10-Q 1 a10q2003may.txt AURA SYSTEMS, INC. 10-Q MAY 31, 2003 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended May 31, 2003 Commission File Number 000-17249 AURA SYSTEMS, INC. (Exact name of Registrant as specified in its charter) Delaware 95-4106894 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 2335 Alaska Ave. El Segundo, California 90245 (Address of principal executive offices) Registrant's telephone number, including area code: (310) 643-5300 Former name, former address and former fiscal year, if changed since last report: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES NO X --------------- --------------- Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Class Outstanding at August 20, 2003 Common Stock, par value $0.005 per share 430,923,150 Shares AURA SYSTEMS, INC. AND SUBSIDIARIES INDEX Page No. PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements Statement Regarding Financial Information 2 Condensed Consolidated Balance Sheets as of May 31, 2003 (Unaudited)and February 28, 2003 3 Condensed Consolidated Statements of Operations for the Three Months Ended May 31, 2003 (Unaudited) and 2002 (Unaudited) 4 Condensed Consolidated Statements of Cash Flows for the Three Months Ended May 31, 2003 (Unaudited) and 2002 (Unaudited) 5 Notes to Condensed Consolidated Financial Statements (Unaudited) 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 ITEM 4. Controls and Procedures 15 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 16 ITEM 2. Changes in Securities 16 ITEM 6. Exhibits and Reports on Form 8-K 16 SIGNATURES AND CERTIFICATIONS 17 AURA SYSTEMS, INC. AND SUBSIDIARIES QUARTER ENDED MAY 31, 2003 PART I. FINANCIAL INFORMATION The consolidated financial statements included herein have been prepared by Aura Systems, Inc. (the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). As contemplated by the SEC under Rule 10-01 of Regulation S-X, the accompanying consolidated financial statements and footnotes have been condensed and therefore do not contain all disclosures required by accounting principles generally accepted in the United States of America. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended February 28, 2003 as filed with the SEC (file number 000-17249). AURA SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS May 31. 2003 February 28, Assets (Unaudited) 2003 ------ --------------- ---------------- Current assets: Cash and cash equivalents $ 125,489 $ 163,693 Receivables, net 175,213 410,717 Inventories, net 1,438,850 1,414,500 Notes receivable 214,505 210,272 Other current assets 595,043 166,589 --------------- ---------------- Total current assets 2,549,100 2,365,771 Property and equipment, at cost 13,839,349 13,839,351 Less accumulated depreciation and amortization ( 6,615,215) (6,495,840) --------------- ---------------- Net property and equipment 7,224,134 7,343,511 Non-current inventories 7,573,225 7,573,225 Long term investments 697,500 1,000,000 Long term receivables 1,950,880 2,006,121 Patents and trademarks, net 2,676,522 2,753,603 Other assets 615,017 725,635 --------------- ---------------- Total assets $ 23,286,378 $23,767,866 =============== ================ Liabilities and Stockholder's Equity Current liabilities: Accounts payable $ 3,085,449 $ 2,753,503 Notes payable 9,610,335 9,542,786 Convertible notes 825,000 3,762,317 Accrued expenses 1,615,035 1,772,936 Deferred income 160,500 160,500 --------------- ---------------- Total current liabilities 15,296,319 17,992,042 Notes payable and other liabilities 38,491 40,275 Minority interest in consolidated subsidiary 1,058,847 1,023,373 COMMITMENTS AND CONTINGENCIES Stockholders' equity ---------------------------------------------------------------------- Series A Convertible, Redeemable Preferred stock par value $0.005 per share and additional paid in capital. 1,500,000 shares authorized, 558,110 shares issued and outstanding at May 31, 2003; 3,937,176 -- none at February 28, 2003. Common stock par value $0.005 per share and additional paid in capital. 500,000,000 shares authorized, 430,923,150 issued and outstanding at May 31 and February 28, 2003. 305,898,468 305,429,815 Committed common stock 3,102,958 3,102,958 Accumulated deficit (306,045,881) (303,820,597) --------------- ---------------- Total stockholders' equity 6,892,721 4,712,176 --------------- ---------------- Total liabilities and stockholders' equity $ 23,286,378 $23,767,866 =============== ================
See accompanying notes to condensed consolidated financial statements. AURA SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS THREE MONTHS ENDED MAY 31, 2003 AND 2002 (Unaudited) Three Months ------------ 2003 2002 ----------- ------------ Net Revenues $ 97,612 $ 183,739 Cost of goods 66,783 80,985 ----------- ------------ Gross Profit 30,829 102,754 Expenses Engineering, research and development expenses 496,072 1,232,818 Selling, general and administrative 1,177,768 2,160,475 ----------- ------------ Total costs and expenses 1,673,840 3,393,293 ----------- ------------ Loss from operations (1,643,011) (3,290,539) Other (income) and expense Interest expense, net 644,088 82,234 Other (income) expense, net (31,695) 585,429 Minority interest in net income of consolidated subsidiary 5,474 -- ----------- ------------ Loss before extraordinary item (2,290,878) (3,958,201) ----------- ------------ Extraordinary item Gain on extinguishment of debt obligations, net of income taxes of $0 65,594 -- ----------- ------------ Net loss $(2,225,284) $(3,958,201) ============ ============ Basic and diluted loss per share Before extraordinary item $ (0.005) $ (0.010) ============ ============ Extraordinary item $ -- -- ============ ============ Total basic and diluted loss per share $ (0.005) $ (0.010) ============ ============ Weighted average shares used to compute basic and diluted loss per share 430,923,150 398,236,320 ============ ============ See accompanying notes to condensed consolidated financial statements. AURA SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MAY 31, 2003 AND 2002 (Unaudited) 2003 2002 ----------- ------------ Net cash used in operations $ (1,301,226) $ (3,969,869) Investing activities: Proceeds from sale of investment 302,500 -- Note receivable 51,008 40,944 ----------- ------------ Net cash provided by investing activities 353,508 40,944 Financing activities: Issuance of debt 644,214 -- Repayment of debt (44,198) (250,000) Issuance of convertible notes 200.000 -- Net proceeds from sale of common stock -- 4,135,000 Net proceeds from sale of Series A preferred stock -- ----------- ------------ 109,500 Net cash provided by financing activities: 909,516 3,885,000 ----------- ------------ Net increase (decrease) in cash (38,202) (43,925) Cash and cash equivalents at beginning of period 163,693 1,143,396 ----------- ------------ Cash and cash equivalents at end of period $ 125,491 $1,099,471 =========== ============ Supplemental disclosures of cash flow information Cash paid during the period for: Interest $ 58,587 $ 43,167 Unaudited supplemental disclosure of noncash investing and financing activities: During the three months ended May 31, 2003, the Company: - exchanged $3,605,973 of convertible notes payable, plus accrued interest, for 534,020 shares of Series A Convertible, Redeemable Preferred Stock. During the three months ended May 31, 2002, the Company: - issued 292,508 shares of the Company's common stock in satisfaction of $92,140 in liabilities. See accompanying notes to condensed consolidated financial statements. AURA SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS May 31, 2003 (Unaudited) 1) Basis of Presentation The condensed consolidated financial statements include the accounts of Aura Systems, Inc. and subsidiaries ("the Company"). All inter-company balances and inter-company transactions have been eliminated. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments (which include normal recurring adjustments) and reclassifications for comparability necessary to present fairly the financial position of Aura Systems, Inc. and subsidiaries at May 31, 2003 and the results of its operations for the three months ended May 31, 2003 and 2002. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. 2) Going Concern In connection with the audit of its consolidated financial statements for the year ended February 28, 2003, the Company received a report from its independent auditors that includes an explanatory paragraph describing uncertainty as to the Company's ability to continue as a going concern. Except as otherwise disclosed, the condensed consolidated financial statements have been prepared on the basis that it is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company continues to experience acute liquidity challenges. The Company had cash of approximately $100,000 and $200,000 at May 31 and February 28, 2003, respectively. For the three months ended May 31, 2003 and the year ended February 28, 2003, the Company incurred a net loss of approximately $2,200,000 and $16,100,000, respectively, on net revenues of approximately $100,000 and $1,100,000, respectively. The Company had working capital deficiencies at May 31 and February 28, 2003 of approximately $12,700,000 and $15,600,000, respectively. These conditions, combined with the Company's historical operating losses, raise substantial doubt as to the Company's ability to continue as a going concern. At July 31, 2003, the Company had less than $100,000 of cash. The Company requires additional debt or equity financing to fund ongoing operations. The Company is seeking to raise additional capital; however, there can be no assurance that the Company will raise sufficient capital to fund ongoing operations. The issuance of additional shares of equity in connection with such financing could dilute the interests of existing stockholders of the Company and such dilution could be substantial. The Company must increase its authorized shares in order to be able to sell common equity and intends to propose to stockholders such action as well as a reverse stock split of its common shares; there can be no assurance that either such action will be approved. The inability to secure additional funding could result in the Company having to cease operations. The cash flow generated from the Company's operations to date has not been sufficient to fund its working capital needs, and the Company does not expect that operating cash flow will be sufficient to fund its working capital needs in its fiscal year ending February 28, 2004. In the past, in order to maintain liquidity, the Company has relied upon external sources of financing, principally equity financing and private and bank indebtedness. The Company expects to fund any operating shortfall in the current fiscal year from cash on hand, sales of non-core assets and external financings. Currently, the Company has no firm commitments from third parties to provide additional financing and there can be no assurance that financing will be available at the times or in the amounts required. If future financing involves the issuance of equity securities, existing stockholders may suffer dilution in net tangible book value per share and such dilution may be significant. If financing cannot be arranged in the amounts and at the times required, the Company will cease operations. The Company has no bank line of credit. 3) Capital In March 25, 2003, the Board of Directors of the Company authorized 1,500,000 shares of Series A convertible, redeemable preferred stock (the "Series A Preferred") with a par value of $0.005. Each Series A Preferred share is convertible into common stock at $0.08 per share. The Series A Preferred can be converted at the option of the holder provided that the Company does not exercise the mandatory conversion on any date on or after March 31, 2004. The Company may exercise its right to mandatory conversion provided that the current market value of the Company's common stock equal or exceeds 120% of the then prevailing conversion price. As the redemption of the Series A Preferred is at the option of the company, all preferred outstanding has been classified as equity in the accompanying condensed consolidated financial statements. In the event that circumstances occur which cause the Series A Preferred to be redeemable at the option of the holder or manditorily redeemable on some future event or date, the Series A Preferred would be reclassified out of equity. The Series A Preferred has liquidation preference of $10 per share. In addition, the holders of the Series A Preferred are entitled to receive cumulative dividends at a rate of 5% per annum. Dividends are payable in arrears on the first day of each quarter, commencing on September 1, 2003. The shares can be redeemed on or after March 31, 2004 in whole or in part at a redemption price equal to $10 per share, plus the amount of any accumulated and unpaid dividends. In the three months ended May 31, 2003, Series A Convertible, Redeemable Preferred Stock ("Series A Preferred") outstanding increased by a total of 558,110 shares as follows: 534,020 shares in exchange for convertible notes payable, plus accrued interest, totaling approximately $3,700,000 and 24,090 shares for $109,500 cash proceeds. As of May 31, 2003 the cumulative preferred dividends were not material the Company's financial statements. Additionally, cumulative preferred dividends in future periods will be disclosed as a reduction in the net loss available to common shareholders. The Company did not issue shares of Common Stock during the quarter ended May 31, 2003. 4) Inventories Inventories, stated at the lower of cost (first in, first out) or market, consist of the following: May 31. 2003 February 28, (unaudited) 2003 ---------- ------------ Raw materials $3,886,841 $ 3,846,439 Finished goods 6,803,234 6,819,286 Reserved for potential product obsolescence (1,678,000) (1,678,000) ----------- ------------ 9,012,075 8,987,725 Non-current portion 7,573,225 7,573,225 =========== ------------ $1,438,850 $ 1,414,500 =========== ============
Inventories consist primarily of components and completed units for the Company's AuraGen product. Management has analyzed its inventories based on its current business plan, backlog, and pending proposals with perspective customers and has determined that the Company does not expect to realize all of its inventories within the 12-month period ending May 31, 2004. Because of this, the Company has assessed the net realizability of these assets, the proper classification of the inventory, and the potential obsolescence of inventory for the future if sales do not materialize. In these evaluations, management has recorded a reserve of $1,678,000 at May 31 and February 28, 2003. The net inventories as of May 31 and February 28, 2003 which are not expected to be realized within a 12-month period have been reclassified as long term. 5) Significant Customers In the three months ended May 31, 2003, the Company sold AuraGen related products to three significant customers for a total of approximately $68,000 or 69% of net revenues. None of these customers are related to or affiliated with the Company. At May 31, 2003, the Company held accounts receivable from two of these significant customers for a total of approximately $56,000 or 18% of net receivables. None of these customers are related to or affiliated with the Company. 6) Contingencies The Company is engaged in certain material legal proceedings as described in Item 3 of the Company's Form 10-K for the year ended February 28, 2003 as filed with the SEC. In the case of a judgment or settlement, appropriate provisions have been made in the financial statements. 7) Notes Payable and Other Liabilities Notes payable and other liabilities consist of the following: May 31, 2003 February 28, (unaudited) 2003 --------------- ---------------- Notes payable-buildings (a) $ 5,030,572 $ 5,058,774 Convertible notes payable (b) -- 2,012,320 Convertible notes payable (c) 625,000 1,750,000 Convertible notes payable (d) 200,000 -- Litigation payable (e) 2,201,604 2,201,604 Trade debt (f) 1,204,144 1,308,533 Note payable-related party (g) 1,000,000 1,000,000 Note payable (h) 200,000 -- Notes payable-equipment (i) 12,5077 14,147 --------------- ---------------- 10,473,826 13,345,378 Less: current portion 10,435,335 13,305,103 --------------- ---------------- Long-term portion $ 38,491 $ 40,275 ================== ================
(a) Notes payable-buildings consist of a 1st Trust Deed on two buildings in California bearing interest at the rate of 7.625%. A final balloon payment is due in Fiscal 2009. In April 2003, the Company defaulted on these notes payable and the notes remain in default at July 31, 2003. As such, these notes payable were classified as current liabilities at May 31 and February 28, 2003. (b) The notes payable bear interest at 5% per annum, mature at various dates, and are convertible into shares of the Company's Series A Preferred at a rate of $1.00 principal amount of notes for each $2.20 of Series A Preferred. During the quarter ended May 31, 2003, the Company issued an additional $466,500 of these notes payable and recorded interest expense of $466,500 related to the conversion feature thereon. On March 31, 2003, the Company completed the conversion of these notes into Series A Preferred (see Note 3). (c) The notes carry an 8% interest rate and are convertible into common stock at various conversion rates. During the quarter ended May 31, 2003, the Company issued an additional $200,000 of these convertible notes payable. In March, 2003, the conversion of $1,125,000 of the notes was completed (see Note 3). The conversion feature on the notes approximated fair value of the underlying shares at the date of issuance. (d) The litigation payable represents the legal settlements entered into by Aura with various parties. These settlements call for payment terms with 8% interest rate to the plaintiffs through fiscal 2004. (e) On May 29, 2003, the Company received $200,000 of interim funding and issued term notes bearing interest at 5% per annum, convertible into shares of Series A Preferred. The conversion feature on the notes approximated fair value of the underlying shares at the date of issuance. (f) Trade debt was restructured with payment terms over a three-year period with interest at 8% per annum commencing in January 2000. During the quarter ended May 31, 2003 and the year ended February 28, 2003, the Company settled $59,818 and $1,456,213, respectively, of this trade debt, including accrued interest, for $14,356 and $385,142, respectively. The gains on the extinguishment of debt of $65,594 and $1,050,995, which are reflected as extraordinary items in the quarter ended May 31, 2003 and the year ended February 28, 2003, respectively, resulted in extraordinary income per share of less than $0.01 in each period. To fund these transactions, the Company issued $307,862 of the convertibles notes payable described in (b) above in the year ended February 28, 2003. (g) Note payable - related party consisted of a $1,000,000 note payable, which was entered into in connection with the sale of a minority interest in Aura Realty, as more fully described in the Company's Form 10-K for the year ended February 28, 2003 as filed with the SEC. The note bears interest at 12.3% per annum and is secured by a security interest in a certain note receivable. The Company is required to make interest only payments for the first 17 months of the term, and the $1,000,000 principal is due on May 31, 2004. (h) During the quarter ended May 31, 2003, the Company entered into a note payable agreement for $200,000. The note payable bears interest at a fixed rate of $10,000. The note payable and the $10,000 fixed fee mature on June 7, 2003. On the maturity date of the note payable, the Company will issue warrants to purchase 1,000,000 shares, which was later modified to 3,000,000 shares, of the Company's common stock with an exercise price of $0.05, expiring on June 7, 2006. The warrants are to be included in the next S-1 filing. The note is secured by 177,777 shares of one of the Company's long term investments. As of July 8, 2003, the note was in default. In August 2003, the Company issued warrants to purchase 3,000,000 shares of common stock in relation to this note. The Company is in negotiations to obtain new financing from a different investor to replace this note payable agreement. (i) Notes payable-equipment consists of a note maturing in February 2005 with an interest rate of 8.45%. 8) Subsequent Events Between May 29 and July 11, 2003, the Company received $600,000 of interim funding from Koyah Leverage Partners, LLP to meet its immediate cash needs and issued term notes bearing interest at 5% per annum, convertible into shares of Series A Preferred (the "Term Notes"). From July 24, 2003 through August 20, 2003, the Company has received an additional $646,086 of interim funding. These amounts are evidenced by secured notes payable (the "Secured Notes") on October 24, 2003, which date automatically extends to January 24, 2004 if the Company has not received $2,000,000 of additional funding by October 24, 2003. The Secured Notes bear interest at 10% per annum and are convertible at the option of the holder into new debt or equity securities at of the Company at a 20% discount to the best terms by which such new debt or equity is sold to any new investor. The Secured Notes may be prepaid on notice at a 20% premium. Repayment of the Secured Notes is secured by substantially all the assets of the Company (with limited exceptions). The $600,000 of Term Notes were replaced with Secured Notes as part of this transaction. Although the Company is in discussions with the investor with regard to further financing, there can be no assurance that additional financing will be obtained. On June 11, 2003, the Company sold a portion of one of its long-term investments realizing net proceeds of approximately $112,500. The Company intends to sell the remainder of this investment and is actively seeking buyers but has no commitments from any buyers at this time. In June 2003, the Company received an order for over $1,000,000 of AuraGen(R) units, including mounting brackets and installation, from an existing customer. As of August 20, 2003, approximately $240,000 of this order has been delivered. The remainder of this order will be delivered at the customer's request through June 2006. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview This Form 10-Q report may contain forward-looking statements which involve risks and uncertainties. Such forward-looking statements include, but are not limited to, statements regarding future events and the Company's plans and expectations. The Company's actual results may differ significantly from the results discussed in forward-looking statements as a result of certain factors, including those discussed in the Company's Form 10-K for the period ended February 28, 2003 and this report. The Company expressly disclaims any obligations or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations or any events, conditions or circumstances on which any such statement is based. This report includes product names, trade names and marks of companies other than the Company. All such company or product names are trademarks, registered trademarks, trade names or marks of their respective owners and are not the property of the Company. Results of Operations For the three month period ended May 31, 2003 The Company's net loss for the three months ended May 31, 2003 (the "First Quarter FY2004") was $2,225,284 compared to a net loss of $3,958,201 for the three months ended May 31, 2002 (the "First Quarter FY2003"). Net operating revenues and gross profit were $97,612 and $30,829, respectively, in the First Quarter FY2004 and $183,739 and $102,754, respectively, in First Quarter FY2003. Net revenues for the First Quarter FY2004 decreased to $97,612 from $183,739 in the First Quarter FY2003. This represents a decrease of $86,127 (47%) from the First Quarter FY2003. Revenues are lower in Fiscal 2004 due largely to the Company's financial condition adversely impacting sales. Cost of goods decreased to $66,783 in the First Quarter FY2004 from $80,985 in the First Quarter FY2003. This 18% decrease was smaller than the change in net revenues (47%) resulting in a reduction in gross margin to 32% in First Quarter FY2004 from 56% for First Quarter FY2003. This reduction in gross margin results from a normal level of expense associated with warranty and demo units against an unusually low amount of revenue. The Company's cost for the goods included in revenue for the quarter was consistent with the historical gross margins. Cost of goods includes only the direct material and labor costs incurred. Engineering, research and development expenses decreased by $736,746 (60%) to $496,072 in the First Quarter FY2004 from $1,232,818 in the First Quarter FY2003. The decrease was primarily due to the cost control efforts taken throughout fiscal 2003 and into the First Quarter FY2004, most significantly, reductions in headcount. Labor and labor related costs included in engineering expense amounted to approximately $468,000 in the First Quarter FY2004, compared to approximately $774,000 in the First Quarter FY2003. The Company also reduced its research and development activities throughout fiscal 2003 and expects these efforts to continue at or below this reduced level at least through the second quarter of fiscal 2004. Selling, general and administrative ("SG&A") expenses decreased to $1,177,768 in the First Quarter FY2004 from $2,160,475 in the First Quarter FY2003; a reduction of $982,707 (45%). The SG&A expenses were lower due primarily to cost control efforts taken throughout fiscal 2003 and into the First Quarter FY2004, most significantly, reductions in headcount. Labor and labor related costs included in SG&A amounted to approximately $618,000 in the First Quarter FY2004, compared to approximately $1,252,000 in the First Quarter FY2003. Other income was $31,695 in the First Quarter FY2004 compared to other expense of $585,429 in First Quarter FY2003. Net interest expense for the First Quarter FY2004 increased $561,854 to $644,088 from $82,234 in the First Quarter FY2003 due principally to the recording of $466,500 of expense representing the beneficial conversion feature related to the issuance of convertible notes payable. Additional borrowing required in the First Quarter FY2004 caused the remainder of the interest expense increase. Critical Accounting Policies and Estimates The Company's discussion and analysis of its financial conditions and results of operations are based upon its 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, the Company evaluates its estimates, including, but not limited to, those related to revenue recognition. The Company uses authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. Actual results could differ from those estimates. The Company believes that the following critical accounting policies affect its more significant judgments and estimates in the preparation of its consolidated financial statements. Revenue recognition The Company is required to make judgments based on historical experience and future expectations, as to the reliability of shipments made to its customers. These judgments are required to assess the propriety of the recognition of revenue based on Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition," and related guidance. The Company makes these assessments based on the following factors: i) customer-specific information, ii) return policies, and iii) historical experience for issues not yet identified. Inventory The Company is required to make judgments based on historical experience and future expectations as to the realizability of inventory. The Company makes these assessments based on the following factors: i) existing orders, ii) age of the inventory, and iii) historical experience. Valuation of long-lived assets Long-lived assets, consisting primarily of property and equipment, and patents and trademarks, comprise a significant portion of the Company's 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. The cash flow projections are based on historical experience, management's view of growth rates within the industry, and the anticipated future economic environment. Factors that the Company considers important that could trigger a review for impairment include the following: (a) significant underperformance relative to expected historical or projected future operating results, (b) significant changes in the manner of its use of the acquired assets or the strategy of its overall business, and (c) significant negative industry or economic trends. When the Company determines that the carrying value of patents and trademarks, long-lived assets and related goodwill and enterprise-level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, it measures any impairment based on a projected discounted cash flow method using a discount rate determined by its management to be commensurate with the risk inherent in its current business model. Financial Position, Liquidity and Capital Resources The Company continues to experience acute liquidity challenges. The Company had cash of approximately $100,000 and $200,000 at May 31 and February 28, 2003, respectively. For the three months ended May 31, 2003 and the year ended February 28, 2003, the Company incurred a net loss of approximately $2,200,000 and $16,100,000, respectively, on net revenues of approximately $100,000 and $1,100,000, respectively. The Company had working capital deficiencies at May 31 and February 28, 2003 of approximately $12,300,000 and $15,600,000, respectively. These conditions, combined with the Company's historical operating losses, raise substantial doubt as to the Company's ability to continue as a going concern. At July 31, 2003, the Company had less than $100,000 of cash. The Company requires additional debt or equity financing to fund ongoing operations. The Company is seeking to raise additional capital; however, there can be no assurance that the Company will raise sufficient capital to fund ongoing operations. The issuance of additional shares of equity in connection with such financing could dilute the interests of existing stockholders of the Company and such dilution could be substantial. The Company must increase its authorized shares in order to be able to sell common equity and intends to propose to stockholders such action as well as a reverse stock split of its common shares; there can be no assurance that either such action will be approved. The inability to secure additional funding could result in the Company having to cease operations. The cash flow generated from the Company's operations to date has not been sufficient to fund its working capital needs, and the Company does not expect that operating cash flow will be sufficient to fund its working capital needs in its fiscal year ending February 28, 2004. In the past, in order to maintain liquidity, the Company has relied upon external sources of financing, principally equity financing and private and bank indebtedness. The Company expects to fund any operating shortfall in the current fiscal year from cash on hand, sales of non-core assets and external financings. Currently, the Company has no firm commitments from third parties to provide additional financing and there can be no assurance that financing will be available at the times or in the amounts required. If future financing involves the issuance of equity securities, existing stockholders may suffer dilution in net tangible book value per share and such dilution may be significant. If financing cannot be arranged in the amounts and at the times required, the Company will cease operations. The Company has no bank line of credit. Due to the Company's acute liquidity challenges, it has defaulted in payments under many of its financial obligations (see Note 7 in the Condensed Consolidated Financial Statements). These defaults effectively render these obligations payable on demand and the entire principal balance of each obligation has been included in current liabilities in the accompanying Consolidated Financial Statements. Actions by the parties to these obligations to enforce their rights to collect the amounts due could require the Company to cease operations. At May 31, 2003, the Company had accounts receivable, net of allowance for doubtful accounts, of $175,213; $410,717 at February 28, 2003. As of July 31, 2003, the Company had net accounts receivable of approximately $320,000. From April 1 through June 11, 2003, the Company sold a portion of one of its long-term investments realizing net proceeds of approximately $415,000. The Company intends to sell the remainder of this investment and is actively seeking buyers but has no commitments from any buyers at this time. In May 2003, the Company borrowed $200,000, secured by a portion of the remainder of this investment. This borrowing will be required to be repaid from the proceeds of future sales of this investment. There was no spending for property and equipment in the First Quarter FY2004 or the First Quarter FY2003. The Company has no material capital project that would require funding. The Company's current plant and equipment is sufficient to support its current level of sales. Debt repayments of $44,198 were made in First Quarter FY2004 as compared to $250,000 in First Quarter FY2003. The Company leases warehouse space located in Rancho Dominguez, California. Minimum monthly rent under the lease approximates $3,900. The Company is currently in default of this lease and is negotiating a schedule of payments to remedy this default. The status of the Company's lease of its headquarters and manufacturing facility is discussed in the Company's Form 10-K for the period ended February 28, 2003. Capital Transactions In March 2003, the Company issued approximately $400,000 of "5% Discounted Notes". All of these notes (together with other 5% Discounted Notes previously issued) were converted into Series A Preferred on March 31, 2003 as discussed below. On March 25, 2003, the Company designated 1,500,000 shares of its authorized preferred stock as Series A Convertible Redeemable Preferred Stock (the "Series A Preferred"). Each share of Series A Preferred has a par value of $.005, a liquidation preference of $10.00 plus accrued unpaid dividends and is convertible into common stock at $.080 per share, based on the liquidation preference. Dividends accrue on each share at the rate of 5% of the liquidation preference per annum. The Company may call the Series A Preferred for redemption on or after March 31, 2004 subject to certain conditions. As of May 31, 2003, 558,110 shares of Series A Preferred were outstanding, issued as set forth below. On March 31, 2003, the Company exchanged $1,125,000 of 8% Notes and converted $1,101,573 of 5% Notes and $1,342,900 of 5% Discounted Notes, plus accrued interest in all cases, into 534,020 shares of Series A Preferred. The average effective net acquisition price of the shares of Common Stock underlying the conversion feature, based on the mounts paid for the notes, is $0.054 per share. Between May 29 and July 11, 2003, the Company received $600,000 of interim funding from Koyah Leverage Partners, LLP to meet its immediate cash needs and issued term notes bearing interest at 5% per annum, convertible into shares of Series A Preferred (the "Term Notes"). From July 24, 2003 through August 20, 2003, the Company has received an additional $646,086 of interim funding. These amounts are evidenced by secured notes payable (the "Secured Notes") on October 24, 2003, which date automatically extends to January 24, 2004 if the Company has not received $2,000,000 of additional funding by October 24, 2003. The Secured Notes bear interest at 10% per annum and are convertible at the option of the holder into new debt or equity securities at of the Company at a 20% discount to the best terms by which such new debt or equity is sold to any new investor. The Secured Notes may be prepaid on notice at a 20% premium. Repayment of the Secured Notes is secured by substantially all the assets of the Company (with limited exceptions). The $600,000 of Term Notes were replaced with Secured Notes as part of this transaction. Although the Company is in discussions with the investor with regard to further financing, there can be no assurance that additional financing will be obtained. Also during the first quarter of fiscal 2004: - the Company issued 24,090 shares of Series A Preferred in a private placement for net cash proceeds of $109,500. The effective net acquisition price of the shares of Common Stock underlying the conversion feature, based on the amounts paid for the preferred stock is $0.036 per share. - the Company issued convertible notes payable to third party investors totaling $200,000. The notes bear interest at 5% per annum and are due on demand no later than August 29, 2003. The notes are convertible into Series A Preferred stock at $10.00 per share. The effective net acquisition price of the shares of Common Stock underlying the conversion feature, based on the amounts paid for the notes, is $0.080 per share. - the Company issued a $200,000 note in exchange for a loan. The note and $10,000 fixed fee interest became due on June 7, 2003. As part of this borrowing, the Company is obligated to issue warrants to purchase 1,000,000 shares of the Company's common stock at an exercise price of $0.050, expiring on June 7, 2006. The note is secured by 177,777 shares of one of the Company's long-term investments. The Company did not pay the note when due and is in default. The Company agreed to increase the warrants to be issued to 3,000,000 to compensate the holder for this default, and in August 2003, the Company issued warrants to purchase 3,000,000 shares of common stock at $0.050 per share. The Company is in negotiations to obtain new financing from a different inventor to replace this note payable agreement but there can be no assurance that such financing will be obtained. ITEM 4 Controls and Procedures (a) The Company's chief executive officer and its chief financial officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of a date within 90 days of the filing date of this quarterly report (the "Evaluation Date") have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them timely by others within those entities. (b) There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's disclosure controls and procedures subsequent to the Evaluation Date, nor were there any significant deficiencies or material weaknesses in such disclosure controls and procedures requiring corrective actions. As a result, no corrective actions were taken. PART II - OTHER INFORMATION ITEM 1 Legal Proceedings A group of former officers of the Company, who resigned on February 28, 2002 following the commencement of an SEC investigation into the Company's accounting practices (as described on the company's Annual Report on Form 10-K) filed a lawsuit against the Company, on July 24, 2003, seeking payment of amounts owed under a consulting arrangement. The Company had renegotiated the amounts payable under the consulting arrangement, but defaulted on such amounts. The suit filed by these former officers seeks full payment based on their original employment agreements. The accruals reflected on the Company's financial statements were based on the revised agreements in place at the time of their resignations and, should these former officers be awarded the full amount sought in this suit, the Company would be required to record additional expense of approximately $1,100,000. The Company intends to contest this action vigorously and may bring counterclaims against the individuals. ITEM 2 Changes in Securities For a discussion of recent sales of securities, see Management's Discussion and Analysis. All of the noted sales of unregistered securities were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933 as these offerings were a private placement to a limited number of accredited investors. ITEM 6 Exhibits and Reports on Form 8-K a) Exhibits: 10.28 - Form of convertible note 10.29 - Koyah Security Agreement 10.30 - Koyah Amendment Waiver 10.31 - Koyah Additional Advance Agreement 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 b) Reports on Form 8-K: None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AURA SYSTEMS, INC. ------------------------------------------------ (Registrant) Date: August 20, 2003 By: /s/David A. Rescino --------------- --------------------------- David A. Rescino Interim Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer) CERTIFICATION I, Neal F. Meehan, Chairman and Chief Executive Officer of Aura Systems, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Aura Systems, Inc. and, 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Neal F. Meehan ------------------- Neal F. Meehan Chairman & Chief Executive Officer August 20, 2003 CERTIFICATION I, David A. Rescino, Interim Chief Financial Officer of Aura Systems, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Aura Systems, Inc. and, 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ David A. Rescino --------------------- David A. Rescino Interim Chief Financial Officer August 20, 2003 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Aura Systems, Inc. (the "Company") on Form 10-Q for the period ending November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Neal F. Meehan, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods indicated. /s/ Neal F. Meehan ------------------- Neal F. Meehan Chairman & Chief Executive Officer August 20, 2003 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Aura Systems, Inc. (the "Company") on Form 10-Q for the period ending November 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David A. Rescino, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods indicated. /s/ David A. Rescino --------------------- David A. Rescino Interim Chief Financial Officer August 20, 2003