AURA SYSTEMS INC 10-K

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 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 Axial Flux Induction Motor solution and mobile power 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. Our sales and marketing approaches are composed of direct sales in North America and the use of agents and distributors in other areas. In North America, our primary focus is in (a) mobile exportable power applications, (b) EV motor applications, (c) U.S. Military applications and (d) industrial/commercial motor as well as mobile power applications. 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 optimized power levels for electric motors and new features for our AuraGen ® /VIPER solution such as higher power/torque solutions, and different input and output voltages (DC and AC input and output versions). In Fiscal 2020 stockholders of the Company successfully removed Ronald Buschur, William Anderson and Si Ryong Yu from the Company’s Board of Directors and elected Ms. Cipora Lavut, Mr. David Mann and Dr. Robert Lempert as directors of the Company in their stead. See Item 3, Legal Proceedings for more information. Also, in Fiscal 2020, Melvin Gagerman –– Aura’s CEO and CFO since 2006 –– was replaced. In July 2019 Ms. Lavut succeeded Mr. Gagerman as President and Mr. Mann succeeded Mr. Gagerman as CFO. Dr. Lempert was appointed as Secretary of the Company by the Board of Directors also in July 2019. In the second half of Fiscal 2020, the company began significantly increasing its engineering, manufacturing and marketing activities. From July 8, 2019, the date of the change in management, through the end of Fiscal 2023, the Company shipped approximately 150 units to. Although our operations were impacted in Fiscal 2023, Fiscal 2022 and Fiscal 2021 by the COVID-19 pandemic, during these periods we continued to expand our engineering and manufacturing capabilities. See “Item 1. Business. Impact of the COVID-19 Pandemic” included elsewhere in this Annual Report on Form 10-K for information regarding the impact of COVID-19 on our operations. Our engineering, research and development costs for Fiscal 2023 and Fiscal 2022 were approximately $850,000 and $611,000, respectively. During Fiscal 2018 and Fiscal 2019, the Company’s engineering, manufacturing, sales, and marketing activities were reduced while we focused on renegotiating numerous financial obligations. During this time, the Company’s 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, the Company successfully restructured in excess of $30 million of debt. Robert Kopple, our former Vice Chairman of the Board, was the only significant unsecured note holder that did not executed formal agreements regarding the restructure of his debt. See “Item 3. Legal Proceedings” included elsewhere in this Annual Report on Form 10-K for information regarding the dispute with Mr. Kopple regarding these transactions. In March 2022, the Company reached a settlement that resolves the various claims asserted against us by Mr. Kopple and his affiliated entities. In July 2017, Mr. Kopple and his affiliates brought suit against the Company relating to more than $13 million and the current equivalent of more than approximately 23 million warrants, exercisable for seven years at a price of $0.10 per share, which Mr. Kopple and his affiliated entities (collectively the “Kopple Parties”) claimed to be owed to them pursuant to various agreements with the Company entered into between 2013-2016. Under the terms of the settlement, the Company agreed to pay an aggregate amount of $10 million over a period of seven years, including $3 million initial payment to be paid in June 2022. $150 was paid in June 2022, and the balance of the initial payment of $2.85 million was extended to May 29, 2023. In exchange for the extension, the Company was required to pay $165,000 in extension and forbearance fees in cash and $430,000 in accrued forbearance fees. Beginning in January 2023, interest accrues on the unpaid balance at a rate of 6%, compounded annually. All amounts, including all accrued interest and deferred fees, are to be paid no later than eight years from the date of the initial payment. The Kopple Parties have also received seven-year warrants to purchase up to an aggregate of approximately 3.3 million shares of our common stock at a price of $0.85 per share. The settlement also provides for standard mutual general release provisions and includes customary representations, warranties, and covenants, including certain increases in the amount payable to the Kopple Parties and the right of such parties to enter judgment against the Company if the Company remains in uncured default in its payment obligations under the settlement. (See Part IV, Item 15, Notes 9 and 17 to the Financial Statements) 26 Critical Accounting Policies and Estimates Our management’s discussion and analysis of our financial conditions and results of operations are based upon our 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. In preparing our financial statements, we have made our best estimates and judgments of certain amounts included in the financial statements. We use authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. The full impact of the COVID-19 pandemic is unknown and cannot be reasonably estimated for these key estimates and assumptions. However, we made appropriate accounting estimates based on the facts and circumstances available as of the reporting date. To the extent that there are differences between these estimates and actual results, our financial statements may be materially affected. Revenue Recognition The Company recognizes revenue in accordance with Financial Accounting Standard Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. To determine revenue recognition under ASC 606, an entity performs the following five-steps (i) identifies the contract(s) with a customer; (ii) identifies the performance obligations in the contract; (iii) determines the transaction price; (iv) allocates the transaction price to the performance obligations in the contract; and (v) recognizes revenue when (or as) the entity satisfies a performance obligation. The Company only applies the five-steps to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. In accordance with ASC 606, we recognize revenue, net of discounts, for our generator sets at time of product delivery to the domestic distributor (i.e. point-in-time), which also corresponds to the passage of legal title to the customer and the satisfaction of our performance obligations to the customer. Our payment terms are cash payment due upon delivery and typically includes a 2% price discount off the selling price in accordance with this policy. Our commercial terms and conditions do not include a right of return for reasons other than a defect in performance or quality. We offer a 24-month assurance-type warranty covering material and manufacturing defects, which we account for under the guidance of ASC 460, Guarantee. 27 Inventories Inventories are valued at the lower of cost (first-in, first-out) or net realizable value, on an average cost basis. We review the components of inventory on a regular basis for excess or obsolete inventory based on estimated future usage and sales. When evidence exists that the net realizable value of inventory is lower than its cost, the difference is recognized as a loss in the period in which it occurs. Once inventory has been written down, it creates a new cost basis for inventory that may not be subsequently written up. Leases The Company determines whether a contract is, or contains, a lease at inception. Right-of-use assets represent the Company’s right to use an underlying asset during the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at lease commencement based upon the estimated present value of unpaid lease payments over the lease term. The Company uses its incremental borrowing rate based on the information available at lease commencement in determining the present value of unpaid lease payments. Share-Based Compensation The Company periodically issues stock options and warrants, and shares of common stock to employees and non-employees in non-capital raising transactions for services and for financing costs. Share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period. Recognition of compensation expense for non-employees is in the same period and manner as if the Company had paid cash for services. The Company periodically issues stock options and warrants, and shares of common stock to employees and non-employees in non-capital raising transactions for services and for financing costs. Share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period. Recognition of compensation expense for non-employees is in the same period and manner as if the Company had paid cash for services. COVID-19 The COVID-19 global pandemic has negatively affected the global economy, disrupted global supply chains, and created extreme volatility and disruptions to capital and credit markets in the global financial markets. We began to see the impact of COVID-19 during our fourth quarter of Fiscal 2020 with our Chinese joint venture’s manufacturing facilities being required to close and many of our customers suspending their own operations due to the COVID-19 pandemic. As a result, net sales and production levels during the fourth quarter of Fiscal 2020, Fiscal 2021, Fiscal 2022 and Fiscal 2023 were significantly reduced, thus impacting our results of operations during these periods. 28 In response to the COVID-19 pandemic and business disruption, we implemented certain measures to manage costs, preserve liquidity and enhance employee safety. These measures included the following: ● Reduction of payroll costs through temporary furloughs; ● Enhanced cleaning and disinfection procedures at our facilities, temperature checks for our workers, promotion of social distancing at our facilities and requirements for employees to work from home where possible; ● Reduction of capital expenditures; and ● Deferral of discretionary spending. The extent of the impact of the COVID-19 pandemic on our business, financial results and liquidity will depend largely on future developments, including the duration of the spread of the COVID-19 outbreak within the U.S. and globally, the impact on capital and financial markets and the related impact on our customers, especially in the commercial vehicle markets. These future developments are outside of our control, are highly uncertain, and cannot be predicted. If the impact is prolonged, then it can further increase the difficulty of planning for operations and may require us to take further actions as it relates to costs and liquidity. These and other potential impacts of the COVID-19 pandemic will continue to adversely impact our results for the first quarter of Fiscal 2023, as well as the full Fiscal year, and that impact could be material. Results of Operations Fiscal 2023 compared to Fiscal 2022 Revenues Revenues in Fiscal 2023 were approximately $71,000 as compared to the Fiscal 2022 period of approximately $100,000, a reduction of approximately 29%. Fiscal 2023 revenues consisted principally of the delivery of 9 AuraGen ® /VIPER systems, 7 of which were to a single distributor customer. Fiscal 2022 revenues consisted principally of the delivery of 8 AuraGen ® /VIPER systems, including the initial units of the Company’s new design. We believe that the low levels of revenue in both Fiscal 2023 and Fiscal 2022 were the result of being impacted significantly by the COVID-19 pandemic and its impact on the global economy. Cost of Goods Cost of goods sold was approximately $88,000 and $124,000 in the years ended February 28, 2023, and February 28, 2022, respectively. During Fiscal 2023, we benefited from the utilization of fully reserved inventory to deliver 9 units and recorded material cost at 32% of sales value, direct labor at 43% of sales value and other overheads at 44% of sales. Additionally, the Company recorded an inventory write-down of $4,000 to cost of goods sold, which resulted in a negative gross margin of approximately $17,000 in Fiscal 2023. The disproportionate increase in manufacturing overhead costs resulted from higher depreciation and systems costs without an offsetting increase in production volumes. During Fiscal 2022, we benefited from the utilization of fully reserved inventory to deliver 8 units and recorded material cost at 31% of sales value, direct labor at 41% of sales value and other overheads at 16% of sales. Additionally, the Company recorded an inventory write-down of $36,000 to cost of goods sold, which resulted in a negative gross margin of approximately $24,000 in Fiscal 2022. While both the FY 2023 and FY 2022 periods benefited from the utilization of inventory that was previously fully reserved, the new design ECU units fabricated in those periods did include the costs of new electronics boards. As production levels increase over time, the amount of recoverable inventory will decline and the amount of direct material recorded within cost of goods sold will increase, reducing the gross profit contribution of units of sales. 29 Engineering, Research and Development Engineering, research and development costs increased to approximately $850,000 in Fiscal 2023 from approximately $611,000 in Fiscal 2022, an increase of approximately $239,000 or 39%. The increase is a result of the Company’s augmented engineering activities, including (i) successfully recruiting new additions to the engineering staff; (ii) licensing of modeling and design software tools for the full 12-month period; as well as (iii) additional expenses incurred in the process of designing, fabricating and testing the new version of our electronic control unit (“ECU”) for our AuraGen ® /VIPER products. Selling, General and Administrative Expense Selling, general and administrative expenses decreased approximately $159,000, or 6%, to $2,636,000 in Fiscal 2023 from $2,795,000 in Fiscal 2022 due to several factors. Most notable of these was a decrease in non-cash share-based compensation of approximately $612,000 as all stock options completed vesting in Fiscal 2022 with no new grants in Fiscal 2023. This was partially offset by (i) increased salary and wage-related expenses of approximately $400,000, including higher expenses related to the sales team as well as a full year of costs for the Company’s CFO; and (ii) increased depreciation and software license related costs of approximately $55,000 associated with equipment and computer systems acquired in late Fiscal 2022 and in Fiscal 2023. Non-Operating Income, Interest Expense and Tax Provision Net interest expense decreased significantly to approximately $727,000 in Fiscal 2023 from approximately $1,272,000 in Fiscal 2022, a decrease of approximately $545,000, or 43%. This is principally a result of the settlement of the litigation with Robert Kopple and his affiliates. Under the terms of the settlement, no interest was to accrue until payment of the initial $3 million, which was extended to May 2023. In exchange for the extensions, the company recorded $335,000 of fees which are being categorized as interest, plus note interest of approximately $52,000. The aggregate Kopple-related interest in Fiscal 2023 of approximately $387,000 compares to the Fiscal year 2022 Kopple-related interest of approximately $823,000, a 53% reduction. Extinguishment gains and favorable changes in the fair value of the Company’s derivative warrant liabilities aggregated to an approximately $819,000 positive impact for the Company in Fiscal 2023, an approximate $281,000 increase from the aggregate approximately $538,000 positive impact in Fiscal 2022. The favorable fair value changes and extinguishment gains in Fiscal 2023 were principally associated with the expiration of approximately 4.7 million warrants in February 2023. During Fiscal 2022, the Company recorded other income of approximately $167,000 for the forgiveness of principal and accrued interest on two Payroll Protection Program (“PPP”) loans. The PPP loans provided for up to 100% forgiveness of the debt if the proceeds were used for specifically authorized expenditures. Both of the PPP loans were forgiven at 100% of principal plus accrued interest. Net Loss We recorded net losses of approximately $3,410,000 and $3,992,000 in the Fiscal years ended February 28, 2023 and February 28, 2022, respectively, or an increase of income of approximately $582,000 due to several factors as note above: (i) Fiscal 2023 included the lower interest expense of approximately $545,000; (ii) approximately $110,000 greater non-operating gains related to changes in the fair value of derivatives liabilities and extinguishment of warrants; (iii) decreased operating expenses in selling, marketing and general and administrative of approximately $159,000; and (iv)increased engineering and R&D expenses of approximately $239,000 partially offsetting the other income improvements, 30 Liquidity and Capital Resources For the year ended February 28, 2023, we recorded a net loss of approximately $3.4 million and used cash in operations of approximately $3.1 million and at February 28, 2023, had a stockholders’ deficit of approximately $20.3 million. These conditions raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year from the date of issuance of these financial statements. In addition, the Company’s independent registered public accounting firm, in their report on the Company’s February 28, 2023, audited financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. The net loss in Fiscal 2023 was approximately $582,000 less as compared to Fiscal 2022 due to several offsetting items, but most notably reduced interest expense of approximately $545,000. Fiscal 2022 also included additional expenditures to ramp up the Company’s engineering, R&D, selling and administrative activities. A significant factor in both periods contributing to the negative operating cash flows is the low level of operating activities caused principally by the COVID-19 pandemic. As a result of the impacts of the COVID-19 pandemic, we may be required to raise additional capital and our access to and cost of financing will depend on, among other things, global economic conditions, conditions in the global financing markets, the availability of sufficient amounts of financing, and our future prospects. At February 28, 2023, we had cash of approximately $15,000, compared to cash of approximately $150,000 at February 28, 2022. Subsequent to February 28, 2023, the Company issued 2,334,847 shares of common stock in exchange for cash proceeds of $770,120. Working capital deficit at February 28, 2023 was a $13.7 million deficit as compared to an $21.7 million deficit at the end of the prior fiscal year. The principal reasons for the decrease in the deficit is the March 2022 settlement agreement the Company reached with a related party note holder (Kopple) to resolve all outstanding litigation between them related to notes payable and accrued interest of $12.1 million. The February 28, 2023 financial statements reflect the reclassification to non-current of $7.1 million of the debt to Robert Kopple and his affiliated entities (collectively the “Kopple Parties”) as a result of the settlement. At February 28, 2023 and February 28, 2022, we had no significant accounts receivable. Prior to Fiscal 2020, in order to maintain liquidity, we relied upon external sources of financing, principally equity financing and private indebtedness. We have no bank line of credit and will require additional debt or equity financing to fund ongoing operations. Based on a cash flow analysis performed by management, we estimate that we will need an additional $6 million to maintain existing operations for Fiscal 2024 and increase the volume of shipments to customers. We cannot assure the reader that additional financing will be available nor that the commercial targets will be met in the amounts required to keep the business operating. 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 the needed funds, we will 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. Between July 2017 and March 2022, the Company was engaged in litigation with a former director, Robert Kopple, relating to more than $13 million and the current equivalent of the approximately 23 million warrants, exercisable for seven years at a price of $0.10 per share, which Mr. Kopple and his affiliated entities (collectively the “Kopple Parties”) claimed should have been originally issued to them pursuant to various agreements with the Company entered to between 2013-2016. In March 2022, the Company reached a settlement with the Kopple Parties that resolved all claims asserted against the Company without any admission, concession or finding of any fault, liability or wrongdoing on the part of the Company. Under the terms of the settlement, the Company agreed to pay an aggregate amount of $10 million over a period of seven years, including $3 million initial payment to be paid in June 2022. $150 was paid in June 2022, and the balance of the initial payment of $2.85 million was extended to May 29, 2023. In exchange for the extension, the Company was required to pay $165,000 in extension and forbearance fees in cash and $430,000 in accrued forbearance fees. Beginning in January 2023, interest accrues on the unpaid balance at a rate of 6%, compounded annually. All amounts, including all accrued interest and deferred fees, are to be paid no later than eight years from the date of the initial payment. The Kopple Parties have also received seven-year warrants to purchase up to an aggregate of approximately 3.3 million shares of our common stock at a price of $0.85 per share. The settlement also provides for standard mutual general release provisions and includes customary representations, warranties, and covenants, including certain increases in the amount payable to the Kopple Parties and the right of such parties to enter judgment against the Company if the Company remains in uncured default in its payment obligations under the settlement. 31 We consider the transactions described above with Mr. Kopple to be related party transactions. See “Item 3. Legal Proceedings” and “Part IV, Item 15, Note 9 and Note 17 to the Financial Statements” included elsewhere in this Annual Report on Form 10-K for information regarding the dispute and settlement with Mr. Kopple regarding these transactions. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a smaller reporting company, we are not required to provide the information required by this Item 7A. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Index to Financial Statements at page F-1. 32 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE For the year ended February 28, 2023, there were no disagreements or any reportable events to disclose.