Aura Systems Inc: Form 10-Q for the period ended Aug 31, 2019

Forward Looking Statements

This Report contains forward-looking statements within the meaning of the federal securities laws. Statements other than statements of historical fact included in this Report, including the statements under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” regarding future events or prospects are forward-looking statements. The words “approximates,” “believes,” “forecasts,” “expects,” “anticipates,” “estimates,” “intends,” “plans” “would,” “could,” “should,” “seek,” “may,” or other similar expressions in this Report, as well as other statements regarding matters that are not historical fact, constitute forward-looking statements. We caution investors that any forward-looking statements presented in this Report are based on the beliefs of, assumptions made by, and information currently available to, us. Such statements are based on assumptions and the actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our actual future results may differ from our expectations, and those differences may be material. Accordingly, investors should use caution in relying on forward-looking statements to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following:

• Our ability to generate positive cash flow from operations;
• Our ability to obtain additional financing to fund our operations;
• The impact of economic, political and market conditions on us and our customers;
• The impact of unfavorable results of legal proceedings;
• Our exposure to potential liability arising from possible errors and omissions, breach of fiduciary duty, breach of duty of care, waste of corporate assets and/or similar claims that may be asserted against us;
• Our ability to compete effectively against competitors offering different technologies;
• Our business development and operating development;
• Our expectations of growth in demand for our products; and
• Other risks described under the heading “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and those risks discussed in our other filings with the Securities and Exchange Commission, including those risks discussed under the caption “Risk Factors” in our Annual Report on Form 10-K/A for the year ended February 28, 2019, issued on October 24, 2019 (as the same may be updated from time to time in subsequent quarterly reports), which discussion is incorporated herein by this reference.

We do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise except to the extent required by law. You should interpret all subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf as being expressly qualified by the cautionary statements in this Report. As a result, you should not place undue reliance on these forward-looking statements.

Overview

Beginning with fiscal 2017 through 2018, we reduced our engineering, manufacturing, sales, and marketing activities to focus on renegotiating numerous financial obligations and minimizing expenditures while we attempted to raise additional funding and pursue some initial engineering activities

In fiscal 2018, we successfully eliminated approximately 68% of our total indebtedness. Specifically, our secured creditors converted approximately $5.73 million of secured debt into approximately 4.1 million shares of our common stock. The converted debt represented approximately 80% of the total secured debt of the Company. The balance of the secured debt (approximately $960,000) is to be paid to the secured creditors in cash if we raise at least $4.0 million in proceeds through new equity offerings in one or a series of related offerings. Additionally, in fiscal 2018, approximately $12.77 million of unsecured debt was converted into approximately 9.3 million shares of the Company’s common stock and approximately $12.3 million of unsecured debt was forgiven. In total, during fiscal 2018, we eliminated a total of approximately $30.23 million of debt.

As of the date of this filing, Robert Kopple, our former Vice Chairman of the Board, is the only significant unsecured note holder that has not agreed to restructure his debt. Mr. Kopple claims that he and his affiliates are owed approximately $10.1 million on terms significantly preferable to other similarly situated unsecured creditors. We dispute Mr. Kopple’s claims. See “Part II-Other Information, Item 1. Legal Proceedings” included elsewhere in this Quarterly Report on Form 10-Q for information regarding the dispute with Mr. Kopple regarding these transactions. Mr. Kopple has not accepted our numerous offers to restructure this debt.

On February 14, 2018, we effectuated a one-for-seven reverse stock split.

In fiscal 2019, we began increasing our engineering and manufacturing activities. We utilized contractors for these services in order to minimize our expense while we continued to pursue new sources of financing. In July 2019, we began significantly increasing our sales, engineering, manufacturing and marketing activities under our new management team.

Our business is based on the exploitation of our patented mobile power solution known as the AuraGen® for commercial and industrial applications and the VIPER for military applications. Our business model consists of two major components; (i) sales and marketing, (ii) design and engineering.

(i) Our sales and marketing approaches are composed of direct sales in North America and the use of agents, distributors and joint ventures for sales internationally. In North America, our primary focus is in (a) mobile exportable power applications, (b) transport refrigeration, and (c) U.S. Military applications.

(ii) The second component of our business model is focused on the design of new products and engineering support for the sales activities described above. The engineering support consists of the introduction of new features for our AuraGen® solution such as higher power, different voltages, three phase options, shore power systems, higher current solutions as well as interface kits for different platforms. After suspending the majority of our engineering, manufacturing, sales, and marketing activities to focus on renegotiating numerous financial obligations in fiscal 2018 and 2019, we expect modest engineering activities budgeted at approximately $750,000 during the fiscal 2020 year.

Operations.

During the first half of fiscal 2016, we significantly reduced operations due to lack of financial resources. During the second half of fiscal 2016, our operations were further disrupted when the we were forced to move from its facilities in Redondo Beach, California to a smaller facility in Stanton, California. Operations during the second half of fiscal 2016 were sporadic. During fiscal 2017, fiscal 2018 and fiscal 2019, the Company reduced its engineering, manufacturing, sales, and marketing activities to focus on renegotiating numerous financial obligations. During this time, our agreements with numerous customers, third party vendors, and organizations and entities material to the operation of the Company business were canceled, delayed or terminated. During fiscal 2018, we successfully restructured in excess of $30 million of debt. During fiscal 2019, we continued to address our financial needs, was able to ship a small quantity of product during fiscal 2019 and shipped a small amount to customers and maintained a small inventory of finished product. During the six-months ended August 31, 2020, we have increased production and have recognized approximately $348,000 of revenue. Our marketing strategy during fiscal 2020 includes the following key activities:

(i) One element of our business plan is focused on electric transport refrigeration. The market is well understood and both social and economic forces are providing an unprecedented opportunity to gain significant market share. Our immediate focus is on 20-k BTU/hr. midsize trucks and the 50-k BTU/hr. trailers.

(ii) Another element of our business plan is focused on our mobile power solution for military applications around the globe.

(iii) We also plan to seek joint venture opportunities similar to the agreement we entered in China to explore other international opportunities.

Going Concern.

Our independent auditor has expressed doubt about our ability to continue as a going concern and believes that our ability is dependent on our ability to implement our business plan, raise capital and generate revenues. See Report of Independent Registered Public Accounting Firm on page F-1, together with the Company’s audited consolidated financial statements for the fiscal year ended February 28, 2019 on Form 10-K/A issued on October 24, 2019.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial conditions and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements requires management to make estimates and disclosures on the date of the financial statements. On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition. We use authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant judgments and estimates in the preparation of our consolidated financial statements.

Revenue Recognition

We adopted Accounting Standards Codification (“ASC”) 606. ASC 606, Revenue from Contracts with Customers, establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

We have assessed the impact of the guidance by performing the following five steps analysis:

Step 1: Identify the contract

Step 2: Identify the performance obligations

Step 3: Determine the transaction price

Step 4: Allocate the transaction price

Step 5: Recognize revenue

Inventory Valuation and Classification

Inventories are valued at the lower of cost (first-in, first-out) or market, on a standard cost basis. We review the components of inventory on a regular basis for excess or obsolete inventory based on estimated future usage and sales. We have minimally operated and therefore have only produced minimal product since late 2015. As a result, while we believe that a portion of the inventory has value, we are unable to substantiate its demand and market value and as a result we have elected to reserve it in its entirety as of August 31 and February 28, 2019.

Stock-Based Compensation

We account for stock-based compensation under the provisions of FASB ASC 718, “Compensation – Stock Compensation”, which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair value-based method and the recording of such expense in the consolidated statements of operations.

We account for stock option and warrant grants issued and vesting to non-employees in accordance with FASB ASC 505-50, “Equity Based Payments to Non-Employees”, whereas the fair value of the equity-based compensation is based upon the measurement date as determined at the earlier of either (a) the date at which a performance commitment is reached or (b) at the date at which the necessary performance to earn the equity instruments is complete.

For the past, several years and in accordance with established public company accounting practice, we have consistently utilized the Black-Scholes option-pricing model to calculate the fair value of stock options and warrants issued as compensation, primarily to management, employees, and directors. The Black-Scholes option-pricing model is a widely-accepted method of valuation that public companies typically utilize to calculate the fair value of options and warrants that they issue in such circumstances.

Results of Operations

Six-months ended August 31, 2019 compared to six-months ended August 31, 2018

Net revenues were $348,075 for the six-months ended August 31, 2019 (the “Six-Months FY2020”) compared to $39,724 for the six-months ended August 31, 2018 (the “Six-Months FY2019”), or an increase of 776% compared to the same period of fiscal 2019. During the second quarter of 2020, we delivered 52 generator units to distribution customers as compared to 6 units in the same period in the prior year for a military application.

Cost of goods sold were $32,097 in the Six-Months FY2020 compared to $73,444 in the Six-Months FY2019 resulting in a gross profit of $315,978 and a loss of $33,720, respectively, and gross margins of 90.8% and negative 84.9%, respectively. Gross profit and related gross margin for the Six-Months FY2020 shipments were high due to the high utilization of inventory previously fully reserved. We do not expect gross margins above 90% to continue for shipments of generator units in future quarters as the availability of usable parts from fully reserved inventory will decline.

Engineering, research and development expenses were $92,552 in the Six-Months FY2020, compared to $163,876 in the Six-Months FY2019, or a decline of 43.5%.

Selling, general and administrative expense decreased $1,543,312 (75%) to $508,227 in the Six-Months FY2020 from $2,051,539 in the Six-Months FY2019. During Six-Months FY2019, we incurred higher legal expense of expense of $417,000 related to the repricing of warrants and options, $432,000 of higher legal expenses, higher consulting expense and administrative headcount cost.

Net interest expense in the Six-Months FY2020 increased $48,461 or 9%, to $601,833 from $553,372 in the Six-Months FY2019.

Our net loss for the Six-Months FY2020 decreased $1,562,917, or 63%, to $886,659 from $2,449,576 in the Six-Months FY2019.

Three months ended August 31, 2019 compared to three months ended August 31, 2018

Net revenues were $348,075 for the three-months ended August 31, 2019 (the “Three-Months FY2020”) compared to $1,874 for the three-months ended August 31, 2018 (the “Three-Months FY2019”). During the second quarter of 2020, we delivered 52 generator units to distribution customers as compared to 0 units in the same period in the prior year for a military application.

Cost of goods sold were $29,208 in the Three-Months FY2020 compared to $58,317 in the Three-Months FY2019 resulting in a gross profit of $318,867 and a loss of $56,443, respectively, and gross margins of 91.7% and negative 3,012%, respectively. Gross profit and related gross margin for the Three-Months FY2020 shipments were high due to the high utilization of inventory previously fully reserved. We do not expect gross margins above 90% to continue for shipments of generator units in future quarters as the availability of usable parts from fully reserved inventory will decline.

Engineering, research and development expenses were $34,359 in the Three-Months FY2020, compared to $31,023 in the Three-Months FY2019, or an increase of 10.8%.

Selling, general and administrative expense decreased $838,569 (80%) to $211,004 in the Three-Months FY2020 from $1,049,573 in the Three-Months FY2019. During Three-Months FY2020, we incurred less cost for administrative headcount and consultancy cost by $250,000, $400,000 in reduced legal fees associated with legal action directed at Kilpatrick Townsend & Stockton LLP, our prior legal counsel, and reduced other costs of $150,000 than in Three-Months FY2019.

Net interest expense in the Three-Months FY2020 increased $8,633 or 3%, to $284,788 from $276,155 in the Three-Months FY2019.

Our net loss for the Three-Months FY2020 decreased $1,201,855 or 85%, to $211,339 from $1,413,194 in the Three-Months FY2019.

Liquidity and Capital Resources

Net cash used in operations for the six months ended August 31, 2019, was $397,436, a decrease of $1,356,598 from the comparable period in the prior fiscal year. Net cash provided by financing activities during the six-months ended August 31, 2019, was $150,297 from the issuance of common stock as compared to a total of $1,075,000 provided by financing activities in the same period of fiscal 2019 consisting of (i) proceeds from a subscription receivable of $1,150,000 and offset by (ii) principle payment of $50,000 on a note payable. The cash flow generated from our operations to date has not been sufficient to fund our working capital needs, and we cannot predict when operating cash flow will be sufficient to fund working capital needs.

There were no acquisitions of property and equipment during the Six-Months FY2020 or the Six-Months FY2019.

Accrued expenses as of August 31, 2019 increased $43,856 to $3,161,600 from $3,205,456 as of February 28, 2019. At August 31, 2019, approximately $2.6 million of accrued expenses is salaries accrued but unpaid to certain current and former employees due to a lack of resources, and approximately $0.6 million is accrued but unused vacation earned by employees.

The Company had a deficit of $22.0 million in shareholders’ equity as of August 31, 2019, compared to $21.6 million as of February 28, 2019 with the net change attributed to net loss of approximately $886,000 offset by issuance of shares of $480,000.

In the past, in order to generate liquidity we have relied upon external sources of financing, principally equity financing and private indebtedness. We have no bank line of credit and require additional debt or equity financing to fund ongoing operations. The issuance of additional shares of equity in connection with any such financing could dilute the interests of our existing stockholders, and such dilution could be substantial. If we cannot raise needed funds, we would also be forced to make further substantial reductions in our operating expenses, which could adversely affect our ability to implement our current business plan and ultimately our viability as a company.

As of the date of this filing, Robert Kopple, the Company’s Vice Chairman of the Board, is the only significant unsecured note holder that has not agreed to restructure his debt. Mr. Kopple claims to be owed approximately $5.3 million plus interest and approximately 3.14 million warrants on terms significantly preferable to other similarly-situated unsecured creditors. To-date, Mr. Kopple has not accepted the Company’s multiple offers to restructure his debt. The Company is presently engaged in a dispute with Mr. Kopple relating to the debt and securities which Mr. Kopple claims to be owed to him and his affiliates by the Company. See, “Note 3 – Notes Payable” and “Note 5 – Related Parties Transactions” to the Company’s condensed financial statements and “Liquidity and Capital Resources” in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” elsewhere in this quarterly report on Form 10-Q for additional information regarding amounts that may be owed under the Company’s notes payable and the recent restructuring of certain Company debt.

In June 2014, we entered into a Financing Letter of Agreement (the “June 2014 Agreement”) with two affiliate entities of Mr. Kopple, KF Business Ventures and the Kopple Family Partnership (the “Additional Kopple Parties”), pursuant to which the Additional Kopple Parties loaned us an additional $1,000,000 (the “June 2014 Loan”). In connection with the June 2014 Loan, Mr. Kopple also added $202,205 in penalties and accrued interest, credited us with $200,000 for amounts previously repaid by us and consolidated several earlier advances into a single new note (the “June 2014 Kopple Note”) in the principal amount of $2,715,2067 and bearing simple interest at a rate of 10% per annum. We were also required to obtain a subordination agreement from the Breslow Parties in favor of the Kopple Parties with respect to the June 2014 Kopple Note.

Pursuant to the June 2014 Agreement, the Kopple Parties also placed various restrictions on our ability to raise additional capital, hire qualified personnel and pay certain expenses without his prior approval for so long as the principal amount of his note remained outstanding. The June 2014 Kopple Note also required us to issue Mr. Kopple a stock purchase warrant (the “June 2014 Kopple Warrant”) to purchase approximately 771,000 shares of our common stock at an exercise price of $0.70 per share, to be exercisable for seven years. Additionally, if we borrowed funds, issued capital stock or rights to acquire or convert into capital stock, or granted rights in respect to territories to any person for cash consideration of more than $5 million in the aggregate after the date of the June 2014 Kopple Note, we would be required to pay the entire amount of such cash consideration in excess of $5 million as a mandatory prepayment of the June 2014 Kopple Note. Additionally, Mr. Kopple required a default provision providing that in the event that the entire outstanding balance of the June 2014 Kopple Note was not paid in full prior to October 1, 2014, then for each consecutive calendar month during the period beginning October 1, 2014 and ending March 31, 2015, we would issue to Mr. Kopple additional stock purchase warrants, each to purchase 416,458 shares of our common stock, up to a maximum aggregate of approximately 2.5 million shares of our common stock, at $0.70 per share (the “Kopple Penalty Warrants”), the Kopple Penalty Warranties to be exercisable for seven years from the time of their respective issuances. In addition to the Kopple Penalty Warrants, the default provision under the June 2014 Kopple Note provides for a 5% late charge on the total amount due plus 15% per year interest. We have not repaid the Kopple Parties for the amounts loaned to us. Additionally, we have not issued any of the Kopple Penalty Warrants and management believes that Mr. Kopple is not entitled to receive them. We have also cancelled the June 2014 Kopple Warrant.

We consider the transactions described above with Mr. Kopple to be related party transactions.

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the specified time periods. For the last 3 fiscal years, these control and procedures broke down due to insufficient capital to maintain such controls and procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, the Company’s management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures. Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that these controls and procedures were ineffective as of the end of the period covered by this report in ensuring that information requiring disclosure is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms. The Company continues to remediate the findings contained in our Annual Report on Form 10-K/A, for the fiscal year ended February 28, 2019, issued on October 24, 2019.

Changes in Internal Control over Financial Reporting

There have been no other changes in our internal control over financial reporting during our fiscal quarter ended August 31, 2019, not previously identified in our Annual Report on Form 10-K/A, for the fiscal year ended February 28, 2019 and issued on October 24, 2019 which have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the risk factors disclosed in Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K issued on June 13, 2019 and the Amended Annual Report on Form 10-K/A for the year ended February 28, 2019, issued on October 24, 2019.