AURA SYSTEMS INC - Quarter Report: 2009 May (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

[( ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended.................................................May 31, 2009

OR

 

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from..........................to.............................

 

AURA SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

 

 

2330 Utah Avenue.

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 [ X ] NO [ ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [ X ] NO [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated file, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Act).

 

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

 

 

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yesx Noo

 

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date.

 

 

 

 

 

 

 

 

 

 

 

AURA SYSTEMS, INC. AND SUBSIDIARIES

INDEX

 

 

 

AURA SYSTEMS, INC. AND SUBSIDIARIES

 

QUARTER ENDED MAY 31, 2009

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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, 2009 as filed with the SEC (file number 000-17249).

 

 

 

 

AURA SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to these un-audited condensed consolidated financial statements.

 

AURA SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

THREE MONTHS ENDED MAY 31, 2009 AND 2008

(Un-audited)

 

 

 

See accompanying notes to these un-audited condensed consolidated financial statements.

 

 

 

AURA SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MAY 31, 2009 AND 2008

(Un-audited)

 

Un-audited supplemental disclosure of non-cash investing and financing activities:

During the quarter ended May 31, 2009, $35,000 of notes payable were converted into 58,333 shares of common stock and $64,109 of inventory was acquired through the issuance of notes payable.

See accompanying notes to these un-audited condensed consolidated financial statements.

 

 

AURA SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

May 31, 2009

(Un-audited)

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, 2009 and the results of its operations for the three months ended May 31, 2009 and 2008.

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.

Principles of Consolidation

The consolidated financial statements include the accounts of Aura and subsidiary, Aura Realty, Inc.. Investments in affiliated companies are accounted for by the equity or cost method, as appropriate. Significant inter-company amounts and transactions have been eliminated in consolidation.

Comprehensive Income

We utilize Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting comprehensive income and its components in a financial statement. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. Comprehensive income is not presented in our financial statements since we did not have any of the items of comprehensive income in any period presented.

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. However, if a customer determines that a different system configuration would better suit their application, we will allow them to exchange the system and bill them the incremental cost, or credit them if there is a decrease in the system cost. While some sales are for evaluative purposes, they are still considered 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. Any discounts that are offered are done as a reduction of the invoiced amount at the time of billing. 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.

Cash and Cash Equivalents

Cash and cash equivalents include cash in hand and cash in time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less.

Accounts Receivable

Accounts receivable consist primarily of amounts due from customers. We have provided for an allowance for doubtful accounts, which management believes to be sufficient to account for all uncollectible amounts. Allowance for doubtful debts on uncollectible amounts as of May 31, 2009 and February 28, 2009, respectively, amounted to $60,000 and $60,000.

Inventories

Inventories are valued at the lower of cost (first-in, first-out) or market. Due to continuing lower than projected sales, we are holding inventories in excess of what we expect to sell in the next fiscal year.

Property, Plant, and Equipment

Property, plant, and equipment, including leasehold improvements, are recorded at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets as follows:

Improvements to leased property are amortized over the lesser of the life of the lease or the life of the improvements. Amortization expense on assets acquired under capital leases is included with depreciation and amortization expense on owned assets.

Maintenance and minor replacements are charged to expense as incurred. Gains and losses on disposals are included in the results of operations.

Income Taxes

We utilize SFAS No. 109, "Accounting for Income Taxes," which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

 

Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Going Concern

The accompanying financial statements have been prepared on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the three month periods ended May 31, 2009 and 2008, the Company incurred losses of $2,171,109 and $2,038,588, respectively and had negative cash flows from operating activities of $1,609,540 and $1,751,127, respectively during the three month periods ended May 31, 2009 and 2008.

 

If the Company is unable to generate profits or continue to obtain financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.

 

The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to retain its current financing, to obtain additional financing, and ultimately to attain profitability.

 

Recently Issued Accounting Pronouncements

On December 30, 2008 FASB issued FIN 48-3, “Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises”. This FSP defers the effective date of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, for certain non-public enterprises as defined in paragraph 289, as amended, of FASB Statement No. 109, Accounting for Income Taxes, including non-public not-for-profit organizations. However, non-public consolidated entities of public enterprises that apply U. S. GAAP are not eligible for the deferral. Nonpublic enterprises that have applied the recognition, measurement, and disclosure provisions of Interpretation 48 in a full set of annual financial statements issued prior to the issuance of this FSP also are not eligible for the deferral. This FSP shall be effective upon issuance. The Company does not believe this pronouncement will impact its financial statements.

In January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“FSP EITF 99-20-1”). FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be more consistent with the impairment models of FAS No. 115. FSP EITF 99-20-1 achieves this by amending the impairment model in EITF 99-20 to remove its exclusive reliance on “market participant” estimates of future cash flows used in determining fair value. Changing the cash flows used to analyze other-than-temporary impairment from the “market participant” view to a holder’s estimate of whether there has been a “probable” adverse change in estimated cash flows allows companies to apply reasonable judgment in assessing whether an other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1 will not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides additional guidance for estimating fair value measurements in accordance with FASB Statement No. 157 when there is not an active market or where the price inputs being used represent distressed sales. FSP FAS 157-4 provides additional guidance on the major categories for which equity and debt securities disclosures are to be presented and amends the disclosure requirements of FASB Statement No. 157 to require disclosure in interim and annual periods of the inputs and valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period. FSP FAS 157-4 shall be applied prospectively and is effective for interim and annual reporting periods ending after

 

 

June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting this FSP must also early adopt FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairment (“FSP FAS 115-2 and FAS 124-2”). The Company is in the process of evaluating the impact, if any, of applying this FSP on its financial position, results of operations and cash flows.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2. This FSP amends SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” SFAS 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations,” and EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to make the other-than-temporary impairments guidance more operational and to improve the presentation of other-than-temporary impairments in the financial statements. This FSP will replace the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired debt security until recovery with a requirement that management assert it does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis. This FSP provides increased disclosure about the credit and noncredit components of impaired debt securities that are not expected to be sold and also requires increased and more frequent disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. Although this FSP does not result in a change in the carrying amount of debt securities, it does require that the portion of an other-than-temporary impairment not related to a credit loss for a held-to-maturity security be recognized in a new category of other comprehensive income and be amortized over the remaining life of the debt security as an increase in the carrying value of the security. This FSP shall be effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity may early adopt this FSP only if it also elects to early adopt FSP FAS 157-4. Also, if an entity elects to early adopt either FSP FAS 157-4 or FSP FAS 107-1 and APB 28-1, the entity also is required to early adopt this FSP.  The Company is currently evaluating this new FSP but does not believe that it will have a significant impact on the determination or reporting of the financial results.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 require companies to disclose in interim financial statements the fair value of financial instruments within the scope of FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments. However, companies are not required to provide in interim periods the disclosures about the concentration of credit risk of all financial instruments that are currently required in annual financial statements. The fair-value information disclosed in the footnotes must be presented together with the related carrying amount, making it clear whether the fair value and carrying amount represent assets or liabilities and how the carrying amount relates to what is reported in the balance sheet. FSP FAS 107-1 and APB 28-1 also requires that companies disclose the method or methods and significant assumptions used to estimate the fair value of financial instruments and a discussion of changes, if any, in the method or methods and significant assumptions during the period. The FSP shall be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. An entity early adopting FSP FAS 107-1 and APB 28-1 must also early adopt FSP FAS 157-4 as well as FSP FAS 115-2 and FAS 124-2. The Company will adopt the disclosure requirements of this pronouncement for the quarter ended August 31, 2009, in conjunction with the adoption of FSP FAS 157-4, FSP FAS 115-2 and FAS 124-2.

In May 2009, the FASB issued SFAS No. 165, "Subsequent Events" (“SFAS 165”). SFAS 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 will be effective for interim or annual period ending after June 15, 2009 and will be applied prospectively. The Company will adopt the requirements of this pronouncement for the quarter ended August 31, 2009. The Company does not anticipate the adoption of SFAS 165 will have an impact on its consolidated results of operations or consolidated financial position.

 

Reclassifications

Certain reclassifications have been made to the 2008 financial statements to conform to the 2009 presentation.

 

 

We do not expect to realize all of our inventories within the 12-month period ending May 31, 2010.  Because of this, we have assessed the net realizability of these assets, the proper classification of the inventory, and the potential obsolescence of inventory.  The net inventories as of May 31 and February 28, 2009, which are not expected to be realized within a 12-month period, have been reclassified as long term.  We have also recorded a reserve for obsolescence of $2,271,535 at May 31 and February 28, 2009.

Property, plant, and equipment at May 31, 2009 and February 28, 2009 consisted of the following:

Depreciation and amortization expense was $24,465 and $12,199, for the three month periods ended May 31, 2009, and 2008.

 

 

Accrued expenses at May 31, 2009 and February 28, 2009 consisted of the following:

 

 

 

 

 

 

 

 

The Company allocated the investment proceeds to the debt and warrants based on their relative fair values. The relative fair value of the warrants using the Black Scholes method assuming a volatility of

 

 

the stock of 107%, term of five years and a discount of 2.625% was determined to be $ 18,661 which was recorded as debt discount, a reduction of the carrying amount of the debt. The beneficial conversion feature on the notes was $57,161 which was also recorded as debt discount. The debt discount will be amortized over the term of the note and charged to interest expense. During the three month period ended May 31, 2009 $18,956 was expensed.

 

Future maturities of notes payable at May 31, 2009 are as follows:

 

Consists of notes payable to a member of our Board of Directors, payable on demand, bearing interest at a rate of 10% per annum. During the three month period ended May 31, 2009, the Company received additional financing of $700,000 from the related party, also at an interest rate of 10%, and $54,049 accrued and unpaid interest for the period was included in accrued expenses.

During the quarter ended May 31, 2009, we issued 582,916 shares of Common Stock for cash consideration of $335,000. We issued 165,000 shares for a subscription receivable of $90,000, which was received in June, 2009. We also received $ 130,000 for 216,666 shares issued in June 2009. We also issued 94,428 shares of common Stock upon the exercise of 94,428 warrants, for cash consideration of $94,428, and issued 58,333 shares of Common Stock for the conversion of $35,000 of notes payable.

During the quarter ended May 31, 2008, we issued 200,000 shares of Common Stock for consideration of $250,000. We also issued 1,402,062 shares of Common Stock upon the exercise of 1,402,062 warrants, for consideration of $1,402,062, and issued 430,329 shares of Common Stock for the exercise of warrants in lieu of payments on our secured notes payable.

Employee Stock Options

In September, 2006, our Board of Directors adopted the 2006 Employee Stock Option Plan. Activity in this plan is as follows:

The exercise prices for the options outstanding at May 31, 2009, and information relating to these options is as follows:

 

 

 

Warrants

Activity in issued and outstanding warrants is as follows:

 

The exercise prices for the warrants outstanding at May 31, 2009, and information relating to these warrants is as follows:

 

We are a United States based company providing advanced technology products to various industries. The principal markets for our products are North America, Europe, and Asia. All of our operating long-lived assets are located in the United States. We operate in one segment.

Total net revenues from customer geographical segments are as follows for the three month periods ended May 31, 2009 and 2008:

 

 

 

 

In the three months ended May 31, 2009, we sold AuraGen related products to two significant customers whose sales comprised 64% and 14% of net sales, respectively.  These customers are not related to or affiliated with us.

At May 31, 2009, we held accounts receivable from these customers for totaling 52% and 19%, respectively, of net accounts receivable. 

For a discussion of our legal proceedings, we refer you to Item 3 of our Form 10-K for the fiscal year ended February 28, 2009.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

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

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

 

 

For further information regarding these and other risks and uncertainties, we refer you to Part I, Item 1A of our Form 10-K for the fiscal year ended February 28, 2009.

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

 

Overview

 

 

We design, assemble and sell the AuraGen^®, our patented mobile power generator that uses the engine of a vehicle to generate power. The AuraGen^® delivers on-location, plug-in electricity for any end use, including industrial, commercial, recreational and military applications. We began commercializing the AuraGen^® in late 1999. To date, AuraGen^® units have been sold in numerous industries, including recreational, utilities, telecommunications, emergency/rescue, public works, catering, oil and gas, transportation, government and the military.

We have not yet achieved a level of AuraGen^® sales sufficient to generate positive cash flow. Accordingly, we have depended on repeated infusions of cash in order to maintain liquidity as we have sought to develop sales.

Our financial statements included in this report have been prepared on the assumption that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. However, as a result of our losses from operations, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from our possible inability to continue as a going concern.

Our ability to continue as a going concern is dependent upon the successful achievement of profitable operations, and the ability to generate sufficient cash from operations and obtain financing resources to meet our obligations. There is no assurance that such efforts will be successful.

Our current level of sales reflects our efforts to introduce a new product into the marketplace. Many purchases of the product are being made for evaluation purposes. We seek to achieve profitable operations by obtaining market acceptance of the AuraGen^® as a competitive - if not superior - product providing mobile power, thereby causing sales to increase dramatically to levels which support a profitable operation. There can be no assurance that this success will be achieved.

Critical Accounting Policies and Estimates

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

Revenue Recognition

We are required to make judgments based on historical experience and future expectations, as to the reliability of shipments made to our 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. Because sales are currently in limited volume and many sales are for evaluative purposes, we have not booked a general reserve for returns. We will consider an appropriate level of reserve for product returns when our sales increase to commercial levels.

Inventory Valuation and Classification

Inventories consist primarily of components and completed units for our AuraGen^® product. Inventories are valued at the lower of cost (first-in, first-out) or market. 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 continuing lower than projected sales, we are holding inventories in excess of what we expect 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 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. The AuraGen^® 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, 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 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.

Accounts Receivable: We record an allowance for doubtful accounts based on our 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.

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

 

 

Net revenues for the three months ended May 31, 2009 (the “First Quarter FY2010”) increased $397,135 to $632,695, from $235,560 in the three months ended May 31, 2008 (the “First Quarter FY 2009”), an increase of 169%. The increase is primarily due to shipments to a single new customer in the refrigeration trucking industry. These units consist of an 8.5kw Auragen, which carries a higher gross margin than the 5kw unit, resulting in a higher gross margin for the current year quarter.

 

Cost of goods increased $120,150 to $301,092 in the First Quarter FY 2010, from $180,942 in the First Quarter FY 2009, an increase of 66%. The increase is due to the increase in net revenues in the current year period over the prior year period.

 

Engineering, research and development expenses increased $146,454 (40%) to $509,132 in the First Quarter FY2010 from $362,678 in the First Quarter FY 2009. These expenses have recently begun to increase after having decreased in prior years, as we have increased our workforce and renewed our focus on product development on products such as the Tamgen, the 200 amp ECU, and smaller diameter units of the AuraGen. The increase is also partially attributable to the addition of the Georgia facility, which came online in June of 2008.

 

Selling, general and administrative expenses increased $71,509 (4%) to $1,873,201 in the First Quarter FY 2010 from $1,801,692 in the First Quarter FY 2009. These expenses have begun to level off after increasing in the last year over prior years, as we have reached a level of employment and infrastructure that is sufficient to handle our current operations. However, we expect these expenses to begin to increase in the future again due to the increase in business we expect based upon our business plan.

 

Net interest expense in the First Quarter FY 2010 increased $25,881 to $81,448 from $55,567 in the First Quarter FY 2009. The increase is primarily attributable to the interest expense associated with the loans from a member of our Board. These loans totaled $2.5 million as of May 31, 2009, compared to $500,000 at May 31, 2008, and carry an interest rate of 10%.

 

 

 

Other income decreased $123,956 to $2,775 in the quarter ended May 31, 2009. The prior year period included a favorable purchase of inventory items that a vendor had manufactured without an order from us. This predated our bankruptcy filing and the vendor allowed us to purchase the items for approximately 6% of the actual cost of the goods.

 

Our net loss for the First Quarter FY 2010 increased $90,815 (4.5%) to $2,129,403 from $2,038,588 in the First Quarter FY 2009. The increase is a result of the increase in operating expenses and interest expense, and a reduction in other income, partially offset by a higher gross margin resulting from increased sales.

Liquidity and Capital Resources

We had cash of approximately $51,000 and $317,000 at May 31, 2009, and February 28, 2009, respectively.  We had a working capital deficit at May 31, 2009, and February 28, 2009 of $(3,639,204) and $(2,164,606), respectively. At May 31, 2009, we had accounts receivable, net of allowance for doubtful accounts, of $276,799 compared to $319,249 at February 28, 2009. 

Net cash used in operations for the quarter ended May 31, 2009, was $(1,609,540), a decrease of approximately $140,000 from the comparable quarter in the prior fiscal year. Net cash provided by financing activities during the quarter ended May 31, 2009, was $1,451,928, resulting primarily from proceeds from notes payable of approximately $890,000, along with proceeds from the exercise of outstanding warrants and sales of Common Stock totaling approximately $560,000.   

We paid $108,685 for acquisitions of property and equipment in the First Quarter FY2010 with no acquisitions of property and equipment in the First Quarter FY2009. 

Accrued expenses at May 31, 2009, increased approximately $400,000 from the February 28, 2009 balance. The increase is primarily due to an increase in payroll and payroll related expenses resulting from the deferral of salaries by several members of senior management, until such time as cash flow allows these amounts to be paid.

Net proceeds from the issuance of debt totaled $892,500 in the First Quarter FY 2010, compared with debt repayments of $2,787 being made in the First Quarter FY 2009. Included in the debt proceeds of $892,500 in the first quarter of FY2010 was a total of $700,000 from a member of our Board. Subsequent to the end of the first quarter of FY 2010, this board member loaned the Company an additional $520,000 under the same terms and conditions as the previous loans. As of June 30, 2009, the total amount owing this board member is $3,020,000. The Company intends to repay $1,000,000 of these loans from the proceeds of the current private placement.  

The Company had a deficit in shareholders’ equity at May 31, 2009 of $1,216,652, compared to stockholders’ equity of $234,816 at February 28, 2009. The deficit is attributable to the first quarter FY 2010 loss of $2,129,403, partially offset by proceeds from the sale of common stock and the exercise of warrants of approximately $600,000.

The Company anticipates the need for approximately $7.5 million to fund our operations for the upcoming twelve months, and is expecting to raise this funding through a private placement of common stock we are currently engaged in. Based on the indications of interest at this time, we expect to complete this private placement in July, 2009.              

Since 2002 substantially all of our revenues from operations have been derived from sales of the AuraGen^®. The cash flow generated from our operations to date has not been sufficient to fund our working capital needs, and we cannot predict when operating cash flow will be sufficient to fund working capital needs. Since fiscal 2002 we were forced to scale back operations due to inadequate working capital and 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. We have commenced a private placement for up to $7.5 million of common

 

 

stock. Based on the indications of interest at this time, we expect to complete this private placement in July, 2009. However, we cannot assure you that we will be able to complete this private placement or that additional 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.                

Capital Transactions

During the quarter ended May 31, 2009, we issued 747,916 shares of Common Stock for cash consideration of $500,000. We also issued 94,428 shares of common Stock upon the exercise of 94,428 warrants, for cash consideration of $94,428, and issued 58,333 shares of Common Stock for the conversion of $35,000 of notes payable.

During the quarter ended May 31, 2008, we issued 200,000 shares of Common Stock for consideration of $250,000. We also issued 1,402,062 shares of Common Stock upon the exercise of 1,402,062 warrants, for consideration of $1,402,062, and issued 430,329 shares of Common Stock for the exercise of warrants in lieu of payments on our secured notes payable.

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit, is recorded, processed, summarized and reported, within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures. Our Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures and have concluded, as of May 31, 2009, that they were effective.

 

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during our fiscal quarter ended May 31, 2009, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the quarter ended May 31, 2009, we issued 747,916 shares of Common Stock for cash consideration of $500,000, and issued 58,333 shares of Common Stock upon the conversion of $35,000 of notes payable.

All of the sales of unregistered securities are believed to be 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 qualified investors without public solicitation or advertising.

 

ITEM 4. Submission of Matters to a Vote of Securities Holders

The Company held a Special Meeting of Shareholders on March 17, 2009. Three matters were submitted to the shareholders for approval, all of which were approved. Following is a brief description of the matters presented and the voting results:

 

 

 

 

 

 

 

 

 

 

ITEM 6. Exhibits

 

 

 

 

                

 

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.

Melvin Gagerman

Acting Chief Financial Officer

(Principal Financial and Accounting Officer

and Duly Authorized Officer)