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AUSI > SEC Filings for AUSI > Form 10-K on 13-Jun-2014All Recent SEC Filings

Show all filings for AURA SYSTEMS INC

Form 10-K for AURA SYSTEMS INC


13-Jun-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements.

This Management's Discussion and Analysis of Financial Condition and Results of Operations includes many forward-looking statements. For cautions about relying on such forward looking statements, please refer to the section entitled "Forward Looking Statements" at the beginning of this Report immediately prior to "Item 1".

Overview

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 three major components; (i) sales and marketing, (ii) engineering, and (iii) customer service and support.

(i) Sales and marketing -Our sales approach is composed of direct sales in North America and the use of agents and distributors for sales internationally. In North America our primary focus is in (a) Transport refrigeration, and (b) U.S Military applications,.

(a) Our sales and marketing approach for all-electric transport refrigeration is based on our strategic alliance with Zanotti and direct sales to major fleet owners of transport refrigeration. While our sales were slow in fiscal 2014 we expect significant contribution to our fiscal 2015 revenues from this sector.

(b) Our business approach for the U.S military and other government agencies are based on working with a number of defense contractors for a number of upcoming bids and responding to specific RFQs released by different agencies. We constantly sell small quantities of the VIPER for Special Ops, and we are delivering monthly units to the U.S.C.G. under a multi-year contract.

For international sales we have an exclusive distribution agreement with Seokmun Inc. for Korea, Funpos Inc. for Israel, and Fait Holding Ltd. for France and Indonesia. We have an agreement with Zanotti of Italy for sale of electric systems for transport refrigeration in Europe. We entered into agreements with Neva Marine in Turkey and Atlantis Marine in the U.K. agreements for the UK,


(ii)The second component of our business model is focused on the engineering support for the sales activities described above. The engineering support consists of the introduction of new features for our AuraGen/VIPER solution such as higher power, different voltages, 3 phase options, shore power systems, higher current solutions as well as interface kits for different platforms. After a slow-down in our engineering activities during the 2013 and 2014 fiscal year we expect an increase in engineering activities during the fiscal 2015-year.

(iii)The third component of our business model is customer service. We have trained a number of field engineers to support our product in North America. In addition we are working closely with our international distributors to train their staff to be able to support the product. For transport refrigeration we developed a training program for Zanotti's dealers for installation and service.

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

The Company's revenue recognition policies are in compliance with Staff accounting bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collect-ability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.

We recognize revenue for product sales upon shipment and when title is transferred to the customer. When Aura performs the installation of the product, revenue and cost of sales are recognized when the installation is complete. We have in the past earned a portion of our revenues from license fees and recorded those fees as income when we fulfilled our obligations under the particular agreement.

Terms of our sales generally provide for Shipment from our facilities to customers FOB point of shipment. Title passes to customers at the time the products leave our warehouse.

The Company does not offer a general right of return on any of its sales and considers all sales as final. While some sales are for evaluative purposes, they are final sales. The customers' evaluation is for them to determine if there is a benefit to them to outfit additional vehicles in their fleets.

The only potential post delivery obligation the Company might have is for the installation of the unit. However, the unit is typically delivered at the time of installation, and the billing is done when the installation is complete. The Company does not utilize bill and hold. The Company does provide customers with a warranty; however, due to the low sales volume to date, the amount has not been material and is expensed as incurred.

Inventory Valuation and Classification

Inventories consist primarily of components and completed units for our AuraGenŽ product. Inventories are valued at the lower of cost (first-in, first-out) or market, on a standard cost basis. Provision is made for estimated amounts of current inventories that will ultimately become obsolete due to changes in the product itself or vehicle engine types that go out of production. Due to historical reasons, we are holding inventories in excess of what it expects to sell in the next fiscal year. The net inventories which are not expected to be realized within a 12-month period based on current sales forecasts have been reclassified as long term. Management believes that existing inventories can, and will, be sold in the future without significant additional costs to upgrade it to current models and that the valuation of the inventories, classified both as current and long-term assets, accurately reflects the realizable values of these assets. We have accrued and expensed approximately $168 per ECU for the cost to upgrade it to current standards and do not anticipate any additional costs to upgrade the units. The AuraGenŽ product being sold currently is not technologically different from those in inventory. Existing finished goods inventories can be upgraded to the current model with only a small amount of materials and manpower. We make these assessments based on the following factors: i) existing orders, ii) age of the inventory, iii) historical experience and iv) our expectations as to future sales. If expected sales volumes do not materialize or if significant discounts from current pricing levels are granted to generate sales, there would be a material impact on our financial statements.


Valuation of Long-Lived Assets

Long-lived assets, consisting primarily of property and equipment, and patents and trademarks, comprise a small portion of our total assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying values may not be recoverable. Recoverability of assets is measured by a comparison of the carrying value of an asset to the future net cash flows expected to be generated by those assets. Net cash flows are estimated based on expectations as to the realize-ability of the asset. Factors that could trigger a review include significant changes in the manner of an asset's use or our overall strategy.

Stock-Based Compensation

The Company accounts 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.

The Company accounts 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, the Company has 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.

Research and Development

Research and development costs are expensed as incurred.

Specific asset categories are treated as follows:

Accounts Receivable: We record an allowance for doubtful accounts based on management's expectation of collect-ability of current and past due accounts receivable.

Property, Plant and Equipment: We depreciate our property and equipment over various useful lives ranging from five to ten years. Adjustments are made as warranted when market conditions and values indicate that the current value of an asset is less than its net book value.

Patents and trademarks: As our business depends on using new technology to create new products, impairments in patents can be triggered by changed expectations regarding the foreseeable commercial production of products underlying such patents.

When we determine that an asset is impaired, we measure any such impairment by discounting an asset's realizable value to the present using a discount rate appropriate to the perceived risk in realizing such value. When we determine that an impaired asset has no foreseeable realizable value, we write such asset down to zero.


Results of Operations

Fiscal 2014 compared to Fiscal 2013

Revenues

Net revenues in fiscal 2014 decreased $380,220 to $2,337,226 from $2,717,446 in fiscal 2011, a decrease of 14%. With the small customer base we have our sales can vary substantially from period to period.

Cost of Goods

Cost of goods sold in fiscal 2014 increased $634,628 to $2,162,328 from $1,527,700 in fiscal 2013. The increase is primarilly attributable to an increase in the inventory reserve for obsolescense of approximately $1.2 million partially offset by the decrease in sales.

Engineering, Research and Development

Engineering, research and development costs decreased $19,197 to $1,294,619 in fiscal 2014 from $1,313,816 in fiscal 2013. The decrease is primarily attributable to a decrease in the number of employees resulting in lower payroll and payroll related costs.

Selling, General and Administrative Expense

Selling, general and administrative expenses decreased $4,277,931 to $9,099,230 in fiscal 2014 from $13,377,161 in fiscal 2013. The decrease is primarily due to a decrease in stock option compensation expense of $2,537,566, a decrease in salaries of approximately $272,000 due to decreased personnel and a decrease in legal expense of approximately $1.1 million primarily associated with our sale of convertible debt in the prior year third quarter. Stock option compensation expense included in selling, general and administrative expense decreased to $430,456 in fiscal 2014 from $2,968,022 in fiscal 2013, a decrease of $2,537,566, as a result of the non-cash charges for the issuance of employee stock options.

Non-Operating Income and Expenses

Net interest expense increased to $3,991,156 in fiscal 2014 from $3,874,328 in fiscal 2013, an increase of $116,828 due to our increased debt levels. Other income decreased to $49,607 in fiscal 2014 from $2,114,089 in fiscal 2013 due to a legal settlement in the prior year of $2,095,000.

Net Income/Loss

Our net loss in fiscal 2014 decreased to $13,957,451 from $15,147,848 in fiscal 2013, a decrease of $1,190,397. The decrease is primarily a result of the decreased stock option and warrant expense of $2,537,566 as noted above, a decrease in legal expenses of approximately $1. million associated with the legal settlement in the prior year, partially offset by the income from the legal settlement of $2,095,000 in the prior year and the increase in the inventory reserve of approximately $1.2 million.

Fiscal 2013 compared to Fiscal 2012

Revenues

Net revenues in fiscal 2013decreased $618,539 to $2,717,446 from $3,335,985 in fiscal 2012, a decrease of 18.5%. The decrease is attributable to normal sales fluctuations period to period due to our relatively small sales volume and small customer base.

Cost of Goods

Cost of goods sold in fiscal 2013 decreased $244,455 to $1,527,700from $1,772,155 in fiscal 2012. As a percentage of net revenues, cost of goods sold increased to56 % in fiscal 2013 from 53% in fiscal 2012. The increase is attributable to the variation in the mix of products sold.


Engineering, Research and Development

Engineering, research and development costs decreased $14,317 to $ 1,313,816 in fiscal 2013 from $1,328,133 in fiscal 2012. While we had planned for an increase in engineering, research and development in the current fiscal year, a lack of resources prevented us from implementing this plan. However, we expect to increase our expenditures in this area in the upcoming fiscal year.

Selling, General and Administrative Expense

Selling, general and administrative increased $317,870 to $13,337,161 in fiscal 2013 from $13,059,291 in fiscal 2012. The increase is due primarily to an increase in legal expense due to the favorable settlement of a lawsuit where the Company was the plaintiff, offset by a decrease in rent, sales and marketing and health insurance.

Non-Operating Income and Expense

Net interest expense increased $1,861,790 to $3,874,328 in fiscal 2013 from $2,012,538 in fiscal 2012. The increase is primarily attributable to the higher level of debt owing to a Board member, which increased from $10,425,000 at the end of fiscal 2012 to $13,819,960 at the end of fiscal 2013, and the amortization associated with the convertible debt issued to institutional investors in the third quarter of the prior fiscal year. Other income increased to $2,114,689 in fiscal 2013 from $682,658 in fiscal 2012 primarily as a result of a favorable legal settlement in the amount of $2,095,000 in the third quarter of the fiscal year. Gain on conversion of $113,023 in the current year is a result of the conversion $259,729 in notes payable and accrued interest and the conversion of $30,000 of accounts payable into 379,248 shares of our common stock.

Net Income/Loss

The increase in our net loss of $994,144 to $15,147,848 in fiscal 2013 from $14,153,704 in fiscal 2012 is primarily a result of the increase in interest expense noted above, the increase in legal expense associated with the settled lawsuit, partially offset by the increase in other income associated with the settled lawsuit.

Liquidity and Capital Resources

In fiscal 2014, we incurred losses of approximately $13.9 million and had negative cash flows from operations of $5.9 million. Additionally, during fiscal 2013, we received periodic advances from a Board member consisting of $2.5 million in convertible debt carrying an interest rate of 9.5% and $963,000 in demand notes with an interest rate of 10%. As of February 28, 2014, the total amount owing to this Board member is $3,463,000 plus accrued interest of $193,904. We also owe $13.82 million plus accrued interest of $4.825 million to another board member. If the Board members were to demand repayment, we do not currently have the resources to make the payment. We also borrowed $1,196,000 in short term notes from individuals, of which $170,000 was repaid. Accrued expenses include $927,984 of accrued wages that has not been paid to certain employees of the Company.

At February 28, 2014, we had cash of approximately $41,000, compared to cash of approximately $89,000 at February 28, 2013. Working capital at February 28, 2014 was a negative $28.0 million as compared to a negative $22 million at the end of the prior fiscal year. Accrued expenses increased $1.8 million due primarily to the increase of approximately $1.2 million in unpaid salaries from the prior year end. At February 28, 2014, we had accounts receivable, net of allowance for doubtful accounts, of approximately $126,000 compared to approximately $280,000 at February 28, 2013. In fiscal 2014 we made no acquisitions of property and equipment.

In the year ended February 28, 2014, $1,127,002 of notes payable and accrued interest were converted into 2,660,225 shares of common stock, 1,833,333 shares of common stock and 916,666 7-year warrants to purchase our stock with an exercise price of $0.75 were issued to re-price a prior issuance of stock in December 2012, 4,254,250 shares of common stock were issued in exchange for the cancellation of warrants to purchase 5,005,000 shares of common stock at an exercise price of $0.75 per share which would have expired on September 22, 2016, and 3,562,118 shares of common stock were issued for services valued at $974,726.

In the year ended February 28, 2013, we issued 3,866,867 shares of common stock, with 2,033,333 five year warrants attached with an exercise price of $1.00, for cash proceeds of $1,252,100 and the availability for up to an additional $500,000 in loans on favorable terms; 341,748 shares were issued upon the conversion of $259,729 of notes payable and accrued interest with 206,941 five year warrants attached with an exercise price of $1.00; 37,500 shares were issued in settlement of $30,000 of accounts payable with 25,000 five year warrants attached with an exercise price of $1.00; and 415,789 shares were issued for marketing services and investor relation services valued at $316,000.


During the next twelve months we plan to continue expanding our AuraGen/Viper business both domestically and internationally. There are four major components necessary to execute a significantly expanding business; (i) augmentation of management and staff, (ii) purchase orders, (iii) facilities and equipment, and
(iv) working-capital.

In order to achieve the planned results we will need sufficient working capital for (i) daily operations, (ii) purchase of raw materials and subassemblies,
(iii) purchase of the required equipment, and (iv) supporting cash flow. Our cash flow analysis is based on certain assumptions that include 45 days for collection of account receivables after shipment, 30-day terms for accounts payable to vendors and suppliers, and all monthly operational costs paid during the month in which they incurred. Based on our business model and projections, as well as historical costs for COGS and other expenses, we determined that the Company would need to raise approximately $10 million in new capital. This would allow us to fund ongoing operations but would not necessarily allow us to pay back our existing debt. We plan to raise the required capital through the private placement of equity, or straight debt.

We are selling systems for all of the applications currently identified in our business model for fiscal 2014. In addition, we are also in the process of enhancing our product line to address an even larger market segment. We currently provide 5 kW, 8.5 kW and 16 kW solutions and we plan to introduce during the next twelve months 4kW, 12 kW, and 20 kW solution. While there can be no assurances given that we will complete all the developments described above and be able to commercialize them in the planned time, our business model for fiscal 2014 does not contemplate sales for any product currently not available.

Since 2002 substantially all of our revenues from operations have been derived from sales of the AuraGenŽ. The cash flow generated from our operations to date has not been sufficient to fund our ing capital needs, and we cannot predict when operating cash flow will be sufficient to fund working capital needs. In June 2005 we were forced to file for protection under Chapter 11 of the U.S. Bankruptcy Code, from which we emerged under a court-approved plan of reorganization in January 2006.

In the past, in order to maintain 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. Currently, we have no binding commitments from third parties to provide financing and we cannot assure you that financing will be available at the times or in the amounts required. The issuance of additional shares of equity in connection with 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.

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