 17,2008, the Company entered into an Extension Agreement with YA GlobalInvestments, L.P. (formerly Cornell Capital Partners, LP) pursuant to which theparties agreed to extend the maturity date of the 10% Debenture from March 30,2008 to April 30, 2008.

 

On April 30,2008, the Company repaid all remaining principal amounts outstanding pursuantto the series 10% Debenture.  The totalpayment, which included principal and accrued interest, totaled approximately$3.3 million.  The 10% Debenture was theonly remaining convertible debenture held by YA Global Investments in theCompany’s capital structure.

 

Discountsrecorded in connection with the value of warrants, beneficial conversionfeatures and original issue discounts in connection with the above referencedconvertible notes and warrants, is being recognized as non-cash interest overthe term of the respective debt using the effective interest method.  Upon conversion or extinguishment prior toamortization of the total discount, recognition of expense is accelerated forany previously unamortized discount.  Forthe years ended May 31, 2008 and 2007, the Company recognizedapproximately $9,989,000 and $7,080,000, respectively, of non cash interestexpense in connection with the amortization of debt discount.  The carrying value of the debentures willaccrete to the face value over the life of the debt, as the value of thediscounts is expensed.

 

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Thecarrying value of the debentures as of May 31, 2008 and 2007 has beencalculated as follows (in thousands):

 
| ** **                               | ** ** | **May 31,  2008** | ** ** | **May 31,  2007** | ** ** |
|------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Face value of debentures                 |       | $                      | 21,000     |                   | $          | 13,195 |   |
|                                     |       |                   |       |                   |       |
| Less unamortized debt discounts:         |       |                   |       |                   |       |
| Beneficial conversion feature            |       | (7,727                 | )          | (2,924                 | )          |
| Warrants                                 |       | (7,922                 | )          | (3,396                 | )          |
| Original issue discount                  |       | —                 |       | (919                   | )          |
| Debentures carrying value                |       | 5,351                  |       | 5,956                  |       |
| Less current portion                     |       | —                 |       | (1,778                 | )          |
| Long-term portion convertible debentures |       | $                      | 5,351      |                   | $          | 4,178 |   |

 

As of May 31,2008, the debentures, plus accrued interest of $220,000, are convertible into42,000,000 shares of our common stock.

 

### **Note 17 – Commitments and Contingencies**

### ** **

*Operating Leases*

* *

TheCompany conducts all of its operations from leased facilities.  Most of the leases are for 36 month terms,contain annual escalation clauses, and some provide for renewal after theexpiration of the initial term.  In mostcases, management expects that in the normal course of business, leases will berenewed or replaced by other leases.

 

Rentexpense was $456,000 and $404,000 for the years ended May 31, 2008 and2007, respectively.  Future minimumrental payments required under operating leases that have initial or remainingnon-cancelable lease terms in excess of one year as of May 31, 2008 are asfollows:

 
| 2009  |   | $       | 294,000 |   |
|-------|--------|---------|---------|--------|
| 2010  |   | 119,000 |    |
| 2011  |   | 27,000  |    |
| 2012  |   | 23,000  |    |
| 2013  |   | 13,000  |    |
| Total |   | $       | 476,000 |   |

* *

*Employment Contract*

* *

Weentered into an Employment Agreement dated August 25, 2005, between ourcompany and David Saltman whereby our company appointed Mr. Saltman asPresident and Chief Executive Officer. The term of the employment agreement is from September 15, 2005 to September 30,2008.  Pursuant to the terms of theemployment agreement, our company agreed to pay Mr. Saltman an annual basesalary of $250,000 plus annual bonuses as determined by our board of directorsand based upon our company’s financial achievements.  In connection with the original employmentagreement, on August 25, 2005, the Company issued 8,235,662 shares ofcommon stock to Mr. Saltman.  Suchshares were scheduled to vest quarterly over a three-year period commencing December 31,2005, with 686,305 shares scheduled to vest for the first 11 quarters and686,307 shares scheduled to vest in the 12th and final quarter.  On January 30, 2007, the Company and Mr. Saltmanamended the agreement to provide that all shares that were scheduled to vest onMarch 31, 2007, June 30, 2007, September 30, 2007 and December 31,2007, would instead vest ratably on March 31, 2008, June 30, 2008,and September 30, 2008.  On March 30,2008, we entered into an amendment to the employment agreement between us andDavid Saltman, our chairman and chief executive officer, which provides thatall restricted shares granted to Mr. Saltman that were scheduled to veston March 31, 2008 would vest on April 20, 2008.  On April 18, 2008, we entered into anadditional amendment to Mr. Saltman’s employment agreement which providesthat all restricted shares granted to Mr. Saltman that were scheduled tovest on: (1) April 20, 2008 would vest on May 20, 2009; (2) June 30,2008 would vest on August 20, 2009, and (3) September 30, 2008would vest on November 20, 2009. All unvested shares will be cancelled ifthe employment agreement is terminated for cause by our company or if Mr. Saltmanterminates the employment agreement other than for good reason, as defined inthe employment 

 

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agreement.  Finally, Mr. Saltman is entitled tocertain benefits, expenses, an automobile allowance and reasonable officesupport services as set out in the employment agreement.

 

If theCompany terminates the employment agreement due to the death or disability of Mr. Saltmanor for cause as defined in the employment agreement, the Company will pay Mr. Saltman,or his legal representative as applicable, a sum in cash of an amount equal tothe accrued but unpaid salary and any applicable bonuses.  If Mr. Saltman terminates the employmentagreement for good reason, as defined in the employment agreement, or if the Companyterminates the employment agreement for any reason other than for cause, then theCompany will pay Mr. Saltman a termination fee in cash of an amount inaccordance with section 6(b) of the employment agreement.

 

*Supply of Materials*

* *

Thereis currently an industry-wide shortage of semi-conductor grade silicon, anessential raw material in the production of certain of the Company’s primaryproducts.  Continued shortages of siliconused in the manufacture of the Company’s products may result in significantprice increases in PV cells or the Company’s inability to obtain needed rawmaterials on a timely basis, which could result in delays in manufacturing andadversely affect gross margins and results of operations.

 

*Dependence on Limited Number of Suppliers*

* *

TheCompany historically purchased the majority of certain raw materials andcomponents used to manufacture its products from one supplier.  Although the Company is in discussions withmultiple suppliers, it is anticipated that in the future, the Company willcontinue to depend on a limited number of suppliers.

 

*Restrictions on Dividend Payments*

* *

Certainof the Company’s investment related agreements prohibit paying dividendswithout approval.

 

### **Note 18 – Stockholders’ Equity**

### ** **

*Common Stock*

* *

In accordancewith the employment agreement with David Saltman (see Note 17), the Companygranted a total of 8,235,662 common shares that are subject to forfeiture priorto vesting.  The fair value of theseshares at the date of grant was estimated to be approximately $16,600,000 andwas originally recorded as unearned compensation.  Compensation expense for financial statementpurposes will be recognized on a straight-line basis over the term of thevesting schedule which runs through September 30, 2008.  686,305 shares vested quarterly commencing onDecember 31, 2005.  All 2007contractual vesting was deferred in connection with these shares and theremainder of the 4,804,137 unvested shares will vest ratably on March 31,2008, June 30, 2008 and September 30, 2008.  On April 18, 2008, the Company enteredinto an additional amendment to Mr. Saltman’s employment agreement whichprovided that all restricted shares granted to Mr. Saltman that werescheduled to vest on: (1) April 20, 2008 would vest on May 20,2009; (2) June 30, 2008 would vest on August 20, 2009, and (3) September 30,2008 would vest on November 20, 2009.

 

Duringthe years ended May 31, 2008 and 2007, the Company recorded $4,496,000 and$5,396,000, respectively, of expense related to these shares as stock basedcompensation expense.

 

Inaccordance with an employment agreement with an employee and former officer,the Company granted a total of 1,407,805 shares of common stock that aresubject to forfeiture prior to vesting. The fair value of these shares at the date of grant was estimated to beapproximately $2,700,000 and was originally recorded as unearnedcompensation.  Compensation expense willbe recognized on a straight-line basis over the term of the vesting schedulewhich runs through September 30, 2008. The shares vested at the rate of 117,317 shares per quarter commencingon March 15, 2006.  All 2007 vestingwas deferred in connection with these shares and the remainder of the 821,220unvested shares will vest ratably on March 31, 2008, June 30, 2008and September 30, 2008.  On April 18,2008, the Company entered into an additional amendment, which provided that allrestricted shares that were scheduled to vest on: (1) March 31, 2008and June 20, 2008 would vest on April 20, 2008, and (2) September 30,2008 would vest on October 20, 2008.

 

Duringthe years ended May 31, 2008 and 2007, the Company has recorded $992,000and $1,024,000, respectively, of expense related to these shares as stock basedcompensation expense.

 

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On January 12,2007, 5% Convertible Debentures with a face value of $200,000 were convertedinto 695,652 shares of the Company’s common stock.

 

On January 24,2007, 5% Convertible Debentures with a face value of $200,000 were convertedinto 695,652 shares of the Company’s common stock.

 

On January 27,2007, the Company entered into a Consulting Agreement with Timothy Dougherty,pursuant to which the Company issued 338,983 shares of common stock under theCompany’s 2004 Consultant Stock Plan.

 

On February 22,2007, Bank Sal. Oppenheim jr. & Cie. (Schweiz) AG converted theremaining $1,500,000 principal amount of its 0% Debentures at $0.2875 pershare.  The Company correspondinglyissued 5,217,391 shares of its common stock.

 

On March 29,2007, 5% Convertible Debentures with a face value of $200,000 were convertedinto 670,241 shares of the Company’s common stock.

 

Pursuantto the SRS Stock Purchase Agreement, the Company, prior to March 31, 2007,was required to calculate and issue post-closing earnout shares to former SRSshareholders.  The Company determinedthat 1,591,073 shares are issuable to the former SRS shareholders based on theprovisions of the SRS Stock Purchase Agreement, but the Company has not yetissued said shares.  On January 3,2007, the Company recorded additional goodwill and an accrued liability of$732,000 in connection with the final post-closing transaction.  Further, in accordance with the SRS StockPurchase Agreement, the Company is required to register the shares ofRegistrable Stock (as defined in the SRS Stock Purchase Agreement) prior to thefirst anniversary of the closing of said purchase and use its best efforts tohave that registration statement declared effective by the SEC within the timeprescribed in the SRS Stock Purchase Agreement. On March 7, 2008, the Company entered into a settlement and generalrelease agreement with the former stockholders of Solar Roofing Systems, Inc.to settle certain disagreements related to the rights and liabilities of theCompany and the SRS Stockholders.  TheCompany agreed to issue an aggregate of 2,202,594 shares of common stock underthe terms of the settlement agreement, of which 1,834,554 shares remain to beissued as of May 31, 2008.

 

On April 13,2007, 5% Convertible Debentures with a face value of $800,000 were convertedinto 2,751,978 shares of the Company’s common stock.

 

On May 15,2007, 5% Convertible Debentures with a face value of $600,000 were convertedinto 2,063,983 shares of the Company’s common stock.

 

On May 16,2007, 5% Convertible Debentures with a face value of $200,000 were convertedinto 687,994 shares of the Company’s common stock.

 

On May 22,2007, Cornell exercised warrants associated with the 5% Convertible Debenturesand the Company issued 1,000,000 shares of common stock.

 

On May 22,2007, 5% Convertible Debentures with a face value of $1,100,000 were convertedinto 3,670,337 shares of the Company’s common stock.

 

On May 31,2007, 5% Convertible Debentures with a face value of $305,000 were convertedinto 969,793 shares of the Company’s common stock.

 

On June 14,2007, 5% Convertible Debentures with a face value of $900,000 were convertedinto 2,857,143 shares of the Company’s common stock.

 

On June 21,2007, 5% Convertible Debentures with a face value of $240,000 were convertedinto 735,971 shares of the Company’s common stock.

 

On July 20,2007, 5% Convertible Debentures with a face value of $357,449 were convertedinto 926,514 shares of the Company’s common stock.

 

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On July 24,2007, 5% Convertible Debentures with a face value of $221,610 were convertedinto 574,417 shares of the Company’s common stock.

 

On August 8,2007, 5% Convertible Debentures with a face value of $1,475,941 were convertedinto 3,825,664 shares of the Company’s common stock.

 

On August 15,2007, 5% Convertible Debentures with a face value of $575,000 were convertedinto 1,490,410 shares of the Company’s common stock.

 

On August 21,2007, 5% Convertible Debentures with a face value of $2,500,000 were convertedinto 6,480,041 shares of the Company’s common stock.

 

On August 27,2007, 5% Convertible Debentures with a face value of $500,000 were convertedinto 1,180,359 shares of the Company’s common stock.

 

On October 8,2007, 5% convertible debentures with a face value of $800,000 were convertedinto 1,826,484 shares of the Company’s common stock.

 

On February 14,2008, 5% convertible debentures with a face value of $241,900 were convertedinto 1,000,000 shares of the Company’s common stock and on February 22,2008, 5% convertible debentures with a face value of $483,800 were convertedinto 2,000,000 shares of the Company’s common stock.

 

*Warrant Activity for the Period and Summaryof Outstanding Warrants*

* *

OnJune 30, 2006, pursuant to a technology license agreement, the Companyissued a warrant exercisable for 2,233,438 shares of common stock at anexercise price of $1.50. The warrant has a seven year term.

 

In July 2006,the Company and Cornell agreed to amend investment agreements and reduced theexercise price of the warrant to be issued in connection with the purchase ofthe remaining $5,000,000 of 5% Debentures to $0.80 from $1.50 per share andincrease the total number of warrant shares underlying such warrants to6,250,000 from 3,000,000. These warrants were issued on the date of the amendmentand have a five year term.

 

On March 30,2007, warrants to purchase up to 6,000,000 shares of our common stock wereissued in connection with the 10% Debentures. The warrants have an initial exercise price of $0.50 per share, subjectto adjustment, and a term of five years from the issuance date.

 

During the year ended May 31, 2007, a warrant holder exercisedwarrants to purchase 1,000,000 shares of the Company’s common stock for anaggregate of $500,000.

 

On June 15,2007, the Company issued warrants to acquire 4,000,000 shares of the Company’scommon stock, subject to anti-dilution provisions, a floor exercise price of$0.05 per share and have a three year term. In addition, a warrant to purchase 400,000 shares of common stock at therate of $0.50 per share that expires on June 15, 2012, was issued to aninvestment banker for services rendered in connection with the financing.

 

On August 31,2007 the Company issued warrants to acquire 1,200,000 shares of the Company’scommon stock at an exercise price of $0.709, subject to adjustment according tothe anti-dilution provisions, provided that, in no event shall the exerciseprice be reduced to less than five cents ($0.05) per share (such floor price tobe adjusted in the same manner that the exercise price is adjusted).  In addition, a warrant to purchase 72,000shares at $0.709 per share was issued to an investment banker for servicesrendered in connection with the financing. All warrants issued in connection with the 8/31/07 Note have a five yearterm.

 

On September 19,2007, the Company issued warrants to acquire 40,000,000 shares of the Company’scommon stock at an exercise price of $0.506, which is subject toadjustment.  The 9/19/07 Warrant expires 84 months after the initialclosing date of September 19, 2007.  In addition, a separate warrantto purchase 1,600,000 shares of common stock at $0.50 per share was issued toan investment banker for services rendered in connection with thefinancing.  On April 17, 2008, weissued warrants to the holder of our 9/19/2007 

 

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Noteto acquire a total of 3,003,370 shares of our common stock with an exerciseprice of $0.506 per share in lieu of accrued and unpaid interest that was inarrearage.  The other terms of such warrants are substantially the same asthe 9/19/07 Warrants.

 

On December 7,2007, the Company issued warrants to acquire 2,000,000 shares of the Company’scommon stock at an exercise price of $0.506 per share, subject to adjustment,including anti-dilution protection.  Inaddition, the Company issued warrants to acquire 80,000 shares of common stockwith an exercise price of $0.50 per shares was issued to its placementagents.  On May 1, 2008, we issuedwarrants to acquire a total of 44,667 shares of our common stock with anexercise price of $0.506 per share to a holder in lieu of accrued and unpaidinterest that was in arrearage.  Allwarrants issued in connection with the 12/7/07 Note have a seven year term.

 

On April 30,2008, the Company issued warrants to acquire 615,171 shares of the Company’scommon stock upon funding of $1,550,000 against the 4/30/08 Note.  Interest on the 4/30/08 Note is payable inwarrants to acquire shares of the Company’s common stock with an exercise priceof $0.506 per share.  The total number ofwarrants that may be issued, assuming the maximum Loan amount of $3,500,000 isfunded is 1,389,096, which the parties agreed equates to an 18% per annuminterest rate on the Loan.  The warrantshave a seven-year term.

 

Duringthe year ended May 31, 2008, warrant holders exercised warrants topurchase 879,251 shares of the Company’s common stock for an aggregate of$253,000.

 

Asummary of warrant activity for the years ended May 31, 2008 and 2007 isas follows:

 
| ** **                                    | ** ** | ** **         | ** ** | **Initial**  | ** ** | **Current**  | ** ** | ** **               | ** **                                                                                                    |
|-----------------------------------------------|------------|--------------------|------------|--------------|------------|--------------|------------|--------------------------|---------------------------------------------------------------------------------------------------------------|
| ** **                                    | ** ** | **Number of** | ** ** | **Exercise** | ** ** | **Exercise** | ** ** | ** **               | ** **                                                                                                    |
| ** **                                    | ** ** | **Warrants**       | ** ** | **Price**    | ** ** | **Price**    | ** ** | **Expiration Date** | ** **                                                                                                    |
| Outstanding at May 31, 2006              |       | 9,354,261          |       |         |       |         |       |                     |                                                                                                          |
| Granted                                       |       | 2,233,438          |       | $            | 1.5000     |         | $          | 1.5000                   |                                                                                                          | June 30, 2013 |   |
| Granted                                       |       | 6,250,000          |       | $            | 0.8000     |         | $          | 0.5000                   |                                                                                                          | August 17, 2011 |   |
| Granted                                       |       | 6,000,000          |       | $            | 0.5000     |         | $          | 0.5000                   |                                                                                                          | March 29, 2012 |   |
| Exercised                                     |       | (1,000,000         | )          | $            | 0.5000     |         | $          | 0.5000                   |                                                                                                          |   |   |
| Outstanding at May 31, 2007              |       | 22,837,699         |       |         |       |         |       |                     |                                                                                                          |
| Granted                                       |       | 400,000            |       | $            | 0.5000     |         | $          | 0.5000                   |                                                                                                          | June 15, 2010 |   |
| Granted                                       |       | 4,000,000          |       | $            | 0.5000     |         | $          | 0.5000                   |                                                                                                          | June 15, 2012 |   |
| Granted                                       |       | 1,272,000          |       | $            | 0.7090     |         | $          | 0.7090                   |                                                                                                          | August 31, 2012 |   |
| Granted                                       |       | 41,600,000         |       | $            | 0.5060     |         | $          | 0.5060                   |                                                                                                          | September 19, 2014 |   |
| Granted                                       |       | 3,003,370          |       | $            | 0.5060     |         | $          | 0.5060                   |                                                                                                          | April 16, 2015 |   |
| Granted                                       |       | 615,171            |       | $            | 0.5060     |         | $          | 0.5060                   |                                                                                                          | April 19, 2015 |   |
| Granted                                       |       | 2,080,000          |       | $            | 0.5060     |         | $          | 0.5060                   |                                                                                                          | December 6, 2010 |   |
| Granted                                       |       | 44,667             |       | $            | 0.5060     |         | $          | 0.5060                   |                                                                                                          | April 30, 2011 |   |
| Exercised                                     |       | (879,251           | )          | $            | 2.2300     |         | $          | 0.2875                   |                                                                                                          |   |   |
| Outstanding at May 31, 2008              |       | 74,973,656         |       |         |       |         |       |                     |                                                                                                          |
|                                          |       |               |       |         |       |         |       |                     |                                                                                                          |
| Outstanding at May 31, 2008 consists of: |       |               |       |         |       |         |       |                     |                                                                                                          |
|                                          |       | 1,475,010          |       |         |       | $            | 0.2419     |                     | January 31, 2011                                                                                         |   |
|                                          |       | 2,233,438          |       |         |       | $            | 1.5000     |                     | June 30, 2013                                                                                            |   |
|                                          |       | 1,272,000          |       |         |       | $            | 0.7090     |                     | August 31, 2012                                                                                          |   |
|                                          |       | 47,343,208         |       |         |       | $            | 0.5060     |                     | September 19, 2014, December 6, 2010, April 16, 2015,  April 19, 2015, and April 30, 2011 |   |
|                                          |       | 22,650,000         |       |         |       | $            | 0.5000     |                     | March 31, 2011, August 17, 2011, March 29, 2012,  June 15, 2010 and 2012                  |   |
|                                          |       | 74,973,656         |       |         |       |         |       |                     |                                                                                                          |

 

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Weevaluated the outstanding warrants in accordance with the provisions of EITF00-19 and concluded that classification of the fair value of the warrants asequity at May 31, 2008 was appropriate.

 

*Consultant Compensation Plan*

* *

Underthe Company’s 2004 Consultant Compensation Plan, the Board of Directors isauthorized to issue up to 9,771,000 shares to consultants without furthershareholder approval.  On January 27,2007, the Company entered into a Consulting Agreement with Timothy Dougherty,pursuant to which the Company issued 338,983 shares of common stock under theCompany’s 2004 Consultant Stock Plan. As of May 31, 2008, a total of9,432,017 shares issued pursuant to the plan were outstanding.

 

Duringthe years ended May 31, 2008 and 2007, the Company recorded $0 and$194,000, respectively, of expense related to these shares as stock basedcompensation expense.

 

*Shares Issued for Services*

* *

Duringthe year ended May 31, 2007, the Company recorded $766,000 of expenserelated to shares issued for services as stock based compensation expense.  During the year ended May 31, 2007, atotal of 62,500 shares of common stock were issued to employees as part oftheir employment agreements and the Company recorded $69,000 of expense relatedto these shares as stock based compensation expense.  No such issuances occurred during the yearended May 31, 2008 and the Company recorded $0 of expense.

 

*Shares to be Issued*

* *

Weentered into two employment agreements, one of which was with an officer of theCompany, calling for the periodic issuances of common stock as partialemployment compensation.  Under theseagreements, we committed to issue an aggregate of 225,000 shares, issuance andvesting taking place on a quarterly basis. The Company has recorded $2,000 and $35,000 during the years ended May 31,2008 and 2007, respectively, related to these two agreements which have beenrecorded as selling, general and administrative expenses in the accompanyingstatement of operations. In the years ended May 31, 2008 and 2007,respectively, the Company issued 6,250 and 62,500 shares. During the yearending May 31, 2008, remaining shares of 143,750 were cancelled.

 

### **Note 19 - Accounting for Stock-Based Compensation**

### ** **

On November 2,2006, the Board of Directors adopted the Open Energy Corporation 2006 EquityIncentive Plan (the “Plan”), which provides for the granting of stock andnon-stock based compensation awards, including options, stock awards, stock appreciationrights, and cash awards to employees, officers, directors or consultants.  The Board of Directors approved an originalallocation of 8,500,000 shares to the Plan that was subsequently expanded to16,500,000 shares as of August 31, 2007. As of May 31, 2008, 1,029,614 shares remained available for futuregrant under the Plan.  Options generallyvest over a three year period and expire ten years from the date of grant**.** Options granted under the Plan have exercise prices ranging from $0.31to $0.58 per share.

 

On August 31,2007, an option for 1,000,000 shares (500,000 options were subsequentlycancelled) was granted to our Chief Executive Officer, outside of the Plan inconnection with guarantees made by him in connection with the 6/15/07 Note.  Based on the weighted average fair value ofthe options of $0.40 per share, the grant resulted in stock-based compensationexpense of $200,000 for the year ended May 31, 2008.

 

Duringthe years ended May 31, 2008 and 2007, the Company granted a total of 13,070,000and 7,079,193 options, respectively.  The aggregate fair value of theoptions granted was $6,049,269 and $1,974,350 during the years ended May 31, 2008 and 2007, respectively, themajority of which will be amortized as stock compensation expense over 3 years.

 

Theweighted average estimated fair value of stock options granted during the yearsended May 31, 2008 and 2007 was $0.47 and $0.27 per share, respectively,using the Black-Scholes option pricing model. The Company used the following weighted average assumptions for theyears ended May 31, 2008 and 2007:

 

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| ** **              | ** ** | **May 31,  2008** | ** ** | **May 31,  2007** | ** ** |
|-------------------------|------------|------------------------|------------|------------------------|------------|
| Dividend yield          |       | 0.0                    | %          | 0.0                    | %          |
| Expected volatility     |       | 123                    | %          | 70                     | %          |
| Risk-free interest rate |       | 4.18                   | %          | 4.56 – 4.69       | %          |
| Expected life in years  |       | 6                      |       | 6                      |       |
| Forfeiture Rate         |       | 8.26                   | %          | 0.0                    | %          |

 

Stock-basedcompensation expense in connection with options vesting during the years ended May 31,2008 and 2007 was $4,154,000 and $765,000, respectively.  During the year,the Company modified approximately 5,202,000 options of certain employees and aformer director, which included accelerated vesting, repricing and extension ofthe post-employment exercise period.  Since expected vesting for themajority of the modified options was determined to be improbable at the date ofthe modifications, the net change to stock compensation cost as a result of themodifications was a reduction of $209,285.

 

Asummary of the changes in options outstanding during the years ended May 31,2008 and 2007 is as follows:

 
| **Option**                       | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at May 31, 2006 |       | —     |       | $                                      | —     |                                                | —     |                            | $          | — |   |
| Granted                          |       | 7,079,193  | (1)        | 0.52                                   |       | 9.06                                                |       |                            |       |
| Exercised                        |       | —     |       | —                                 |       |                                                |       |                            |       |
| Cancelled                        |       | (214,583   | )          | 0.53                                   |       |                                                |       |                            |       |
| Forfeited                        |       | (640,000   | )          | 0.39                                   |       |                                                |       |                            |       |
|                             |       |       |       |                                   |       |                                                |       |                            |       |
| Outstanding at May 31, 2007 |       | 6,224,610  |       | $                                      | 0.53       |                                                | 9.54       |                            | $          | — |   |
|                             |       |       |       |                                   |       |                                                |       |                            |       |   |   |
| Granted                          |       | 13,070,000 | (2)        | 0.48                                   |       | 9.37                                                |       |                            |       |
| Exercised                        |       | —     |       | —                                 |       |                                                |       |                            |       |
| Cancelled                        |       | (577,000   | )          | 0.57                                   |       |                                                |       |                            |       |
| Forfeited                        |       | (1,147,224 | )          | 0.45                                   |       |                                                |       |                            |       |
|                             |       |       |       |                                   |       |                                                |       |                            |       |
| Outstanding at May 31, 2008 |       | 17,570,386 |       | 0.50                                   |       | 9.06                                                |       |                            |       |
|                             |       |       |       |                                   |       |                                                |       |                            |       |
| Exercisable at May 31, 2008 |       | 8,383,962  |       | $                                      | 0.48       |                                                | 8.82       |                            | $          | — |   |
|                                  |            |            |            |                                        |            |                                                     |            |                                 |            |  |  |  |  |

 

----

(1)                  Includes anoption for 1,827,000 shares that was granted under the terms of a ConsultingAgreement with Connect by Computer, LLC, outside of the plan, in connectionwith the achievement of certain product development, commercialization, andintellectual property milestones, of which 1,600,000 options are vested, and227,000 were cancelled effective October 31, 2007.

 

(2)                  Includes anoption for 1,000,000 shares that was granted to our Chief Executive Officer,outside of the plan, in connection with the 6/15/07 Note, of which 500,000options are vested and 500,000 were cancelled upon repayment of the 6/15/07Note on October 5, 2007

 

As of May 31,2008, the total remaining unrecognized compensation cost related to unvestedstock options amounted to $2,265,580, which is expected to be recognizedover a weighted-average period of 2.21 years.

 

Asummary of nonvested stock options as of May 31, 2008 and 2007 is asfollows:

 

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| **Nonvested Shares**      | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|--------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
| ** **                     | ** ** | ** ** | ** ** | ** **                                              | ** ** |
| Nonvested at May 31, 2006 |       | —     |       | —                                                  |       |
| Granted                        |       | 7,079,193  |       | 0.27                                                    |       |
| Vested                         |       | (1,686,016 | )          | 0.29                                                    |       |
| Cancelled                      |       | (214,583   | )          | 0.31                                                    |       |
| Forfeited                      |       | (640,000   | )          | 0.24                                                    |       |
|                           |       |       |       |                                                    |       |
| Nonvested at May 31, 2007 |       | 4,538,594  |       | $                                                       | 0.29       |   |
| Granted                        |       | 13,070,000 |       | 0.47                                                    |       |
| Vested                         |       | (6,697,946 | )          | 0.38                                                    |       |
| Cancelled                      |       | (577,000   | )          | 0.46                                                    |       |
| Forfeited                      |       | (1,147,224 | )          | 0.40                                                    |       |
|                           |       |       |       |                                                    |       |
| Nonvested at May 31, 2008 |       | 9,186,424  |       | $                                                       | 0.35       |   |

* *

*Restricted Stock*

* *

Inaccordance with their employment agreements, certain of the Company’s officersand a non-executive employee were awarded restricted stock grants thatinitially vested over periods ranging from 2.75 to 3.00 years.  Stockcompensation expense recognized in connection with these grants during the yearended May 31, 2008 and 2007 was approximately $5,488,000 and $6,420,000,respectively.

 

On March 30,2008, the Company entered into an amendment to the employment agreement betweenthe Company and David Saltman, Chairman and Chief Executive Officer, whichprovided that all restricted shares granted to Mr. Saltman that werescheduled to vest on March 31, 2008 would vest on April 20,2008.  On April 18, 2008, the Company entered into an additionalamendment to Mr. Saltman’s employment agreement which provided that allrestricted shares granted to Mr. Saltman that were scheduled to vest on: (1) April 20,2008 would vest on May 20, 2009; (2) June 30, 2008 would vest onAugust 20, 2009, and (3) September 30, 2008 would vest on November 20,2009 (See Note 18).

 

As of May 31,2008, there was approximately $3,071,000 of total unrecognized compensationcost related to nonvested restricted stock awards, which is expected to berecognized over a weighted-average period of 1.5 years.

 

Stockbased compensation recognized during the years ended May 31, 2008 and 2007related to common stock granted for services was $3,000 and $233,000,respectively.

 

### **Note 20  –Income Taxes**

### ** **

On July 13,2006, the FASB issued Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109*(“FIN 48”), which clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements in accordance with SFAS no. 109,*Accounting for Income Taxes* andprescribes a recognition threshold and measurement attributes for financial statementdisclosure of tax positions expected to be taken on a tax return.  Under FIN 48, the impact of an uncertainincome tax position on the income tax return must be recognized at the largestamount that is more-likely-than-not to be sustained upon audit by the relevanttaxing authority.  An uncertain incometax position will not be recognized if it has less than a 50% likelihood ofbeing sustained.  Additionally, FIN 48provides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure and transition.  FIN 48 was effective for fiscal yearsbeginning after December 15, 2006.

 

TheCompany adopted the provisions of FIN 48 on June 1, 2007, and hascommenced analyzing filing positions in all of the federal and statejurisdictions where it is required to file income tax returns, as well as allopen tax years in these jurisdictions. As a result of adoption, the Company hasrecorded no additional tax liability. As of May 31, 2008, the Company hasnot yet completed its analysis of the deferred tax assets for net operatinglosses of $40 million. As such, these amounts and the offsetting valuationallowance have been removed from the Company’s deferred tax assets. The Companywill complete a Section 382 analysis regarding the limitation of the netoperating loss if the Company anticipates utilizing the loss carryforward.

 

Due tothe existence of the valuation allowance, future changes in our unrecognizedtax benefits will not impact the Company’s effective tax rate.

 

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TheCompany is subject to taxation in the U.S. and state jurisdictions. The Company’stax years for 2002 and forward are subject to examination by the US, Canada andCalifornia tax authorities due to the carryforward of unutilized net operatinglosses. The Company is currently under examination by any taxing authorities.

 

TheCompany’s practice is to recognize interest and/or penalties related to incometax matters in income tax expense. During the twelve months ended May 31, 2008, the Company did notrecognize any interest or penalties. Upon adoption of FIN 48 on June 1, 2007, the Company did not recordany interest or penalties.

 

Theadoption of FIN 48 did not impact the Company’s financial condition, results ofoperations or cash flows. At May 31, 2008, the Company had net deferredtax assets of $5.4 million.  Due touncertainties surrounding the Company’s ability to generate future taxableincome to realize these assets, a full valuation has been established to offsetthe net deferred tax asset. Additionally, the future utilization of the Company’s net operating lossto offset future taxable income may be subject to an annual limitation as aresult of ownership changes that may have occurred previously or that couldoccur in the future.  The Company has notyet determined whether such an ownership change has occurred; however theCompany will complete a Section 382 analysis regarding the limitation ofthe net operating loss if the Company generates taxable income.  Until this analysis has been completed, theCompany has removed the deferred tax assets associated with these carryforwardsfrom its deferred tax asset schedule and has recorded a corresponding decreaseto their valuation allowance.  When the Section 382analysis is completed, the Company plans to update its unrecognized taxbenefits under FIN 48.

 
| ** **                                         | ** ** | **May 31, 2008** | ** ** | **May 31, 2007** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | **US**                     | ** ** | **Foreign**                | ** ** | **Total** | ** ** | **US** | ** ** | **Foreign** | ** ** | **Total** | ** ** |
| Deferred tax assets                                |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Net operating loss                                 |       | $                          |       |                       | $          |   |   | $ |   |   | $ | 7,563 |   | $ | 1,677 |   | 9,240 |   |
| Inventory                                          |       | 273                        |       | —                     |       | 273 |   | 763 |   | — |   | 763 |   |
| Warranty                                           |       | 69                         |       | —                     |       | 69 |   | 602 |   | — |   | 602 |   |
| Deferred compensation                              |       | 4,582                      |       | —                     |       | 4,582 |   | 2,394 |   | — |   | 2,394 |   |
| Impairment of note receivable                      |       | 272                        |       | —                     |       | 272 |   | 272 |   | — |   | 272 |   |
| Other                                              |       | 232                        |       | —                     |       | 232 |   | — |   | — |   | — |   |
| Credits                                            |       | 64                         |       | —                     |       | 64 |   | 208 |   | — |   | 208 |   |
| Total gross deferred tax assets                    |       | 5,492                      |       | —                     |       | 5,492 |   | 11,802 |   | 1,677 |   | 13,479 |   |
| Valuation allowance                                |       | (5,492                     | )          |                       |       | (5,492 | ) | (11,802 | ) | (1,677 | ) | (13,479 | ) |
| Net deferred tax assets                            |       | $                          | —     |                       | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                               |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Deferred tax liabilities                           |       |                       |       |                       |       |   |   |   |   |   |   |   |   |
| Intangible assets                                  |       | $                          | (759       | )                          | $          | (112 | ) | $ | (871 | ) | $ | (452 | ) | $ | (139 | ) | $ | (591 | ) |
| Goodwill                                           |       | —                     |       | —                     |       | — |   | — |   | — |   | — |   |
| Beneficial conversion feature of  convertible debt |       | (3,072                     | )          | —                     |       | (3,072 | ) | (1,161 | ) | — |   | (1,161 | ) |
| Total deferred tax liabilities                     |       | $                          | (3,831     | )                          | $          | (112 | ) | $ | (3,943 | ) | $ | (1,613 | ) | $ | (139 | ) | $ | (1,752 | ) |
|                                                    |            |                            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Areconciliation of the expected tax computed at the U.S. federal statutoryincome tax rate to the total benefit for income taxes at May 31, 2008 and2007 is as follows (in thousands):

 
| ** **                           | ** ** | **Years ended May 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Expected tax at 34%                  |       | $                                      | (12,373    | ) | (34.00 | )% | $ | (14,559 | ) | (34.00 | )% |
| State income tax, net of federal     |       | (2,123                                 | )          | (5.83 | )% | (2,498 | ) | (5.83 | )% |
| Change in valuation allowance        |       | 9,478                                  |       | 26.03 | % | 9,119 |   | 21.30 | % |
| Intangibles                          |       | 244                                    |       | .67 | % | 2,805 |   | 6.56 | % |
| Non-deductible expenses              |       | 42                                     |       | .12 | % | 87 |   | 0.20 | % |
| Warrants                             |       | 2,092                                  |       | 5.75 | % | 1,527 |   | 3.56 | % |
| Recapture of BCF                     |       | (467                                   | )          | (1.28 | )% | — |   | — |   |
| Stock options                        |       | 1,655                                  |       | 4.55 | % | 305 |   | 0.70 | % |
| Other                                |       | —                                 |       | — |   | (48 | ) | (0.11 | )% |
|                                 |       |                                   |       |   |   |   |   |   |   |
| Provision (benefit) for income taxes |       | $                                      | (1,452     | ) | (3.99 | )% | $ | (3,262 | ) | (7.62 | )% |

 

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At May 31,2008, the Company had federal and California tax net operating losscarryforwards of approximately $40.00 and $41.00 million, respectively.  The federal and California tax loss carryforwardswill begin to expire in 2019 and 2009, respectively, unless previouslyutilized.

 

Pursuantto Internal Revenue Code Section 382, use of the Company’s net operating losscarryforwards may be limited if a cumulative change in ownership of more than50% occurs within a three-year period.

 

### **Note 21 – Restructuring Costs**

### ** **

On December 13,2007, the Company adopted a plan to shut down operations at its Aurora, Ontariofacility in Canada (the “Plan”).  The Plan was substantially complete asof January 31, 2008.  The Plan did not involve the discontinuance ofany business line.  The Company is continuing development andmanufacturing of its SolarSave membrane product, which was historicallymanufactured at its Aurora facility.  In connection with the Plan, the companyterminated 28 of the 30 full-time employees at the Aurora facility. Pursuant to the Plan, existing operations and specified assets at the Aurorafacility were transferred to the Company’s Grass Valley, Californiafacility.  The Company sold certain of the assets located at the Aurorafacility.

 

TheCompany recorded total costs associated with the Plan of $849,000.  TheCompany incurred $272,000 related to employee termination costs, $210,000 forasset impairment and relocation costs, $171,000 for lease and lease settlementcosts and $196,000 in legal and administrative costs.  At May 31,2008, $68,000 representing lease settlement costs remained outstanding and waspaid monthly through July, 2008.  The following schedule summarizes therestructuring activity for the year ended May 31, 2008.

 
| **Canada Restructuring Accrual:** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| Balance as of May 31, 2007             |       | $          | —     |   |
|                                        |       |       |       |
| Provision                                   |       | 849        |       |
| Payments                                    |       | (781       | )          |
|                                        |       |       |       |
| Balance as of May 31, 2008             |       | $          | 68         |   |

### ** **

### **Note 22 – SubsequentEvents**

### ** **

*12/7/2007 Notes*

* *

On August 29, 2008, we issued warrantsto one of the holders of our 12/7/2007 Notes to acquire a total of 44,667shares of our common stock with an exercise price of $0.506 per share in lieuof accrued and unpaid interest that was in arrearage.  The other terms ofsuch warrants are substantially the same as the 12/7/07 Warrants (see Note 16).

 

*4/30/2008 Note*

* *

On June 3 and June 10, 2008, theCompany was funded the remaining $1,950,000 under the 3,500,000 Loan, bringingthe total amount borrowed under this loan to $3.5 million.  There is no additional borrowing capacityunder this loan.  As of August 15,2008, the Company has made partial prepayments on the loan of $152,000. On June 3and June 10, 2008, we issued warrants to the holder of our 4/30/2008 Noteto acquire a total of 773,925 shares of our common stock in lieu of accrued andunpaid interest that was in arrearage.

 

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*Securities Purchase Agreement*

 

On September 12, 2008, weentered into a definitive securities purchase agreement with The QuercusTrust.  The securities purchase agreement provides for the purchase byQuercus of warrants to acquire 235,000,000 shares of the Company’s common stockat a purchase price of $0.02 per warrant share for a total of $4.2 million ofcash, $300,000 of forgiveness of accrued interest on the Series BConvertible Notes held by Quercus and a $200,000 restructuring fee for theamendment of certain terms of the $3.5 million secured loan previously extendedto the Company by Quercus. The warrants would have an exercise price equalto $0.067 per share and a term of seven years. The secured loan would beamended to (1) extend the maturity date of the secured loan from October 2008to March 2009, (2) reduce the borrowing base collateral requirementto 100% of the outstanding loan amount, and (3) eliminate the requirementthat the Company make prepayments of the secured loan with the proceeds ofCalifornia state solar rebates received by the Company. The closing of thefinancing under the securities purchase agreement is subject to customaryconditions precedent that have not been satisfied as of the date of thisreport.

 

In addition, the securities purchase agreement amended certainprovisions of the Company’s outstanding Series B Convertible Notes held byQuercus and other holders, which amendments (A) provide that futureinterest payments shall be made in the form of warrants in the form of thoseissued in this financings, (B) add additional protective covenants, (C) providefor the granting of voting rights to the holders of the Series BConvertible Notes, upon the amendment of the Company’s articles ofincorporation.  The closing of thetransactions described in the securities purchase agreement are subject toseveral conditions, including the execution and delivery of retention and otheragreements with members of the Company’s senior management.

 

*Forbearance and Repayment Agreement*

* *

On September 12, 2008, the Company entered into a forbearance andrepayment agreement with Suntech, the Company’s largest supplier. Theforbearance agreement provides for a payment plan for approximately $3 millionof payables currently due from the Company to Suntech with interest at 12% perannum. Pursuant to the forbearance agreement, the Company agreed to pay $1million on or prior to September 19, 2008, $500,000 on or prior to January 15,2009, and six payments of $297,558 on a monthly basis beginning on March 15, 2009,until the entire amount is paid in full.

 
| **ITEM 9.** | ** ** | **CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE** |
|-------------|------------|-------------------------------------------------------------------------------------------|

 

**None.**

 
| **ITEM 9A(T).** | ** ** | **CONTROLS AND PROCEDURES** |
|-----------------|------------|-----------------------------|

 

We conducted an evaluation under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures.  The term “disclosure controls and procedures,”as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by the company in the reports it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms.  Disclosure controls and procedures alsoinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal executive and principal financialofficers, or persons performing similar functions, as appropriate, to allowtimely decisions regarding required disclosure.

 

Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer have concluded that our disclosure controlsand procedures were not effective as of May 31, 2008 at the reasonableassurance level for the reasons discussed below related to material weaknessesin our internal control over financial reporting.

 

**Management’sReport on Internal Control Over Financial Reporting**

** **

Our management is responsible forestablishing and maintaining adequate internal control over financial reporting(“ICFR”) as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act.  Our ICFR is intended toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith accounting principles, generally accepted in the United States of America(“GAAP”).  Our ICFR includes thosepolicies and procedures that:

 
| 1.     |   | pertain to  the maintenance of records that in reasonable detail accurately and fairly  reflect the transactions and dispositions of our assets;                                                                                                                                         |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                     |
| 2.     |   | provide  reasonable assurance that transactions are recorded as necessary to permit  preparation of financial statements in accordance with GAAP, and that our  receipts and expenditures are being made only in accordance with the  authorization of our management and directors; and |

 

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| 3. |   | provide reasonable  assurance regarding prevention or timely detection of unauthorized  acquisition, use or disposition of our assets that could have a material  effect on the financial statements. |
|----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Ourmanagement, including our Chief Executive Officer and Chief Financial Officer,does not expect that our disclosure controls and procedures or ICFR willprevent all errors or all instances of fraud. A control system, no matter howwell designed and operated, can provide only reasonable, not absolute,assurance that the control system’s objectives will be met. Further, the designof a control system must reflect the fact that there are resource constraints,and the benefits of controls must be considered relative to their costs.Because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that all control issues and instancesof fraud, if any, within our company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty, and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part upon certain assumptionsabout the likelihood of future events, and any design may not succeed inachieving its stated goals under all potential future conditions. Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures. Becauseof the inherent limitation of a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected.

 

Management,in conjunction with a third-party consultant, initiated its assessment of theeffectiveness of our internal control over financial reporting as of May 31,2008 based on the framework set forth in the report entitled *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission,or COSO.  However, because of our limitedstaff and financial resources, this assessment was not completed by the filingdate of this annual report.

 

A material weakness is a deficiency, or acombination of deficiencies, in internal control over financial reporting, suchthat there is reasonable possibility that a material misstatement of theCompany’s annual or interim financial statements will not be prevented ordetected on a timely basis.

 

Based on work completed to date andinformation known to management, we have concluded that our internal controlover financial reporting as of May 31, 2008 was not effective because ofthe following material weaknesses that have been identified:

 
|   | 1.     | we have not  completed the design and implementation of effective internal control  policies and procedures necessary to provide reasonable assurance regarding  the preparation of financial statements in accordance with GAAP;                                                                                                                                                                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 2.     | we did not  maintain sufficient in-house personnel resources with the technical  accounting knowledge, expertise and training in the selection, application  and implementation of GAAP to certain complex or non-routine transactions;                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 3.     | we have not  completed the design and implementation of effective internal control  policies and procedures necessary to provide reasonable assurances regarding  accurate and timely financial accounting, recording and reporting of routine  and non-routine commitments and transactions and effective management  oversight of the accounting for routine and non-routine transactions, or to  monitor the effectiveness of our internal controls; |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 4.     | we have not  completed the design and implementation of effective internal control  policies and procedures necessary to provide reasonable assurance regarding  accurate and timely period end financial closing and reporting;                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 5.     | we did not  maintain adequate segregation of duties for staff members responsible for  certain financial accounting and reporting functions;                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 6.     | we have not  completed the design and implementation of effective internal control  policies and procedures related to risk assessment and fraud prevention and  detection activities;                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 7.     | we have not  completed the design and implementation of effective internal control  policies and procedures necessary to provide reasonable assurance regarding  the accuracy and integrity of spreadsheets and other “off system” work papers  that are used in the financial accounting process; and                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 8.     | we have not  completed the design and implementation of internal control policies and  procedures necessary to provide reasonable assurance with respect to the  accuracy and completeness of assertions and disclosures related to  significant financial statement accounts, and with respect to IT general and  application controls.                                                                                                                |

 

It ispossible had we been able to complete our assessment of ICFR that additionalmaterial weaknesses may have been identified. We are in the process ofattempting to remediate the above noted material weaknesses, but thatremediation was not complete as of May 31, 2008 or the filing date of thisreport.

 

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Ourplans to remediate the identified material weaknesses include: developingaction plans to complete the implementation of internal controls necessary tocorrect each such weakness; assessing the need to take additional actionsincluding, but not limited, to the following: evaluate accounting and controlsystems to identify opportunities for enhanced controls;  recruit and hire additional staff to providegreater segregation of duties;  evaluatethe need for other employee changes; expand executive management’s ongoingcommunications regarding the importance of adherence to internal controls andcompany policies; and evaluate such other actions as our advisors mayrecommend.

 

Managementdoes not believe that any of the Company’s annual or interim financialstatements issued to-date contain a material misstatement as a result of theaforementioned weaknesses in our ICFR.

 

We didnot include in this filing an attestation report from our independent registeredpublic accounting firm regarding ICFR. Management’s report was not subject toattestation by our independent registered public accounting firm pursuant tothe temporary rules of the SEC that permit the company to provide only themanagement’s report.

 

**Changesin Internal Control over Financial Reporting**

** **

Wemade no changes during our most recently completed fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting, as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act.

 
| **ITEM 9B.** | ** ** | **OTHER INFORMATION** |
|--------------|------------|-----------------------|

 

None.

 

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**PART III**

** **
| **ITEM 10.** | ** ** | **DIRECTORS EXECUTIVE  OFFICERS AND CORPORATE GOVERNANCE** |
|--------------|------------|------------------------------------------------------------|

 

Theinformation required by this Item is incorporated by reference from ourdefinitive proxy statement to be delivered to Stockholders in connection withour 2008 Annual Meeting of Stockholders.

 
| **ITEM 11.** | ** ** | **EXECUTIVE COMPENSATION** |
|--------------|------------|----------------------------|

 

Theinformation required by this Item is incorporated by reference from ourdefinitive proxy statement to be delivered to stockholders in connection withour 2008 Annual Meeting of Stockholders.

 
| **ITEM 12.** | ** ** | **SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|--------------|------------|-----------------------------------------------------------------------------------------------------|

 

Theinformation required by this Item is incorporated by reference from ourdefinitive proxy statement to be delivered to stockholders in connection withour 2008 Annual Meeting of Stockholders.

 
| **ITEM 13.** | ** ** | **CERTAIN RELATIONSHIPS  AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE** |
|--------------|------------|--------------------------------------------------------------------------------|

 

Theinformation required by this Item is incorporated by reference from ourdefinitive proxy statement to be delivered to stockholders in connection withour 2008 Annual Meeting of Stockholders.

 
| **ITEM 14.** | ** ** | **PRINCIPAL ACCOUNTANT  FEES AND SERVICES** |
|--------------|------------|---------------------------------------------|

 

Theinformation required by this Item is incorporated by reference from ourdefinitive proxy statement to be delivered to stockholders in connection withour 2008 Annual Meeting of Stockholders.

 

**PART IV**

 
| **ITEM 15.** | ** ** | **EXHIBITS, FINANCIAL  STATEMENT SCHEDULES** |
|--------------|------------|----------------------------------------------|

 

(a) Indexto Consolidated Financial Statements.

 

SeeIndex to Consolidated Financial Statements and financial statement schedulesimmediately following the signature page to this report on Form 10-K.

 

(b) Indexto Exhibits.

 

SeeIndex to Exhibits immediately following the signature page to this reporton Form 10-K.

 

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**SIGNATURES**

** **

Inaccordance with Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|     |   | Open Energy Corporation |
|----------|--------|-------------------------|
|     |   |                    |
|     |   | By:                     | /s/  David Saltman |
| * * |   | * *                | *President and Chief Executive Officer**(Principal Executive Officer)* |

 

Eachperson whose signature appears below hereby severally constitutes and appointsDavid Field and Aidan H. Shields, and each of them, his true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitutionfor him and in his name, place and stead, in any and all capacities to sign anyand all amendments to this Report, and to file the same, with all exhibitsthereto, and other documents in connection therewith, with the Commission,granting unto said attorney-in-fact and agents, and each of them, full powerand authority to do and perform each and every act and thing requisite or necessaryfully to all intents and purposes as he might or could do in person, herebyratifying and confirming all that each said attorneys-in-fact and agents or anyof them or their or his substitute or substitutes, may lawfully do or cause tobe done by virtue hereof.

 

Inaccordance with the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of registrant in theircapacities and on September 15, 2008.

 
| **Signature**            | ** ** | **Title**                                                          | ** ** | **Date**                |
|--------------------------|------------|--------------------------------------------------------------------|------------|-------------------------|
|                     |       |                                                               |       |                    |
| /s/ David P. Saltman     |       | Director and Chief Executive Officer (Principal Executive Officer) |       | September 15, 2008 |
| David P. Saltman         |       |                                                               |       |                    |
|                     |       |                                                               |       |                    |
| /s/ Aidan H. Shields     |       | Chief Financial Officer and Treasurer (Principal Financial and     |       | September 15, 2008 |
| Aidan H. Shields         |       | Accounting Officer)                                                |       |                    |
|                     |       |                                                               |       |                    |
| /s/ David A. Field       |       | Director and President and Chief Operating Officer                 |       | September 15, 2008 |
| David A. Field           |       |                                                               |       |                    |
|                     |       |                                                               |       |                    |
|                     |       | Director                                                           |       |                    |
| Steven J. Kemper         |       |                                                               |       |                    |
|                     |       |                                                               |       |                    |
| /s/ Edward Douglas Ward  |       | Director                                                           |       | September 15, 2008 |
| Edward Douglas Ward      |       |                                                               |       |                    |
|                     |       |                                                               |       |                    |
| /s/ Kenneth S. Potashner |       | Director                                                           |       | September 15, 2008 |
| Kenneth S. Potashner     |       |                                                               |       |                    |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit**                                                                                                                                                                                                                                                                                                       |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                                                        |
| 3.1                 |       | Articles of Incorporation, incorporated by reference from  Exhibit 3.1 to the Form SB-2 filed August 1, 2002.                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 3.2                 |       | Bylaws, incorporated by reference from Exhibit 3.1 to the  Form 10-Q filed April 19, 2006.                                                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 3.3                 |       | Certificate of Amendment filed with the Secretary of State of Nevada  on February 23, 2004, incorporated by reference from Exhibit 3.3 to  the Form 100-KSB filed September 12, 2005.                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 3.4                 |       | Certificate of  Amendment filed with the Secretary of State of Nevada on May 4, 2005,  incorporated by reference from Exhibit 3 to Form 8-K filed  August 31, 2005.                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 3.5                 |       | Certificate of Merger  filed with the Secretary of State of Nevada on April 21, 2006,  incorporated by reference from Exhibit 3.1 to the Form 8-K filed April 25,  2006.                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 3.6                 |       | Amendment No. 1 to  Bylaws dated June 12, 2008, incorporated by reference from  Exhibit 99.1 to Form 8-K filed June 17, 2008                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.1                 |       | Secured Convertible  Debenture No. CCP-4, issued on October 30, 2006 in favor of Cornell  Capital Partners, LP., incorporated by reference from Exhibit 4.1 to the  Form 8-K filed November 3, 2006.                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.2                 |       | Agreement and Plan of  Merger, dated December 21, 2006, by and among Open Energy Corporation,  Open Energy/WE Acquisition Corporation, WaterEye Corporation, and certain  other parties thereto, incorporated by reference from Exhibit 2.1 to  Form 8-K filed December 28, 2006.             |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.3                 |       | Securities Purchase  Agreement dated March 30, 2007 by and between Open Energy Corporation  and Cornell Capital Partners, L.P., incorporated by reference from  Exhibit 4.1 to Form 8-K filed April 5, 2007.                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.4                 |       | Secured Convertible  Debenture dated March 29, 2007 issued by Open Energy Corporation to  Cornell Capital Partners, L.P., incorporated by reference from  Exhibit 4.2 to Form 8-K filed April 5, 2007.                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.5                 |       | Security Agreement  dated March 29, 2007 by and among Open Energy Corporation, Connect  Renewable Energy, Inc., Solar Roofing Systems, Inc., WaterEye  Corporation and Cornell Capital Partners, L.P., incorporated by reference  from Exhibit 4.3 to Form 8-K filed April 5, 2007. |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.6                 |       | Warrant to Purchase  Common Stock dated March 29, 2007 issued by Open Energy Corporation to  Cornell Capital Partners, L.P., incorporated by reference from  Exhibit 4.4 to Form 8-K filed April 5, 2007.                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.7                 |       | Registration Rights  Agreement dated March 29, 2007 by and between Open Energy Corporation  and Cornell Capital Partners, L.P. incorporated by reference from  Exhibit 4.5 to Form 8-K filed April 5, 2007.                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.8                 |       | Letter Agreement, dated  May 21, 2007, between Open Energy Corporation and Cornell Capital  Partners, L.P., incorporated by reference from Exhibit 10.1 to the  Form 8-K filed May 24, 2007.                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.9                 |       | Note and Warrant  Purchase Agreement dated June 15, 2007, incorporated by reference from Exhibit 10.1  to the Form 8-K filed June 21, 2007.                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.10                |       | Form of Warrant,  incorporated by reference from Exhibit 10.2 to the Form 8-K filed  June 21, 2007.                                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.11                |       | Form of Stock  Pledge Agreement, incorporated by reference from Exhibit 10.3 to the  Form 8-K filed June 21, 2007.                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.12                |       | Form of Note,  incorporated by reference from Exhibit 10.4 to the Form 8-K filed  June 21, 2007.                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.13                |       | Convertible Debenture  dated June 15, 2007, incorporated by reference from Exhibit 10.5 to  the Form 8-K filed June 21, 2007.                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.14                |       | Form of Default  Warrant, incorporated by reference from Exhibit 10.6 to the  Form 8-K filed June 21, 2007.                                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.15                |       | Form of  Registration Rights Agreement, incorporated by reference from  Exhibit 10.7 to the Form 8-K filed June 21, 2007.                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                              |
| 4.16                |       | Securities Purchase  Agreement, dated August 31, 2007, by and between Open Energy Corporation  and Everest Asset Management AG, incorporated by reference from  Exhibit 4.1 to Form 8-K filed September 6, 2007.                                                                              |

 

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| 4.17         |   | Convertible Note, dated  August 31, 2007, issued by Open Energy Corporation to Everest Asset  Management AG, incorporated by reference from Exhibit 4.2 to  Form 8-K filed September 6, 2007.                                                                                                    |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.18         |   | Warrant, dated  August 31, issued by Open Energy Corporation to Everest Asset Management  AG, incorporated by reference from Exhibit 4.3 to Form 8-K filed  September 6, 2007.                                                                                                                   |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.19         |   | Registration Rights  Agreement, dated August 31, 2007, by and between Open Energy Corporation  and Everest Asset Management AG, incorporated by reference from  Exhibit 4.4 to Form 8-K filed September 6, 2007.                                                                                 |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.20         |   | Amendment dated  December 7, 2007 to Securities Purchase Agreement dated as of  September 19, 2007 between the registrant and certain accredited  investors, incorporated by reference to Exhibit 4.1 to the Form 8-K  filed on December 13, 2007.                                               |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.21         |   | Form of  Convertible Note, dated December 7, 2007, issued by the registrant to  certain accredited investors, incorporated by reference to Exhibit 4.3  to the Form 8-K filed on September 25, 2007.                                                                                        |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.23         |   | Form of  Series B Warrant, dated December 3, 2007, issued to by the  registrant to certain accredited investors, incorporated by reference to  Exhibit 4.2 to the Form 8-K filed on September 25, 2007.                                                                                |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.24         |   | Amendment to  Series B Convertible Notes, dated April 16, 2008, incorporated by  reference from Exhibit 4.4 to the Form 10-QSB filed April 21,  2008.                                                                                                                                       |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.25*        |   | Loan and Security  Agreement dated as of April 30, 2008 by and between the registrant and  The Quercus Trust.                                                                                                                                                                                                   |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.26*        |   | Promissory Note dated  as of April 30, 2008 issued by the registrant to The Quercus Trust.                                                                                                                                                                                                                      |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.27         |   | Letter Agreement, dated August 30, 2007, by and between Open  Energy Corporation and YA Global Investments, L.P., incorporated by reference  from Exhibit 4.1 to Form 10-KSB/A filed on October 31, 2007.                                                                                        |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 4.28*        |   | Securities Purchase Agreement, dated September 12, 2008, by and  between Open Energy Corporation and The Quercus Trust.                                                                                                                                                                                         |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.1†   |   | Open Energy Corporation  2006 Equity Incentive Plan, incorporated by reference from Exhibit 10.1  to the Form 8-K filed November 8, 2006.                                                                                                                                                             |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.1.1† |   | Form of Stock  Option Agreement under the Open Energy Corporation 2006 Equity Incentive  Plan, incorporated by reference from Exhibit 10.2 to the Form 8-K  filed November 8, 2006.                                                                                                              |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.1.2† |   | Form of Stock  Award Agreement for Restricted Stock under the Open Energy Corporation 2006  Equity Incentive Plan, incorporated by reference from Exhibit 10.3 to  the Form 8-K filed November 8, 2006.                                                                                          |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.1.3† |   | Form of Stock  Award Agreement for Stock Units under the Open Energy Corporation 2006 Equity  Incentive Plan, incorporated by reference from Exhibit 10.4 to the Form 8-K  filed November 8, 2006.                                                                                               |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.2†   |   | Amendment No. 1 to  CBC Consulting Agreement, dated December 14, 2006, incorporated by  reference from Exhibit 10.1 to the Form 8-K filed December 19,  2006.                                                                                                                               |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.3         |   | Agreement and Plan of  Merger dated as of December 21, 2006, by and among Open Energy  Corporation, Open Energy/WE Acquisition Corporation, WaterEye Corporation,  and certain other parties thereto, incorporated by reference from  Exhibit 2.1 to the Form 8-K filed December 19, 2006.  |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.4†   |   | Employment Agreement  dated as of December 22, 2006, by and between Open Energy Corporation  and Thomas D. Wolfe, incorporated by reference from Exhibit 10.4 to the  Form 10-QSB filed February 1, 2007.                                                                                        |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.5         |   | Indenture Agreement  (Lease) and Amendment No. 1 to Lease with Acton Management Co. Limited  dated November 22, 2006, incorporated by reference from Exhibits 10.1  and 10.2, respectively, to the Form 8-K filed November 29, 2006.                                                             |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.6†   |   | Amendment No. 1 to  Executive Employment dated January 30, 2007 by and between Open Energy  and David Saltman incorporated by reference from Exhibit 10.6 to the  Form 10-QSB filed February 1, 2007.                                                                                       |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.7†   |   | Amendment No. 2 to  Executive Employment dated January 30, 2007 by and between Open Energy  and Cheryl Bostater, incorporated by reference from Exhibit 10.7 to the  Form 10-QSB filed February 1, 2007.                                                                                    |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.10†  |   | Employment Agreement,  dated November 1, 2006, by and between Open Energy Corporation and  Jeffrey Stein, incorporated by reference from Exhibit 10.5 to the  Form 10-QSB filed April 23, 2007.                                                                                                  |
|         |   |                                                                                                                                                                                                                                                                                                                 |
| 10.11†  |   | Amendment No. 1 to  Employment Agreement, dated April 6, 2007, by and between Open Energy  Corporation and Jeffrey Stein, incorporated by reference from  Exhibit 10.6 to the Form 10-QSB filed April 23, 2007.                                                                             |

 

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| 10.12       |   | Letter Agreement, dated  May 21, 2007, between Open Energy Corporation and Cornell Capital  Partners, L.P., incorporated by reference from Exhibit 10.1 to the  Form 8-K filed May 24, 2007.                                                                                                                                     |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.13† |   | Employment Agreement  with Aidan H. Shields dated June 15, 2007, incorporated by reference  from Exhibit 10.9 to the Form 8-K filed June 21, 2007.                                                                                                                                                                               |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.14† |   | Employment Agreement  with John E. Hart dated June 15, 2007, incorporated by reference from  Exhibit 10.10 to the Form 8-K filed June 21, 2007.                                                                                                                                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.15† |   | Employment Agreement  with David Field dated November 1, 2006 and Amendment No. 1 to the  Employment Agreement dated June 15, 2007, incorporated by reference from  Exhibit 10.11 to the Form 8-K filed June 21, 2007.                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.16† |   | Amendment No. 2 to  Executive Employment dated March 30, 2008 by and between Open Energy and  David Saltman incorporated by reference from Exhibit 10.6 to the  Form 10-QSB filed April 21, 2008.                                                                                                                           |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.17† |   | Amendment  No. 3 to Executive Employment dated April 18, 2008 by and between  Open Energy and David Saltman incorporated by reference from  Exhibit 10.7 to the Form 10-QSB filed April 21, 2008.                                                                                                                           |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.18† |   | Consulting Agreement  between the registrant and Patricia Eckert, dated December 26, 2007,  incorporated by reference from Exhibit 10.1 to Form 10-QSB filed  April 21, 2008.                                                                                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.19† |   | Legal Services  Agreement, dated as of January 2, 2008 by and between the registrant and  Dalton W. Sprinkle, incorporated by reference from Exhibit 10.2 to  Form 10-QSB filed April 21, 2008.                                                                                                                                  |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.20       |   | Surrender Agreement,  dated as of February 21, 2008 between Hamil Inc. and the registrant,  incorporated by reference from Exhibit 10.3 to Form 10-QSB filed  April 21, 2008.                                                                                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.21       |   | Settlement Agreement  dated as of March 7, 2008, by and among the registrant and the former  stockholders of Solar Roofing Systems, Inc., incorporated by reference  from Exhibit 10.4 to Form 10-QSB filed April 21, 2008.                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.22       |   | Extension Agreement,  dated as of March 17, 2008, by and between the registrant and YA Global  Investments L.P., incorporated by reference from Exhibit 10.5 to  Form 10-QSB filed April 21, 2008.                                                                                                                               |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.23† |   | Employment Agreement, dated  as of November 1, 2007 by and between the registrant and Christopher S.  Gopal, incorporated by reference from Exhibit 10.1 to Form 8-K  filed on November 7, 2007.                                                                                                                                      |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.24       |   | Distributor Agreement, dated November 16, 2007, by and among  Open Energy Corporation, Tri-Valley Supply, Inc., and solely with  respect to Section 8(c), Petersen-Dean, Inc., incorporated by  reference from Exhibit 10.1 to Form 8-K filed on November 27,  2007.                                              |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.25*      |   | Amendment No. 1 to Joint Marketing and Distribution Agreement between  the registrant and Burlingame Industries, Inc., dated April 10,  2008 (Confidential treatment has been requested with respect to certain  portions of this exhibit. Omitted portions have been filed separately with  the Securities and Exchange Commission). |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.26† |   | Amendment No. 1 to Employment Agreement dated June 15, 2007  by and between the registrant and David Field.                                                                                                                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.27*      |   | Forbearance and Repayment Agreement dated September 12, 2008 by and  between the registrant and Suntech America, Inc.                                                                                                                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 14.1        |   | Code of Ethics,  incorporated by reference from Exhibit 14.1 to Form 10-KSB filed  September 12, 2005.                                                                                                                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                                 |
| 16.1        |   | Letter from  Peterson & Co., LLP to the Securities and Exchange Commission, dated  December 1, 2006, incorporated by reference from Exhibit 16.1 to  the Form 8-K/A filed December 1, 2006.                                                                                                                             |

 

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| 21.1* | List of Subsidiaries.                                                                                                      |
|-------|----------------------------------------------------------------------------------------------------------------------------|
| 23.1* | Consent of Squar,  Milner, Peterson, Miranda & Williamson, LLP.                                                   |
| 24.1* | Power of Attorney  (included on signature page).                                                                           |
| 31.1* | Certification of  Principal Executive Officer as required pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
| 31.2* | Certification of  Principal Financial Officer as required pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
| 32.1* | Certification of  Principal Executive Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.             |
| 32.2* | Certification of  Principal Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.             |

 

----

*Filedherewith.

†Indicates amanagement contract or compensatory plan.

 

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