Company Description and Overview

Open Energy Corporation is a renewable energy company focused on the development and commercialization of a portfolio of solar electric technologies for residential, commercial and industrial applications. The Company currently designs, manufactures and distributes building-integrated photovoltaic (BIPV) roofing tiles, roofing membranes and architectural photovoltaic glass products under the SolarSaveŽ trade name. The company maintains two facilities: A corporate office in Solana Beach for senior management, marketing, sales, customer service, legal and finance and an engineering facility in Grass Valley, California for product design, project engineering, prototyping, custom glass manufacturing, and materials management.

The following three strategic initiatives distinguish our approach from others in an 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.

During the fiscal year ended May 31, 2008, we participated with our channel partners in the training of over 350 roofers and sales personnel to sell and install our proprietary products. In April 2008, we amended our joint marketing and distribution agreement with Eagle Roofing Products whereby Eagle has agreed to purchase at least 82,500 tiles in monthly increments from April 2008 through December 2008. In November 2007 we signed a distribution agreement with Petersen-Dean Roofing systems to distribute SolarSaveŽ products across 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.

During the 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 2,000 to 20,000 tiles per month. Our outsourced supply chain strategy provides flexibility, allowing us to match supply and demand, while providing the lowest total installed cost to our customers. In January 2008, we completed the shutdown of operations at our Aurora, Ontario, manufacturing facility in Canada. We continue to utilize the resources in our Grass Valley, California facility to perform design and supplemental manufacturing and assembly functions.

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, a 47-unit condominium project co-sited with a Whole Foods store and other mixed retail outlets in San Diego, California. The project is a LEED certified "green" development and construction commenced during the summer of 2008.

Critical Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

Management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. The Company has identified the following accounting policies, described below, as the most important to an understanding of the Company's current financial condition and results of operations.

Revenue Recognition

The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition ("SAB 104"). The Company generates revenue from the sale of photovoltaic roofing tiles, photovoltaic roofing membranes, balance of system products, water monitoring equipment and subscriptions and management system products to dealers and other parties. The Company does not perform any installations of photovoltaic products. The Company does, however, install water monitoring systems and recognizes corresponding license/subscription revenue consistent with AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition requirements.

SAB 104 requires that four basic criteria be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the seller's price to the buyer is fixed and determinable; and (4) collectability is reasonably assured. Amounts billed or received from customers in advance of performance are recorded as deferred revenue. In addition, the Company records deferred revenue in connection with sales to certain customers of products that qualify for state rebates that have been assigned to the Company by the customer. Based on the assignment of the rebate to the Company, the Company bills the customer net of the anticipated rebate and assumes the responsibility for collection of the rebate. The rebate processing cycle involves a multi-step process in which the Company accumulates and submits information required by the state agency necessary for

the collection of the rebate. The entire process can take up to 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 the determination of the ultimate price to be received, the Company defers revenue on the portion of the selling price related to the rebate, until such time that the rebate claim is submitted to the state agency.

Cost of sales related to revenue that has been deferred in connection with rebate collection process is recorded as deferred charges until such time as the related revenue is recognized.

Accounts Receivable

The Company regularly evaluates the collectability of its accounts receivable. An allowance for doubtful accounts is maintained for estimated credit losses, and such losses have been minimal and within management's expectations. When estimating credit losses, the Company considers a number of factors including the aging of a customer's account, creditworthiness of specific customers, historical trends and other information. Accounts receivable consist of trade receivables and amounts due from state agencies or utilities for rebates on state-approved solar systems installed. These rebate amounts are passed on to the customer at the time the customer is billed and the rebate is assigned to the Company. Generally, state agencies or utilities can take 120 days or more to remit the rebate amounts to the Company.

Inventories

Inventories are valued at lower of cost (first in, first out) or market. Management provides a reserve, as necessary, to reduce inventory to its net realizable value. Certain factors could impact the realizable value of inventory so management continually evaluates the recoverability based on assumptions about customer demand and market conditions. The evaluation may take into consideration expected demand, new product development, the effect new products might have on the sale of existing products, product obsolescence and other factors. The reserve or write down is equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves or write downs may be required. If actual market conditions are more favorable, reserves or write-downs may be reversed.

Goodwill and Intangible Assets

Goodwill represents the excess of costs over fair value of assets of businesses acquired. Per Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS No.142"), goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead must be tested for impairment annually or more frequently if circumstances indicate that indicators of impairment may be present. Management assesses goodwill for impairment at the reporting unit level on an annual basis at fiscal year-end or more frequently under certain circumstances. Such circumstances include (i) significant adverse change in legal factors or in the business climate, (ii) an adverse action or assessment by a regulator, (iii) unanticipated competition, (iv) a loss of key personnel,
(v) a more-likely-than-not expectation that a reporting unit or a significant portion of that unit will be sold or otherwise disposed of, and (vi) recognition of an impairment loss in a subsidiary that is a component of a reporting unit. Management must make assumptions regarding estimating the fair value of the Company reporting unit. If these estimates or related assumptions change in the future, the Company may be required to record an impairment charge.

Evaluation of Long-lived Assets

The Company's policy is to assess potential impairments to its long-lived assets when there is evidence that events or changes in circumstances have made recovery of the assets carrying value unlikely and the carrying amount on the asset exceeds the estimated undiscounted future cash flows. If such evaluation were to indicate a material non-recoverability of these long-lived assets, such impairment would be recognized by a write down of the applicable asset to its estimated fair value under SFAS No. 144,Accounting for the Impairment of Disposal of Long-Lived Assets.

Income Taxes

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

Beneficial Conversion and Warrant Valuation

In accordance with EITF No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios and EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, the Company records a beneficial conversion feature ("BCF") related to the issuance of convertible debt instruments that have conversion features at fixed rates that are in the money when issued, and the fair value of warrants issued in connection with those instruments. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds to warrants, based on their relative fair value, and as a reduction to the carrying amount of the convertible instrument equal to the intrinsic value of the conversion feature. The discounts recorded in connection with the BCF and warrant valuation are recognized as non-cash interest expense over the term of the convertible debt, using the effective interest method.

Limited Operating History

There is limited historical financial information about our company upon which to base an evaluation of our future performance. Our company has generated limited revenues from operations. We cannot guarantee that we will be successful in our business. We are subject to risks inherent in a fast growing company, including limited capital resources, possible delays in product development and manufacturing, and possible cost overruns due to price and cost increases. There is no assurance that future financing will be available to our company on acceptable terms. Additional equity financing will likely result in substantial dilution to existing stockholders.

Results of Operations - Fiscal Year Ended May 31, 2008 compared to Fiscal Year Ended May 31, 2007

The following table sets forth the Company's consolidated statement of operations data for the years ended May 31, 2008 and 2007.

Summary Statement of Operations (in thousands):



                                             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

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

During the year ended May 31, 2008, revenues of $6,938,000 primarily consisted of $4,448,000 in sales of SolarSaveŽ Tiles for residential projects and $1,250,000 in sales of SolarSaveŽ PV Glass for the remainder of the California Academy of Sciences Museum installation in Golden Gate Park, San Francisco, California, and to another PV Glass customer. SolarSaveŽ Tile revenues have increased by 280% from 2007 primarily as a result of our change in distribution strategy to utilization of the Eagle Roofing Products sales channel.

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

For the year ended May 31, 2007, revenues for SolarSaveŽ Tile and SolarSaveŽ Membrane products and WaterEye water monitoring subscriptions totaled $4,292,000. Revenues were significantly below our initial financial projections primarily due to a manufacturing and cell procurement cost structure that was too high relative to the competition and which caused us to price our products at a premium. In addition, our initial sales strategy for our SolarSaveŽ Tile of selling through solar integrators resulted in a sales cost structure that compounded the price disadvantage.

Cost of Sales

For the 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 and 2007, was $4,162,000 and $4,788,000, respectively.

The gross loss for the year ended May 31, 2008 of $4,162,000 reflects: the high cost of laminates for the SolarSaveŽ Tile for low volume purchase quantities, higher than expected freight and manufacturing costs incurred as a result of our need to satisfy tight delivery schedules, a $996,000 increase to warranty reserve related to diode failures of SolarSaveŽ Membrane product shipments and a $372,000 increase to warranty reserve related to tile delamination on a small percentage of early production Solar SaveŽ Tiles.

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

Our industry is still developing and the highly competitive environment continues to put pressure on pricing. In addition, scarce resources of silicon have increased costs of sales. The combination of these factors is putting pressure on gross margins.

We have undertaken a number of initiatives to improve gross margin, the most significant 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 SolarSaveŽ Membrane product scheduled for release to market early in 2009 will address the previous product failure issues. We are negotiating with outsourced manufacturers on product pricing for our current and next generation SolarSaveŽ roofing tiles and are also evaluating other cost effective supply options for our laminates and products. As we mature in our relationship with our suppliers and customers and improve forecasting, we expect to reduce costs. In addition, we are currently evaluating the potential of licensing the intellectual property associated with our tile and membrane products. We believe that such a licensing strategy would result in greater operational profitability.

Operating Expenses

Selling, general and administrative

For the years ended May 31, 2008 and 2007, selling, general and administrative expenses ("SG&A") were $18,747,000 and $17,084,000, respectively.

For the 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 and intangible asset amortization expense, and $1,707,000 of legal and professional fees associated primarily with SEC reporting, contractual matters, and efforts to protect the Company's intellectual property.

SG&A expenses for the year ended May 31, 2007 were $17,084,000. SG&A expenses included $7,421,000 in non-cash compensation for stock grants to key management, directors, and consultants. Cash-based management fees, wages and salaries were approximately $3,536,000 for fiscal 2007. Legal, professional and consulting fees were approximately $2,249,000 for fiscal 2007. The legal and professional fees were primarily related to our financing activities, our registration statement that went effective in October 2006, the acquisition 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. These expenses were related to the branding of the Open Energy name, participation in trade shows, and the marketing of the SolarSave Ž Tiles, Membranes, and Glass.

Research and Development

For the years ended May 31, 2008 and 2007, research and development expenses were $290,000 and $513,000, respectively.

The research and development expenses incurred in both years were related to the ongoing development of the SolarSaveŽ Tiles, SolarSaveŽ Membranes, SolarSaveŽ Glass and future product development. Future research and development efforts will be focused on improvements to our SolarSaveŽ Tiles and Membranes, as well as a suite of asphalt shingle products which we believe will contribute to increasing and retaining market share.

Restructuring costs

For the year ended May 31, 2008, restructuring costs were $849,000. The Company did not incur restructuring costs in 2007.

In December 2007, we adopted a plan to shut down operations at our Aurora, Ontario facility in Canada. The plan was substantially complete as of January 31, 2008. In connection with the plan, we terminated 28 of our 30 full-time employees at the Aurora facility. Existing operations and specified assets at the Aurora facility were transferred to our Grass Valley, California facility and we sold certain of the other assets located at the Aurora facility. We recorded total costs associated with the plan of $849,000, of which $272,000 related to employee termination costs, $210,000 related to asset impairment and relocation costs, $171,000 pertained to lease and lease settlement costs and $196,000 was incurred for legal and administrative costs. At May 31, 2008, $68,000 of lease settlement costs remained outstanding.

Impairment of intangibles and goodwill

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

During the 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 in SRS of $3,500,000 and $2,731,000, respectively, and an impairment of goodwill in WaterEye of $2,525,000. In addition, the Company wrote-off the unamortized amount of $1,694,000 of the SunCone TM CSP license agreement.

Impairment of note receivable

In 2007, the Company wrote off a note receivable of $683,000, including accrued interest totaling $33,000, relating to the divestiture of its oil and gas interests.

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

Other income (expense)

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

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

In fiscal 2007, other expense was $9,206,000. Interest expense was $8,924,000 in fiscal 2007, of which $8,211,000 was due to warrant repricings and non-cash interest expense related to amortization of the warrants, beneficial conversion feature and original issue discount associated with various debentures.

Net Loss

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

For the 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 and amortization expense, and $10,833,000 in non-cash interest from the amortization of the discounts recorded in connection with warrants, beneficial conversion features and original issue discounts, and non-cash deferred financing fees associated with convertible debentures and notes payable.

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

Liquidity and Capital Resources

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

During the year ended May 31, 2008, we funded our operations primarily from private sales of equity and debt securities. We have no unused sources of liquidity. Thus, additional equity or debt financing will need to be raised in the near future to continue operations and implement our business strategy. As discussed below, in April 2008, we entered into a loan and security agreement with The Quercus Trust pursuant to which Quercus agreed to loan us up to $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, 2008 the remaining $1,950,000 had been funded. The loan and security agreement is collateralized by a general security interest in all of our inventory, specified accounts receivable and our cash accounts. If we were to default under the terms and conditions of the loan and security agreement, or if our specified collateral ratios fall below certain levels, Quercus would have the right to accelerate the outstanding indebtedness under the loan and security agreement and foreclose on the collateral. Such a foreclosure would have a material adverse effect on our business, liquidity, results of operations and financial position.

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

During the year ended May 31, 2008, we took steps to improve our debt structure in an effort to increase our ability to secure additional financing. We repaid our 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 Global Investments, L.P., and its affiliates (formerly known as Cornell Capital Partners, L.P.). The redemption payment, which included principal, accrued interest and a redemption premium, totaled approximately $3,100,000. The Company recognized an immaterial gain on the early extinguishment. While the scheduled maturity date of the 2006 Debentures was in March 2009, the 5% Debentures permitted the holder to demand redemption and a redemption premium for so long as the Company's common stock was trading below $.50 per share. The 2006 Debentures were the only remaining variably-priced convertible securities in the Company's capital structure. YA Global Investments held one additional 10% Debenture (defined below) in the principal amount of $3,000,000, which was scheduled to mature in March 2008. YA Global Investments agreed to extend the maturity date and on April 30, 2008, the Company repaid all remaining principal . . .