**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549




**Form
      10-K**


(Mark
      One)




**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**




x For the
      fiscal year ended......................................February 28,
      2005




OR




 ̈ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES


EXCHANGE
      ACT OF 1934 [NO FEE REQUIRED]




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


Commission
      File Number................................................... **0-17249**




**AURA
      SYSTEMS, INC.**


(Exact
      name of Registrant as specified in its charter)




**Delaware**
            **95-4106894**(State
                or other jurisdiction of incorporation or
              organization)
            (I.R.S.
                Employer Identification No.)




**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:




Name
      of
      each exchange on which registered: **None**


Securities
      registered pursuant to Section 12(b) of the Act: **None**


Securities
      registered pursuant to Section 12(g) of the Act: **Common
      Stock**




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
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. o




On
      August
      31, 2004 the aggregate market value of the voting stock held by non-affiliates
      of the Registrant was approximately $14.7 million. The aggregate market value
      has been computed by reference to the last trading price of the stock on August
      31, 2004. On May 31, 2005, the Registrant had 439,074,474 shares of common
      stock
      outstanding.










**TABLE
      OF CONTENTS**




**PART I**ITEM
                  1. BUSINESS
              4ITEM
                  2. PROPERTIES
              11ITEM
                  3. LEGAL PROCEEDINGS
              11ITEM
                  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
              11ITEM
                  5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
                  AND
                  ISSUER PURCHASES OF EQUITY SECURITIES
              12ITEM
                  6. SELECTED FINANCIAL DATA
              13**PART II**ITEM
                  7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                  RESULTS OF OPERATIONS
              14ITEM
                  7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                  RISK
              23ITEM
                  8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
              23ITEM
                  9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                  AND
                  FINANCIAL DISCLOSURE
              23ITEM
                  9A. CONTROLS AND PROCEDURES
              23ITEM
                  9B. OTHER INFORMATION**PART III**ITEM
                  10. DIRECTORS AND EXECUTIVE OFFICERS
              24ITEM
                  11. EXECUTIVE COMPENSATION
              26ITEM
                  12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
                OWNERS
                  AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
              28ITEM
                  13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
              30ITEM
                  14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
              30**PART IV**ITEM
                  15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
              31SIGNATURES
              32






2





**SPECIAL
      NOTE REGARDING 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 headings “Management’s
      Discussion and Analysis of Financial Condition and Results of Operations,”
“Business” and elsewhere in this Report 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:*





·
            *Our
                ability to generate positive cash flow from
                operations;*


·
            *Our
                ability to obtain additional financing to fund our
                operations;*


·
            *Our
                business development and operating development;
                and*


·
            *Our
                expectations of growth in demand for our
                products.*




**  *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.* **




*References
      in this report to “we”, “us”, “the Company,” “Aura” or “Aura Systems”, includes
      Aura Systems, Inc. and its subsidiaries.*





**WHERE
      YOU CAN FIND MORE INFORMATION**




As
      a
      public company, we are required to file annual, quarterly and special reports,
      proxy statements and other information with the SEC. You may read and copy
      any
      of our materials on file with the SEC at the SEC’s Public Reference Room at 100
      F Street N.E., Washington, DC 20549. Our filings are available to the public
      over the Internet at the SEC’s website at http://www.sec.gov. Please call the
      SEC at 1-800-SEC-0330 for further information on the operation of the Public
      Reference Room. We also make available copies of our Forms 8-K, 10-K, 10-Q,
      Proxy Statement and Annual Report at no charge to investors through our website,
      http://www.aurasystems.com, as soon as reasonably practicable after filing
      such
      material with the SEC.





3




**PART
      I**




**ITEM
      1. BUSINESS**




**Introduction
      and History**




We
      design, assemble and sell the AuraGen ® ,
      our
      patented mobile power generator that uses the engine of a vehicle to generate
      electric power. The AuraGen delivers on-location, plug-in electricity for any
      end use, including industrial, commercial, recreational and military
      applications. The AuraGen system consists of three primary subsystems (i) the
      patented axial-design alternator, (ii) the Electronic Control Unit (“ECU”) and
      (iii) mounting kit that is a mechanical interface between the alternator and
      the
      automobile. Compared to the traditional solutions addressing the multi-billion
      dollar North American mobile power market (i.e., Gensets, traditional
      alternators, permanent magnet alternators dynamic and static inverters), we
      believe the AuraGen ® provides
      c(pure sine wave AC power as well as simultaneous DC power with greater
      reliability and flexibility at a lower cost to the end user. We began
      commercializing the AuraGen ® in late
      1999 as a 5,000-watt 120/240V AC machine compatible with certain Chevrolet
      engine models. In 2001, we added an 8,000 watt configuration and also introduced
      AC/DC and the Inverter Charger System (“ICS”) options. More recently we
      introduced a dual system that generates up to 16,000-watts of continuous power.
      We now have configurations available for more than 90 different engine types
      including a majority of General Motors and Ford models, some Daimler Chrysler
      models and numerous others engine models made by International, Isuzu, Nissan,
      Mitsubishi, Caterpillar, Detroit Diesel, Cummins, and Freightliner. More
      recently, a number of boats have had AuraGens installed for both government
      and
      recreational end-users.




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. Our objective is to be the leading
      developer and supplier of fully integrated mobile electric power
      systems.




We
      continue to hold several patents, in addition to those related to the
      AuraGen ® ,
      which
      we believe provide the basis for economically viable products in addition to
      the
      AuraGen ® ,
      but
      sales of the AuraGen ® currently provide  substantially
      all our operating revenues.




Aura
      Systems, Inc. a Delaware corporation, was founded in 1987 and, until 1992,
      primarily engaged in supplying defense related technologies to classified
      military programs . In
      1992
      we acquired the Electronic Ceramic Facility. This facility produced Piezo
      electric material that we required for our Actuated Mirror Array “AMA”
technology. In 1996 we licensed our AMA technology to Daewoo Electronics. During
      the same period we acquired Delphi Electric Components who developed and built
      microelectronic circuits and components. In 1994 we started NewCom to
      manufacture and sale computer modems, sound cards and other multimedia
      components. By the mid 1990s the Company was organized into 4 divisions (i)
      AuraSound -producing and selling audio speakers based on a new and patented
      magnetic design, (ii) Aura Industrial & Automotive - developing numerous
      automotive and industrial related magnetic devices such as linear and rotary
      actuators with applications for variable valves, active suspension, actuators
      for many industrial machines, and the development of the AuraGen power system,
      (iii) NewCom- manufacturing and selling modems and computer multimedia kits,
      (iv) Aura display- using the AMA technology to develop very large very bright
      display systems. By 1998 the Company had 3 facilities in California, a facility
      in New Hope Minnesota, and facilities in Osaka Japan, Kuala Lumpur Malaysia,
      and
      New Delhi India. During the period the Company, was investing large capital
      into
      the development of the AuraGen.




In
      1997
      the Company spun off NewCom as a public Company with Aura retaining
      approximately 60% of the stock. NewCom owed Aura approximately $40 million
      that
      was to be repaid by late 1998. In the summer of 1998, the computer industry
      experienced a significant slow-down and most original equipment manufacturers
      (“OEMs”), in order to revive their sales, introduced build - in modems and
      multi-media functions as an integral part of the computer. This caused severe
      pressure on NewCom’s operations. By early 1999, NewCom had ceased operations and
      closed down.




During
      1999, the Company sold the Speaker operations, the Ceramic Operation, and
      Delphi. All activities on the AMA were stopped and the Company was totally
      focused on the completion of the AuraGen development and
      commercialization





4




Since
      fiscal 2002 sales of the AuraGen ® product
      have accounted for substantially all of our operating revenues.




During
      fiscal 2002 through fiscal 2005, we substantially reduced our internal staffing
      due to the slower-than-anticipated level of AuraGen ® sales.
      We also suspended substantially all research and development activities. We
      continued to downscale our operations in fiscal 2005. However, the impact of
      the
      related cost reductions was insufficient to offset our extremely weak financial
      condition, which was worsened by late fees, penalties and transaction costs
      incident to financial defaults. In June 2005, we filed for protection under
      Chapter 11 of the Bankruptcy Code, and emerged on January 31, 2006 under a
      plan
      of reorganization.




**The
      AuraGen** **®**




The
      AuraGen ® is
      composed of three basic subsystems. The first subsystem is the generator that
      is
      bolted to, and driven by, the vehicle's engine. The second subsystem is an
      electronic control unit, which filters and conditions the electricity to provide
      clean, steady voltages for both AC and DC power. The third subsystem is mounting
      brackets and supporting components for installation and integration of the
      generator with the vehicle engine.




The
      AuraGen is now available in three continuous power levels, (a) 5,000 Watts
      AC/DC, (b) 8,000 Watts AC/DC and (c) 16,000 Watts AC/DC.  All AC power are
      pure sine wave with total harmonic distortion  “THD” of less than 2.1% and
      are available in both 120 VAC and or 240 VAC.  In addition, the power
      generated on all models can be partitioned to provide simulations AC and 14
      or
      28 volts of direct current “DC” or only DC, if required by the user.  The
      AuraGen power levels can be generated while the vehicle is being driven or
      parked. The AuraGen/VIPER system includes as an option a complete power
      management system which monitors in real time (i) the batteries voltage and
      temperature, (ii) provides a partition of the power between AC and DC
      simultaneously with the ability to be programmed from all AC to all DC, (iii)
      monitors the RPM of the generator, (iv) monitors the temperatures of the
      generator and the ECU, (iv) monitors the raw power generated, (v) monitors
      both
      the AC and DC loads as to voltage and current, (vi) provides programming of
      load
      prioritization and load shedding, and (vii) monitors the voltage of the internal
      400VDC buss.




We
      provide custom engineered brackets for our models that attach to over 90
      different engine and chassis models. We also provide power-take-off (PTO) and
      hydraulic driven interfaces for bigger trucks that do not involve direct
      attachment to the vehicle engine.




**Mobile
      Power Industry**




The
      mobile power generation market is large and growing. Vehicles used in the
      telecommunications, utilities, public works, construction, catering, and oil
      and
      gas industries, and emergency/rescue, military and recreational vehicles rely
      heavily on mobile power for their internal systems. In addition, mobile work
      sites require on-location electricity to power equipment ranging from computers
      to power tools.




Based
      on
      studies conducted by the U.S. government, Business Communications Company,
      Inc.
      ("BCC") and others, we estimate the annual gross North American mobile power
      generation market in 2005 is at least $2.5 billion and growing. Worldwide growth
      is expected to be fueled by increases in the development and construction of
      industrial infrastructures, significant growth in homeland security
      expenditures, and increased use of sophisticated electronic equipment in
      underdeveloped areas where grid-based electricity is unavailable or unreliable.
      We also believe that mobile power has become increasingly important as backup
      to
      electric grid power supply.




The
      traditional available solutions for mobile power users are:




·
            Gensets.
                Gensets are standalone power generation units which are not incorporated
                into a vehicle and require external fuel, either gasoline or diesel,
                in
                order to generate electricity. Gensets are generally (i) noisy and
                cumbersome to transport because of their weight and size, (ii) they
                typical run at constant speed to generate 50 or 60 Hz of AC power,
                (iii)
                must be operated at a significant part of the rated power to avoid
                wet
                staking, (iv) are significantly de-rated in the presence of harmonics
                in
                the loads and (v) require significant scheduled maintenance and service.
                Genset technology has been utilized since the 1950s.




5




·
            High-Output
                Alternators.
                High-Output Alternators are traditionally found in trucks and commercial
                vehicles and the vehicles engine is used as the prime mover. All
                alternators provide their rated power at very high RPM and significantly
                less power at lower RPM. In addition alternators are generally only
                30%
                efficient at the low RPM range and increase to 50% efficiency at
                the high
                RPM range.The
                power generated by alternators is 12 or 24 Volt DC and an inverter
                is
                required if 120 Volt AC power is needed. In addition, due to the
                low power
                output at low RPM, in order to get significant power, a throttle
                controller is used to spin-up the engine.




·
            Invertersare devices that invert battery direct current to alternating current.
                Inverters as mobile power generators are traditionally used in low
                power
                requirements, typically less than 2500 Watts, and do not have the
                ability
                to recharge the batteries used as the source of power. Thus typical
                inverter users require other means to recharge the used batteries
                such as
                “shore-power” or gensets. More recently dynamic inverters became
                available. Dynamic inverters use power from the alternator to augment
                power from the batteries and are able to achieve power levels of
                6,000
                watts plus. The dynamic inverters introduce significant stresses
                on both
                the batteries and alternators that cause significant life shortening
                for
                both. Dynamic inverters use power from the alternator. When the inverter
                is turned on, the alternator is switched off from the vehicle battery
                and
                tied into a transformer that uses electronics controls to change
                the DC
                alternator inputs to AC inverter output. A separate transform winding
                provides battery charging so fully regulated 120 Volt AC and 12 Volt
                DC
                power is available as long as the engine is running at high enough
                RPM to
                provide power for the load and the battery charging. All dynamic
                inverters
                require a high output alternator to be able to output significant
                AC
                power. As is often the case, the limiting factor is the high output
                alternator. In order to get stable output a very accurate throttle
                controller is also needed to maintain steady speed on the engine.




·
            Permanent-Magnet
                (“PM”) alternators.
                Recently a number of companies have introduced alternators using
                exotic
                permanent magnets. These alternators tend to have higher power generation
                capabilities than regular alternators at lower engine RPM. In order
                to be
                practical in a under-the-hood environment (200oF)
                one must add active cooling since the magnets are demagnetized at
                approximately (176oF).
                There are other issues that require an active control system that
                will add
                and subtract magnetic field strength as the engine RPM
                increases.




·
            Fuel
                cellsare solid-state, devices that produce electricity by combining a
                fuel
                containing hydrogen with oxygen. They have a wide range of applications,
                and can be used in place of the internal combustion engine and traditional
                lead-acid and lithium-ion batteries.So
                why aren't fuel cells being installed everywhere? The most
                widely deployed fuel cells cost about $4,500 perkilowatt.





·
            Batteries
                convert stored chemical energy to electrical
                energy.




**Competition**




The
      industry in which we operate is competitive. The primary competition for the
      AuraGen ® are
      Gensets and there are approximately 44 Genset manufacturers in the United
      States. These competitors include: Onan, Honda and Kohler.




There
      are
      many High Output Alternator manufacturers. Some of the better known ones are
      Delco-Remy, Bosh, Nippon Densu, Hitachi, Mitsubishi and Prestelite.




There
      are
      many inverter manufacturers; some of the better-known ones are, Trace
      Engineering, Vanner, and Xentrex.




Most
      of
      our competitors have greater financial, technical and marketing resources,
      have
      larger budgets for research, new product development and marketing and have
      long-standing customer relationships. We must also compete with many larger
      and
      more established companies in the hiring and retention of qualified personnel.
      In the past our financial condition has limited our ability to promote the
      AuraGen ® and make
      potential customers aware of its existence.




6




The
      AuraGen ® uses new
      technology and has only been available in the marketplace for a a number of
      years.. Because our product is radically different from traditionally available
      mobile power solutions, users may require lengthy evaluation periods in order
      to
      gain confidence in the product. Original equipment manufacturers ("OEMs") and
      large fleet users also typically require considerable time to make changes
      to
      their planning and production Because our limited financial and staff resources,
      we have focused our sales and marketing activities to a few industrial and
      military segments. In particular we focused on the US military including the
      USCG, homeland security agencies and emergency/rescue.




More
      recently we expanded our focus and are now marketing to companies in the oil
      and
      gas segment, state and local governments in particular DOT, and recreational
      boating industry.




**Competitive
      Advantages of the AuraGen** **®**




We
      believe the AuraGen ® is a
      superior product due to its convenience, cost efficiency, fuel efficiency,
      reliability, flexibility in power output, and the quality of the electricity
      generated. The AuraGen is not sensitive to temperature or altitude variations
      and generates the rated power at or near idle engine RPM.




The
      AuraGen ® does not
      require scheduled maintenance and is offered with a three year warranty compared
      to the typical one year warranty available for a Genset or
      inverter.




In
      addition, the AuraGen ® is
      significantly cleaner for the environment than gensets, the other generally
      available mobile power solutions. The AuraGen ® uses the
      automotive engine which is highly regulated for environmental protection.
      Gensets use small engines that produce significantly higher levels of emissions
      per unit of power output than the automobile engine.




We
      believe that barriers to entry make it less likely that a product superior
      to
      the AuraGen ® will
      become available in the foreseeable future. The inventions upon which the
      AuraGen ® is based
      are protected by patents issued by the U.S Patent office. To our knowledge,
      there are no other patents for axial induction machines with solid rotors.




Manufacturers
      and end users of mobile power solutions (including the military) typically
      require completion of extensive evaluation and approval processes before
      embracing new systems. After extensive testing, a number of Federal, state,
      DOT
      departments, and some r industrial companies have approved the
      AuraGen ® for
      purchase.




Thousands
      of AuraGen ® units
      are currently being used for multiple applications and in all types of operating
      environments, providing a good sample set for reliability analysis. The results
      show very low failure rates, which we are reducing further via minor hardware
      and software modifications, better assembly procedures and improved installation
      training. The U.S. Army has performed its own tests and is continuing to test
      the AuraGen ® under
      severe conditions. The VIPER (the name for the military version of the
      AuraGen ® ),
      in use
      by Special Operations and other combat forces, has been air-drop-certified
      by
      the Army and has been and is successfully deployed in Operation Enduring Freedom
      and Operation Iraqi Freedom.




The
      AuraGen ® system
      passed all of the UL testing in 2002 and 2003. In late 2004 early 2005, the
      USMC
      core successfully tested the AuraGen/VIPER for safety and other operational
      capabilities at the Aberdeen Test grounds..




**Target
      Markets**




When
      the
      Company emerged from Chapter 11 reorganization under new management the sales
      and marketing activities have been expanded to include:




7




Military,
      Homeland Security Administration and Other Federal Agencies




We
      believe the VIPER (the military version of the AuraGen ® )
      is a
      superior mobile power solution compared with existing alternatives for numerous
      military applications. The VIPER capability to produce both 120 Volt AC and
      28
      Volt DC power simultaneously at low engine RPM is critical for many military
      applications. In addition the power management system which is inherited in
      the
      VIPER provides the military users with the ability to monitor, the quality
      and
      quantity of available power, the state of the on board batteries, and the
      ability to prioritize different electric loads. The USCG after 3 years of
      testing selected the VIPER as the power system for its 190 new patrol boats;
      SAIC is using the VIPER on all of its VACIS gamma ray scan systems that are
      used
      for homeland and base security applications, numerous units of special forces
      and regular army are using the VIPER in both Iraq and Afghanistan, The DOD
      report to congress in August 2006 discussed the success of the VIPER in Iraq
      and
      Afghanistan. More recently a number of military OEMs are exploring the use
      of
      the VIPER for the MRAP, MMPV and similar military programs. The Company is
      also
      pursuing marketing the VIPER for the upcoming JLTV program.




Marine




We
      believe that the AuraGen is an ideal product for the recreational boating in
      the
      25-50 ft range. The National Oceanic and Atmospheric Administration “NOAA”
tested the AuraGen on the “Magna Spirit” for 3,000 miles on the open oceans and
      reported flawless performance. The USCG tested the VIPER for 3 years before
      choosing it to power the 190 new patrol boats. Both of these organizations
      are
      the leaders in introduction of new technologies and safety for marine
      applications. More recently a major boat OEM successfully tested the AuraGen
      on
      one of their production boats and the Company is currently pursuing the required
      boat related certifications from UL. While the Company is not expecting any
      delays in getting the required certification, no assurances can be given as
      to
      when such required certification will be completed.




Oil
      and Gas industry




The
      oil
      and gas industry are heavy users of mobile power for service. We have identified
      a number of oil and gas service providers that require the power level as well
      as the power quality generated by the AuraGen. In particular the need for very
      large power to start inductive loads such as compressors, fans and electric
      motors. Typically the starting power required is knows as lock rotor and can
      easily go as high as 30,000 watts. The AuraGen ICS design and architecture
      is
      such that it can easily support these power levels for very short times that
      are
      required to start the loads. We have demonstrated 30,000 watts starting power
      for numerous compressors and motors.




Mid
      size Refrigeration Trucks.




Mid
      size
      refrigeration trucks are used throughout the country for the delivery of food.
      These trucks typically have a diesel engine mounted over the cab that is used
      as
      a generator for the refrigeration unit. The AuraGen is an ideal power source
      that can eliminate the need for the extra diesel engine thus reducing operating
      cost and fuel costs. The AuraGen ability to provide large start-up power is
      critical for this application since a typical refrigeration system requires
      a
      2-4 horsepower compressor. Such compressors require 20,000-30,000 watts of
      starting power. The Company has now sold over 100 systems for this application
      and is anticipating significant growth in this segment.




Emergency/Rescue




The
      emergency/rescue market relies heavily upon mobile power for lights,
      communications gear, instruments, medical equipment and digital equipment and
      tools. As the emergency/rescue market has undergone a transition to digital
      equipment and portable computers, it has experienced constant growth in mobile
      power needs. Approximately 20 organizations have started to use the
      AuraGen ® .
      Recently the Red Cross has used the AuraGen to power their communication needs
      in support of disaster relief during Katrina and the wild fires in California
      in
      October 2007. In addition hundreds of fire trucks are now using the AuraGen
      as
      their mobile power source.




8




**Facilities,
      Manufacturing Process and Suppliers**




As
      of
      February 28, 2005, we assembled and tested the AuraGen ® at our
      27,000 square foot facility in El Segundo, California with components which
      are
      produced by various suppliers. We established these facilities with a maximum
      production capacity of 1,000 units per month.




Early
      in
      our AuraGen ® program,
      we determined it was most cost-effective to outsource production of components
      and subassemblies to volume-oriented manufacturers, rather than produce these
      parts in house. As a result of this decision, and based on then anticipated
      sales, we purchased, prior to fiscal 2001, a substantial inventory of components
      and subassemblies at volume prices.. Since sales did not meet such expectations,
      we have been assembling, testing and selling product from this inventory for
      several years. Many of the components and subassemblies are mechanical in
      nature, do not deteriorate and are readily usable for all of our AuraGen models.
      Some of the subassembly are in the form of electronic control units that have
      also not deteriorated and, even though there have been improvements and
      modifications over this period, the units in inventory required only minor
      applications of parts and labor to bring them to current specifications.




From
      fiscal 2002 through fiscal 2005, we substantially reduced our internal staffing
      to be more appropriate to the slower-than-anticipated level of sales. We have
      also suspended substantially all research and development activities. Since
      the
      emergence from Chapter 11 reorganization in February 2006, the Company has
      constantly increased the research and development efforts.




In
      order
      to renew our inventory of components, we will need to renew contracts with
      such
      manufacturers or locate other suitable manufacturers. Since February 2006,
      the
      Company has renewed its relationships with a number of its old suppliers and
      is
      developing new relationships with others. To ensure quality and reliability
      in
      the field, we use highly qualified suppliers, the majority of which are ISO
      9002
      compliant.




We
      provide a turnkey product and service to support our customers in every area.
      We
      have performed all of the development, from basic physics to detailed
      engineering. We believe our core capabilities provide a solid foundation to
      resolve technical issues, develop an ongoing line of new products and
      continually enhance our products.




Our
      vehicle integration team develops, engineers, and supplies all of the brackets,
      pulleys, idlers, belts, tensioners and other components that comprise a mounting
      system. The group also specifies all of the requirements of the
      AuraGen ® to allow
      its use with other mobile drives, such as hydraulic systems and Power Take
      Off
      ("PTO") applications.




**Research
      and Development**




From
      fiscal 2002 through fiscal 2005, we suspended substantially all research and
      development activities due to our weakened financial condition. Accordingly,
      during the fiscal years ended February 28, 2005 and February 29, 2004, our
      expenditures for research and development ("R&D") activities were
      negligible. During the fiscal year ended February 28, 2003, we spent
      approximately $0.4 million on R&D activities. Although we believe that
      ongoing R&D is important to the success of our product in order to utilize
      the most recent technology, to develop additional products and additional uses
      for existing products, and to stay current with changes in vehicle manufacture
      and design and to maintain an ongoing advantage over potential competition,
      our
      financial condition has not allowed significant expenditures on R&D as all
      costs are being minimized while we seek to maintain solvency and attain
      profitability.




In
      February 2006, when the Company emerged from Chapter 11 reorganization, we
      started to rebuild our research and development team. We already introduced
      and
      started to ship our dual and Tamgen systems that generate up to 16,000 watts
      of
      continuous power with both AC and DC simultaneous capabilities. We have
      completed the design and are currently testing a smaller unit that one third
      smaller than the current 5,000 and 8,000 watts system that will supply 3,000
      to
      4,000 watts. We are also pursuing the development of a larger unit that should
      have 25,000 watts capability.




9




**Patents
      and Intellectual Property**




The
      Company’s Intellectual Property portfolio consists of trademarks, proprietary
      know-how and patents.




In
      electromagnetic technology the Company developed numerous magnetic systems
      and
      designs that result in a significant increase of magnetic field density per
      unit
      volume that can be converted into useful power energy or work. This increase
      in
      field density is a factor of 3 to 4 which when incorporated into mechanical
      devices could have a significant reduction in size and cost for the same
      performance.




The
      applications of these technological advances are in mechanical machines used
      every day by industrial, commercial and consumers. The Company has applied
      the
      above technology to numerous applications in industrial machines such as
      generators, motors, actuators and linear motors.




The
      U.S.
      Patent Office awarded the Company 29 Patents applicable to automotive and
      industrial applications. Of the above patents, four (4) are focused directly
      on
      the AuraGen, seven (7) are basic magnetic actuation, two (2) are for control
      systems associated with controlling the magnetic fields in different
      configurations and sixteen (16) are focused on the EVA application.




The
      sixteen (16) patents associated with EVA cover the implementation of a
      controlled magnetic field as applied to linear motors. Many of the same
      techniques are implemented into the AuraGen control and in particular, the
      control of the high power board used in the new AuraGen inverter mode, which
      uses many elements from the EVA system. The Company is looking for a potential
      licensor for this technology




Areas
      of
      AuraGen Technology Innovation




Patents:
      5,734,217; 6,157,175; 6,700,214; 6,700,802; with expiration dates of 2015,
      2017,
      2019 and 2019 respectively. The above patents cover three areas as described
      below.




1-
      Induction Machine-




Basic
      Patent covers a new form of induction machine with superior performance in
      a
      much smaller size than conventional machines. The solid cast rotor, the shaped
      magnetic field, the secondary conduction path through the steel and the axial
      magnetic orientation is a key component of this innovation.




2-
      Control Systems




The
      system separates the power generation from the power delivery by introducing
      a
      400 VDC bus. For each cycle of each phase part of the cycle power is drawn
      from
      the bus to run the electronics and energize the coils while during the other
      part of the cycle power is delivered to charge up the bus. The control system
      must balance all the timing to effect zero voltage change to the bus under
      dynamic variations of frequency and loads. The ability to optimize in real
      time
      the slip frequency is a key innovation in motor and generator control for
      variable speed variable frequency and variable load systems.




3-
      Bi-Directional Power Supply (BDP)




The
      patented ICS system developed by Aura provides a new capability in power
      systems. The BDP allows a system with simultaneous multi sources for power.
      It
      is a key component in providing the ability to deliver both AC and DC power
      simultaneously as well as the ability to handle large power surges without
      the
      need for a throttle controller.




**Employees**




As
      of
      February 28, 2005, we employed 46 persons. We reduced our workforce
      significantly in the two years ended February 28, 2005, to conserve cash. We
      are
      not a party to any collective bargaining agreements.




10




**Significant
      Customers**




We
      sold
      our AuraGen ® product
      to four customers during fiscal 2005 who each accounted for more than 10% of
      our
      revenues, for an aggregate total of approximately $1.1 million, or 44% of net
      revenues.




**Backlog**




We
      had no
      material backlog as of the end of the 2004 and 2005 fiscal years.




**ITEM
      2. PROPERTIES**




As
      of
      February 28, 2005, our majority owned subsidiary, Aura Realty, Inc. (“Aura
      Realty”), owned the 47,000 square foot headquarters facility and adjacent 27,690
      square foot manufacturing facility in El Segundo, California that we use for
      our
      AuraGen ® product.
      These properties were encumbered by a deed of trust securing a note in the
      original principal amount of $5.4 million.




During
      fiscal 2003, we sold a minority interest in Aura Realty. During fiscal 2004,
      we
      defaulted on payments under the note secured by our headquarters and
      manufacturing facilities. Such default continued past year-end and the lender
      took actions regarding a possible foreclosure sale. In June 2004, we paid all
      arrearages, cured this default and were current on our obligations under the
      note as of June 30, 2005.




In
      December 2005, Aura Realty sold the two buildings to an unrelated third party.
      We then leased the smaller facility and moved out of the headquarters facility.
      Effective December 31, 2007, our current lease expired and we are currently
      on a
      month-to-month lease. In February 2008, we entered into a lease for a new
      facility of approximately 25,500 square feet, near our current facility. The
      lease is for a term of five years, commencing May 1, 2008, and carries a base
      rent of $28,019 per month. We feel this facility is sufficient for our current
      needs.




**ITEM
      3. LEGAL PROCEEDINGS**




As
      of
      February 28, 2005, the Company was engaged in numerous legal actions by
      creditors seeking payment of sums owed. Actions by the parties to these
      obligations to enforce their rights to collect the amounts due could have
      required the Company to cease operations. The filing by the Company of the
      Chapter 11 bankruptcy proceeding in June 2005 acted as an automatic stay of
      all
      pending litigation as of the filing date without further approval of the
      Bankruptcy Court.




**2002
      Securities and Exchange Commission Settlement**




In
      June
      2002, the Securities and Exchange Commission ("SEC") brought a civil action
      against us, NewCom (our former subsidiary), and certain former members of our
      management team, in U.S. District Court, Central District of California (Case
      Nos. CV-02-4555NM and CV-02-4553RMT) for violations of the antifraud and books
      and records provisions of the securities laws. The complaint relates to the
      financial statements for various transactions during fiscal years 1996 through
      1999. Without admitting or denying the allegations in the complaint, the company
      as well as the former officers settled the case. We consented to a permanent
      injunction against violations of specified sections of the securities laws,
      with
      no penalty imposed based on our financial condition. Mr. Kurtzman, our former
      CEO and director, consented to a permanent injunction against violations of
      specified sections of the securities laws, paid a $75,000 civil penalty and
      was
      permanently barred from serving as an officer or director of a public company.
      Mr. Veen, our former CFO, paid a $50,000 civil penalty and was suspended for
      five years from appearing or practicing before the SEC. Mr. Papazian, our former
      President, consented to a permanent injunction against violations of specified
      sections of the securities laws and paid a $25,000 civil penalty.




**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




No
      matters were submitted to a vote of security holders in the fourth quarter
      of
      fiscal 2005.




11




**PART
      II**




**ITEM
      5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES**




From
      May
      21, 1991, to July 21, 1999, our common stock was listed on the NASDAQ National
      Stock Market. In July 1999 the shares were de-listed from the NASDAQ National
      Market as a result of our failure to meet the minimum $1.00 bid price and other
      requirements. On February 1, 2001, our shares were listed on the OTC Bulletin
      Board under the symbol "AURA". In July 2005, following the filing of our Chapter
      11 proceeding, our common stock ceased to be quoted on the OTC Bulletin Board.
      Since such time our common stock has been traded on the over-the-counter market
      under the symbol “AUSI”.




Set
      forth
      below are high and low bid prices for our common stock for each quarterly period
      in the two most recent fiscal years. Such quotations reflect inter-dealer
      prices, without retail mark-up, markdown or commissions and may not necessarily
      represent actual transactions in the common stock. We had approximately 9,173
      stockholders of record as of May 31, 2005.




Period
            
            High
            
            LowFiscal
                2004First
                Quarter ended May 31, 2003
            
            $
            0.104
            
            $
            0.057Second
                Quarter ended August 31, 2003
            
            $
            0.070
            
            $
            0.032Third
                Quarter ended November 30, 2003
            
            $
            0.130
            
            $
            0.055Fourth
                Quarter ended February 28, 2004
            
            $
            0.109
            
            $
            0.052




Period
            
            High
            
            LowFiscal
                2005First
                Quarter ended May 31, 2004
            
            $
            0.067
            
            $
            0.026Second
                Quarter ended August 31, 2004
            
            $
            0.055
            
            $
            0.03Third
                Quarter ended November 30, 2004
            
            $
            0.07
            
            $
            0.035Fourth
                Quarter ended February 28, 2005
            
            $
            0.041
            
            $
            0.027




On
      June
      30, 2005, the reported closing sales price for our common stock was
      $0.036.




**Dividend
      Policy**




We
      have
      not paid any dividends on our common stock and we do not anticipate paying
      any
      dividends on our common stock in the foreseeable future. During fiscal 2004
      we
      issued shares of Series A Convertible Redeemable Preferred Stock and in fiscal
      2005 we issued Series B Preferred Stock. Under the terms of the preferred shares
      we could not pay dividends on our common stock until dividends had been paid
      on
      the preferred shares. Effective with the implementation of our Chapter 11
      reorganization plan in January 2006 all of the outstanding shares of Series
      A
      Preferred Stock and Series B Preferred Stock were converted into common
      stock.




**Sales
      of Unregistered Securities**




We
      did
      not conduct any offerings of equity securities during the fourth quarter of
      fiscal 2005 that were not registered under the Securities Act of 1933 other
      than
      the private placement of securities as part of the 2004 Recapitalization
      described in Item 7, “Management’s Discussion and Analysis of Results of
      Operations - Liquidity.” All of the 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 without public solicitation or advertising.




12






**Repurchases
      of Equity Securities**




We
      did
      not repurchase any shares of our common stock during the fourth quarter of
      fiscal 2005.




**Securities
      Authorized for Issuance Under Equity Compensation Plans**




**Equity
      Compensation Plan Information as of February 28, 2005**




**Number of Securities****Weighted-average**
              
              **Remaining Available for****Number of Securities to**
              
              **Exercise Price of**
              
              **Future Issuance Under Equity****be Issued Upon Exercise**
              
              **Outstanding**
              
              **Compensation Plans****of Outstanding Options,**
              
              **Options, Warrants**
              
              **(Excluding Securities Reflected in****Plan Category**
              
              **Warrants and Rights**
              
              **and Rights**
              
              **Column (a))**Equity
                  compensation plans approved by security holders
              
              
              53,698,727
              
              $
              0.05-2.30
              
              
              -Equity
                  compensation plans not approved by security holders
              
              
              —
              
              
              —
              
              
              —Total
              
              
              53,698,727
              
              $
              0.05-2.30
              
              
              -




**ITEM
      6. SELECTED FINANCIAL DATA**




The
      following Selected Financial Data has been taken or derived from our audited
      consolidated financial statements and should be read in conjunction with and
      is
      qualified in its entirety by the full-consolidated financial statements, related
      notes and other information included elsewhere herein.




13




AURA
      SYSTEMS, INC. AND SUBSIDIARIES


February 28,
                2005
              
              February 29,
                2004
              
              February 28,
                2003
              
              February 28,
                2002
              
              February 28,
                2001Net
                  revenues
              
              $
              2,525,431
              
              $
              1,864,325
              
              $
              1,103,770
              
              $
              3,116,295
              
              $
              2,512,508Cost
                  of goods sold
              
              $
              1,573,116
              
              $
              934,769
              
              $
              571,099
              
              $
              1,480,736
              
              $
              1,216,637Inventory
                write down
              
              $
              2,088,703
              
              $
              550,968
              
              $
              -
              
              $
              1,510,871
              
              $
              -Gross
                  profit (loss)
              
              $
              (1,136,388
              )
              $
              378,588
              
              $
              532,671
              
              $
              124,688
              
              $
              1,295,871Expenses:Engineering,
                  research & development
              
              $
              2,482,678
              
              $
              2,135,061
              
              $
              3,956,886
              
              $
              9,224,376
              
              $
              8,762,793Selling,
                  general and administrative
              
              $
              6,886,542
              
              $
              7,191,925
              
              $
              7,374,961
              
              $
              10,006,844
              
              $
              12,695,833Class
                  action litigation & other legal settlements
              
              $
              2,765,192
              
              $
              -
              
              $
              233,259
              
              $
              (2,750,000
              )
              $
              1,512,769Adjustment
                  to accounts payable
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              (651,685
              )
              $
              (1,046,324
              )Impairment
                  losses on long-lived assets
              
              $
              544,510
              
              $
              2,000,398
              
              $
              2,300,000
              
              $
              7,661,559
              
              $
              -Severance
                  expense
              
              $
              -
              
              $
              -
              
              $
              241,243
              
              $
              1,080,525
              
              $
              -Total
                  expenses
              
              $
              12,678,912
              
              $
              11,327,384
              
              $
              14,106,349
              
              $
              27,571,619
              
              $
              21,925,071Loss
                  from operations
              
              $
              (13,815,300
              )
              $
              (10,948,796
              )
              $
              (13,573,678
              )
              $
              (24,446,931
              )
              $
              (20,629,200
              )Other
                  (income) and expense:Impairment
                  of investments
              
              $
              286,061
              
              $
              500,000
              
              $
              818,019
              
              $
              1,433,835
              
              $
              240,000Loss
                  on sale of minority interest in Aura Realty
              
              $
              -
              
              $
              231,000
              
              $
              626,676
              
              $
              -
              
              $
              -(Gain)
                  loss on sale of investments
              
              $
              -
              
              $
              (201,061
              )
              $
              -
              
              $
              -
              
              $
              -Interest
                  expense
              
              $
              18,965,852
              
              $
              2,409,732
              
              $
              2,656,592
              
              $
              2,495,551
              
              $
              2,263,916Other
              
              $
              (166,345
              )
              $
              129,337
              
              $
              (362,096
              )
              $
              (535,179
              )
              $
              (446,399
              )Change
                  in derivative liability
              
              $
              (4,622,235
              )
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Provision
                  (benefit) for taxes
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              (1,549,882
              )
              $
              (2,203,145
              )Minority
                  interest
              
              $
              (3,970
              )
              $
              (365,514
              )
              $
              14,018
              
              $
              -
              
              $
              -Gain
                  on extinguishment of debt obligations, net of income taxes
              
              $
              -
              
              $
              67,415
              
              $
              1,186,014
              
              $
              1,889,540
              
              $
              -Preferred
                  stock dividend
              
              $
              525,377
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Net
                  loss
              
              $
              (28,800,040
              )
              $
              (13,584,875
              )
              $
              (16,140,873
              )
              $
              (24,936,895
              )
              $
              (20,929,971
              )Net
                  loss per common share
              
              $
              (0.06
              )
              $
              (0.03
              )
              $
              (0.05
              )
              $
              (0.08
              )
              $
              (0.08
              )Weighted
                  average number of common shares
              
              
              435,294,451
              
              
              430,923,150
              
              
              415,863,637
              
              
              327,587,590
              
              
              261,568,346Cash/cash
                  equivalents
              
              $
              61,376
              
              $
              83,200
              
              $
              163,693
              
              $
              1,143,396
              
              $
              1,265,912Working
                  capital
              
              $
              (34,338,147
              )
              $
              (14,011,245
              )
              $
              (15,626,271
              )
              $
              (2,512,553
              )
              $
              (5,105,345
              )Total
                  assets
              
              $
              13,305,777
              
              $
              17,760,733
              
              $
              23,767,866
              
              $
              28,761,990
              
              $
              45,278,043Total
                  debt
              
              $
              36,535,119
              
              $
              15,545,829
              
              $
              13,345,378
              
              $
              10,895,466
              
              $
              38,485,108Net
                  stockholders' equity (deficit)
              
              $
              (22,883,233
              )
              $
              (3,614,425
              )
              $
              4,712,176
              
              $
              12,652,733
              
              $
              2,045,035




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




**Forward
      Looking Statements.**




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





14




**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 to more than 500 customers in numerous industries, including
      recreational, utilities, telecommunications, emergency/rescue, public works,
      catering, oil and gas, transportation, government and the military.




We
      were
      founded in 1987 and, until 1992, primarily engaged in supplying defense
      technology to classified military programs. In 1992 we transitioned to being
      primarily a supplier of consumer and industrial products and services using
      our
      technology. In 1994, we founded NewCom, Inc., which sold and distributed
      computer communications and sound products such as CD-ROMs and sound cards.
      In
      1997, we acquired MYS Corporation of Japan, a manufacturer of speaker systems.
      NewCom ceased operations in 1999 and we experienced severe financial hardship
      from this and other causes. In fiscal 2000, we sold MYS, our business divisions
      providing sound products, and other assets, restructured substantial
      indebtedness and concentrated our focus on the AuraGen ® product.
      Since fiscal 2002 sales and support of the AuraGen ® have
      provided substantially all of our operating revenues.




We
      have
      not yet achieved a level 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. During fiscal 2002 through fiscal 2004, we substantially reduced
      our internal staffing due to the slower-than-anticipated level of
      AuraGen ® sales.
      We also suspended substantially all research and development activities. We
      continued to downscale our operations in fiscal 2005.




In
      September 2004, we entered into agreements with a group of investors and holders
      of secured debt in order to recapitalize the company. These agreements are
      referred to as the "2004 Recapitalization Transactions" or “2004
      Recapitalization” and are described in more detail below under "Liquidity and
      Capital Resources - The 2004 Recapitalization Transactions". Completion of
      the
      2004 Recapitalization Transactions was intended to provide us with a more stable
      financial condition by infusing new capital of up to $15 million through the
      sale of units comprising Series B Preferred Stock and common stock warrants,
      conversion of $3.5 million of secured debt into Series B Preferred Stock and
      warrants and extension of the maturity of the remaining $2.1 million of secured
      debt to August 2005, and the settlement of legal claims with former management.
      However, we continued to require further financing to remain solvent.
      Accordingly, subsequent to the end of fiscal 2005, in June 2005 we filed for
      protection under Chapter 11 of the U.S. Bankruptcy Code, and emerged on January
      31, 2006 under a plan of reorganization.




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 and default on
      certain of our obligations (see Note 2 and Note 9 to the Consolidated Financial
      Statements), 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 sources 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.





15





**Critical
      Accounting Policies and Estimates**




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




*Revenue
      Recognition*




We
      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 it expects to sell in the
      next fiscal year. The net inventories which are not expected to be realized
      within a 12-month period based on current sales forecasts have been reclassified
      as long term. Management believes that existing inventories can, and will,
      be
      sold in the future without significant 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 or if significant discounts from current
      pricing levels are granted to generate sales, there would be a material impact
      on our financial statements.




*Valuation
      of Long-Lived Assets*




Long-lived
      assets, consisting primarily of property and equipment, and patents and
      trademarks, comprise a significant 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 realizability of the asset.
      Factors that could trigger a review include significant changes in the manner
      of
      an asset's use or our overall strategy.




Specific
      asset categories are treated as follows:




Accounts
      Receivable: We record an allowance for doubtful accounts based on management's
      expectation of collectibility 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.




Long-Term
      Investments: As we do not hold a sufficient interest in our investments to
      exercise significant influence and the fair market value of the investments
      are
      not readily determinable, long-term investments have been accounted for under
      the cost method. Management reviews financial and other available information
      pertaining to such investments to determine if and when a decline, other than
      temporary, in the value of any investment has occurred and an adjustment is
      warranted.





16





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




When
      we
      determine that an asset is impaired, it measures 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, it writes such
      asset
      down to zero.




**Results
      of Operations**




Our
      fiscal 2005 net loss was $28.8 million, of which $17.8 million of that loss
      related to non-cash charges for depreciation, amortization, asset impairments
      and beneficial conversion of certain debt instruments. In fiscal 2004, the
      net
      loss was $13.6 million and the similar non-cash charges were $7.0 million.
      In
      fiscal 2003, the net loss was $16.1 million and similar non-cash charges were
      $5.6 million. Net operating revenues and gross profit were $2.5 million and
      $(1.1) million, respectively, in fiscal 2005, $1.9 million and $0.4 million,
      respectively, in fiscal 2004 and $1.1 million and $0.5 million, respectively,
      in
      fiscal 2003.




*Revenues*




Net
      revenues in fiscal 2005 increased $661,106 to $2,525,431 from $1,864,325 in
      fiscal 2004, an increase of 35%. This was due primarily to a contract with
      a
      supplier of vehicles for the government.







Net
      revenues in fiscal 2004 increased $760,555 to $1,864,325 from $1,103,770 in
      fiscal 2003, an increase of 69% due primarily to expanding direct sales to
      U.S.
      military and governmental entities.




*Cost
      of Goods*




Cost
      of
      goods sold in fiscal 2005 increased $634,347 to $1,573,116 from $934,769 in
      fiscal 2004. As a percentage of net revenues, cost of goods sold was 62.4%
      in
      fiscal 2005 compared to 50.1% in fiscal 2004. This was a result of the mix
      of
      products sold.




Cost
      of
      goods increased to $0.9 million in fiscal 2004 from $0.6 million in fiscal
      2003.
      As a percentage of costs of net revenues, cost of goods sold was 50.1% in fiscal
      2004 compared to 51.7% in fiscal 2003.




*Engineering,
      Research and Development*




Engineering,
      research and development increased $347,607 to $2,482,668 in fiscal 2005 from
      $2,135,061 in fiscal 2004. The increase is primarily attributable to engineering
      expense related to a government contract. As a percentage of net revenues,
      engineering, research and development was 98.3% in fiscal 2005 compared to
      114.5% in fiscal 2004. Research and development activities were negligible
      in
      fiscal 2005 and 2004 ($0.4 million in fiscal 2003) as we significantly reduced
      our research activities due to our financial condition. Engineering, research
      and development expense for fiscal 2004 of $2.1 million represents a 46%
      decrease from $3.5 million in fiscal 2003. The full year impact of cost control
      efforts taken during fiscal 2003 and continued in fiscal 2004, most
      significantly a reduction in engineering headcount, produced the majority of
      the
      expense reductions in fiscal 2004. As a percentage of net revenues, engineering,
      research and development was 114.5% in fiscal 2004 compared to 358.5% in fiscal
      2003.




*Selling,
      General and Administrative*




Selling,
      general and administrative expenses ("SG&A") declined $1,130,383 (15.7%) to
      $6,061,542 in fiscal 2005 from $7,191,925 in fiscal 2004. As a percentage of
      net
      revenues, SG&A was 240% in fiscal 2005 compared to 385.7% in fiscal 2004.
      The decrease is primarily attributable to our ongoing cost cutting efforts
      and
      personnel reduction.




Selling,
      general and administrative expenses declined 3% from fiscal 2003 to $7.2 million
      in fiscal 2004, from $7.4 million in fiscal 2003. The full year impact of cost
      control efforts taken during fiscal 2003 and continued in fiscal 2004, primarily
      staffing reductions, were substantially offset by a $2.1 million write off
      of a
      long-term note receivable that stopped performing during fiscal 2004 (see Note
      6
      in the Consolidated Financial Statements). As a percentage of net revenues,
      SG&A was 385.7% in fiscal 2004 compared to 668.2% in fiscal
      2003.





17





*Legal
      Settlements*




Legal
      settlements of $2,765,192 were recorded in fiscal 2005 primarily as a result
      of
      the settlement of litigation against us and certain of our officers by members
      of our former management and others as part of the 2004 Recapitalization.
      Approximately $1.5 million of this expense arose from valuations of the
      warrants, options and Series B units issued as part of the settlement. There
      was
      no comparable expense is fiscal 2004. See “Liquidity and Capital Resources”
below for further information regarding the terms of the settlement. **




*Asset
      Impairment*




During
      fiscal 2005 we recorded an asset impairment charge of $544,510 for the book
      value of our patents due to continued low sales.




During
      fiscal 2004, we recorded an asset impairment charge of $2.0 million with regard
      to the book value of certain of our patents and trademarks related to products
      which were not related to our core business where we could not justify that
      value based on our projections of revenues or cash flows during their remaining
      lives.




During
      fiscal 2003, in connection with our efforts to sell our headquarters, we
      recorded a $2.3 million asset impairment charge to reflect a realizable value
      for assets held for sale less than net book value.




*Severance
      Expense*




We
      did
      not incur any severance expense during fiscal 2005 or 2004. Severance expense
      of
      $0.2 million incurred in fiscal 2003 was principally due to the termination
      of
      the employment of Mr. Joshua Hauser, a former officer.




*Non-Operating
      Income and Expenses*




We
      incurred $0.3 million, $0.5 million and $.8 million of asset impairment charges
      in fiscal 2005, fiscal 2004 and fiscal 2003, respectively, primarily due to
      a
      decline in the value of non-core long-term investments.




During
      fiscal 2003, we realized a $0.6 million loss on a minority interest in our
      Aura
      Realty subsidiary. During fiscal 2004, we recorded an additional loss of $0.2
      million to account for the issuance of additional warrants to the purchasers
      of
      this minority interest due to our failure to register certain shares for resale
      and (see Item 7 - Liquidity and Capital Resources and Note 4 to the Consolidated
      Financial Statements).




Interest
      expense increased to $19 million in fiscal 2005 from $2.4 million in fiscal
      2004. Interest expense in 2005 consisted primarily of approximately $19.2
      million in charges attributable to a beneficial conversion feature of
      convertible notes, and warrants issued as part of the global settlement arising
      from the settlement of litigation.




Interest
      expense decreased to $2.4 million in fiscal 2004 from $2.7 million in fiscal
      2003. Interest expense in each of these periods included non-cash charges of
      $1.3 million and $1.5 million in fiscal 2004 and fiscal 2003, respectively
      attributable to a beneficial conversion feature of convertible notes.




Other
      income/expense, net was an expense of $0.17 million in fiscal 2005 and $0.1
      million in fiscal 2004 compared to income of $0.4 million in fiscal 2003.




We
      realized extraordinary gains of approximately $0.02 million in fiscal 2005,
      $0.1
      million in fiscal 2004 and $1.2 million in fiscal 2003 from the forgiveness
      of
      debt by certain of our creditors.





18





**Liquidity
      and Capital Resources**




The
      cash
      flow generated from our operations has not been sufficient to fund our working
      capital needs. In the past, in order to maintain liquidity we have relied upon
      external sources of financing, principally equity financing and private
      indebtedness.




During
      fiscal 2005 we continued to experience acute liquidity challenges. At February
      28, 2005, we had cash of approximately $61,000 as compared to a cash level
      of
      approximately $83,000 at February 29, 2004, and a working capital deficit of
      approximately $34 million as compared to a deficit of approximately $14 million
      at the end of the prior fiscal year.




During
      fiscal 2005, we continued to rely on third party funding to cover our cash
      shortfalls and to provide funding to cure the defaults under the mortgage on
      our
      headquarters facility. Principal sources of liquidity during this time were
      secured funding from private lenders and the sale of Series B Preferred Stock
      in
      connection with the 2004 Recapitalization Transactions. These transactions
      are
      described below.




Due
      to
      our acute liquidity challenges, we defaulted in making payments when due under
      many of our financial obligations (see Note 10 in the Consolidated Financial
      Statements). These conditions raised substantial doubt as to our ability to
      continue as a going concern as of the end of fiscal 2005. In June 2005 we filed
      for protection under Chapter 11 of the U.S. Bankruptcy Code.




At
      February 28, 2005, we had accounts receivable, net of allowance for doubtful
      accounts, of approximately $637,000 and approximately $682,000 February 29,
      2004. Our collections tend to average 60 - 90 days from invoice due to the
      nature of our significant customers. There was no spending for property and
      equipment in fiscal 2005 and less than $0.1 million in each of fiscal 2004
      and
      fiscal 2003.




Debt
      repayments of $0.1 were made in fiscal 2005 as compared to $0.3 million in
      fiscal 2004 and $1.0 million in fiscal 2003.




*Principal
      Capital Transactions During Fiscal 2004*




Series
      A Preferred Stock




In
      March
      2003, we designated 1,500,000 shares of our 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 $0.005, a liquidation preference of
      $10.00 plus accrued unpaid dividends and is convertible into common stock at
      $0.080 per share, based on the liquidation preference. Dividends accrue on
      each
      share at the rate of 5% of the liquidation preference per annum. We may call
      the
      Series A Preferred for redemption on or after March 31, 2004 subject to certain
      conditions. As of February 29, 2004, and February 28, 2005, 591,110 shares
      of
      Series A Preferred were outstanding, issued in fiscal 2004 as
      follows:




·
            We
                exchanged approximately $2.5 million principal amount of our notes
                plus
                accrued interest, into an aggregate of 534,020 shares of Series A
                Preferred.




·
            We
                issued 57,090 shares of Series A Preferred in a private placement
                for net
                cash proceeds of $259,500.




Intercreditor
      Secured Debt




In
      fiscal
      2004 and 2005 we received approximately $6.94 million **** of
      interim funding from Koyah Leverage Partners, LLP, Koyah Partners, LP, certain
      affiliated and non-affiliated parties to meet our immediate cash needs. These
      amounts were evidenced by secured notes originally payable on June 15, 2004
      (the
      "Secured Notes"). The Secured Notes bear interest at 10% per annum and were
      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. Repayment of the Secured Notes is secured by
      substantially all the assets of the company (with limited exceptions). Pursuant
      to the 2004 Recapitalization Transactions, the maturity of such notes was
      extended to June 30, 2005, the conversion discount / prepayment premium was
      eliminated, and a portion of such notes (initially $3.0 million of principal
      and
      interest) were converted into Series B Preferred Stock.





19





In
      connection with the foregoing financing, primarily as inducements to the lender
      to continue to provide interim funding, we agreed to issue warrants to purchase
      an aggregate of 3,200,000 shares of common stock at a price per share of $0.11,
      exercisable through January 7, 2011, and additional warrants (with a net
      exercise feature) to purchase an aggregate of 10,209,878 shares of common stock
      at a price per share of $0.024.




*Capital
      Transactions Subsequent to Fiscal 2004*




The
      2004 Recapitalization Transactions




In
      September 2004, we entered into agreements with a group of investors and holders
      of secured debt in order to recapitalize the company. These agreements are
      referred to as the "2004 Recapitalization Transactions" and are described in
      more detail below. Completion of the 2004 Recapitalization Transactions was
      intended to provide us with a more stable financial condition by infusing new
      capital of up to $15 million, payable in installments over an eight month period
      through the sale of units comprising Series B Preferred Stock and common stock
      warrants, conversion of $3.5 million of secured debt into Series B Preferred
      Stock and warrants and extension of the maturity of the remaining $2.1 million
      of secured debt to August 2005, and the settlement of legal claims with former
      management. However, even with the completion of the 2004 Recapitalization
      Transactions in September 2004, we were dependent on future subscription
      payments from investors and we continued to require forbearance of several
      creditors and the resolution of the transactions related to the proposed sale
      of
      our real estate facilities to a third party. See “Sale of the Headquarters
      Facility” below for information relating to the sale of our real estate
      facilities. Completion of the 2004 Recapitalization Transactions substantially
      diluted the interests of existing stockholders, reducing by more one-half their
      proportional ownership interest.




*Issuance
      and Terms of Series B Preferred Stock.* Each of
      the components of the 2004 Recapitalization Transactions involved issuance
      of
      Series B Preferred Stock. To consummate the 2004 Recapitalization Transactions,
      our Board of Directors designated 5,000,000 shares of our authorized preferred
      stock as Series B Cumulative Convertible Preferred Stock. Each share of Series
      B
      Preferred has a par value of $0.005, a liquidation preference of $0.02 per
      share
      plus accrued unpaid dividends and is convertible into common stock at $0.02
      per
      share. Dividends accrue on each share at the rate of 8% of the liquidation
      preference per annum. The Series B Preferred Stock ranks senior to our common
      stock and Series A Preferred Stock in respect of payment of dividends and
      distributions upon liquidation. The conversion price is subject to adjustment
      to
      the lowest price at which in the future we sell shares of common stock, with
      limited exceptions. We have the right to force conversion of the Series B
      Preferred Stock into common stock upon the satisfaction of a number of
      conditions, including our common stock trading at a price in excess of $0.10
      for
      20 consecutive trading days. The Series B Preferred Stock has class voting
      rights to elect four directors and to approve certain corporate transactions,
      including the issuance of any shares of preferred stock on parity with or senior
      to the Series B Preferred Stock. The Series B Preferred Stock cannot be
      converted into common shares unless and until the shareholders approve an
      increase in the number of authorized common shares. As part of the 2004
      Recapitalization Transactions, we committed to seek such shareholder approval
      as
      soon as possible.




*The
      Series B Placement.* As part
      of the 2004 Recapitalization Transactions, in September 2004 we consummated
      the
      sale of units in a private placement (‘Series B Placement”) consisting of Series
      B Preferred Stock and warrants, for a total subscription price equal to the
      liquidation value of the Series B Preferred Stock. Each unit included warrants
      to purchase common stock in an amount equal to the 25% of the number of shares
      of common stock obtainable upon conversion of the associated Series B Preferred
      Stock, at a price per share of $0.02, exercisable for seven years. Thus, for
      an
      investment of $100,000, an investor received shares of Series B Preferred Stock
      with a liquidation preference of $100,000, convertible into 5,000,000 shares
      of
      common stock, and warrants to purchase an additional 1,250,000 shares of common
      stock at $0.02 per share. The purchasers of the units agreed to pay a portion
      of
      the purchase price in the form of unsecured personal promissory notes bearing
      interest at 8% and payable with a term up to nine months. We received total
      commitments to purchase approximately $8.5 million of units, exclusive of
      conversion of Secured Notes, of which $1 million was payable through conversion
      of debt. As of February 28, 2005 $4.6 million was advanced as cash to us to
      be
      applied to the placement, and $3.9 million remained outstanding as a
      subscription receivable. Because the fair market value of the promissory notes
      was deemed to be substantially less than their face value, and because a portion
      of the subscription price was assigned to the included warrants, for accounting
      purposes the Series B Preferred Stock was deemed sold at a substantial discount
      to its liquidation preference, and therefore our capital account was not
      increased by the full liquidation preference of the offering.





20





*The
      Conversion of Intercreditor Secured Debt to Equity.* Concurrent with the Series B Placement described above, the holders of the
      Secured Notes (with a balance, including accrued interest of approximately
      $8.1
      million as of September 15, 2004) agreed to convert $2.5 million of Secured
      Notes into shares of Series B Preferred Stock and warrants, on the same terms
      as
      the cash investors. To the extent we raised additional capital funding and
      met
      other specified conditions, such holders agreed to convert an additional amount
      of Secured Notes equal to the amount of such new excess capital funding
      obtained. Our agreement with the holders of the Secured Notes also extended
      the
      due dates of the remaining Secured Notes to August 2005 and gave holders of
      the
      Secured Notes the right to convert all or a portion of the Secured Notes at
      any
      time on the foregoing terms, terminates any other rights they hold to convert
      the Secured Notes into new securities sold by us, and permitted us to prepay
      the
      remaining Secured Notes at any time without premium. In fiscal 2005 we recorded
      approximately $7.45 million of interest expense related to the beneficial
      conversion feature and warrants to be issued upon conversion of the Secured
      Notes. See Note 13 to our Consolidated Financial Statements.




*The
      Litigation Settlement.* As a
      precondition to obtaining new funding, we negotiated a litigation settlement
      with former officers Zvi (Harry) Kurtzman, Cipora Lavut Kurtzman, Arthur
      Schwartz and Steven Veen, and Yair Ben Moshe and David Maimon, all of whom
      are
      collectively referred to as the "Aries Group". The settlement contained mutual
      general releases, mutual covenants not to sue and terminated the litigation
      against the company and members of our management. Pursuant to the settlement,
      we agreed (i) to pay members of the Aries Group an aggregate of $801,509 in
      16
      monthly installments (which total payments would be reduced to $726,508 if
      we
      timely paid all installments), subject to acceleration if certain additional
      capital raising targets were met and subject to the option to convert unpaid
      amounts into units of the Series B Placement, (ii) to reinstate approximately
      14
      million options and warrants previously issued to members of the Aries Group
      with exercise prices not less $0.31 per share of common stock, (iii) to issue
      to
      members of the Aries Group new ten-year warrants to purchase an aggregate of
      34,500,000 shares of common stock exercisable at a price of $0.07 per share,
      (iv) to issue to members of the Aries Group 6,208,048 shares of our common
      stock
      and (v) to issue to members of the Aries Group shares of Series B Preferred
      Stock with an aggregate liquidation preference of $458,583 and approximately
      5.7
      million seven-year warrants exercisable at a price of $0.02, consistent with
      the
      Series B Placement. Certain members of the Aries Group also participated in
      the
      Series B placement. A failure by us to pay amounts due or issue shares or
      warrants as provided by the settlement would terminate the Aries Group's
      requirement to fund its Series B placement commitment. Conversely, a failure
      of
      the Aries Group to pay amounts due pursuant to its Series B placement commitment
      would waive our requirement to pay amounts due under the settlement unless
      and
      until such payments are made.




*Management
      Changes.* In
      connection with the 2004 Recapitalization Transactions, Neal Meehan agreed
      to
      resign from his position as Chief Executive Officer. In addition, Messrs.
      Albert, Diamant and Harrington agreed to resign from our Board of Directors
      effective with initial funding of the 2004 Series B Placement in September
      2004.
      The new board members selected by the Series B Preferred Stock investors were
      Raymond Yu, Dr. Fred Balister and Izar Fernbach. Mr. Meehan continued as the
      fourth board member to be elected by the holders of the Series B Preferred
      Stock.




Events
      Subsequent to Consummation of the September 2004 Recapitalization
      Transactions




*The
      Sale of the Headquarters Facility* .
      In May
      2004, the company, Aura Realty and the minority shareholders in Aura Realty,
      which included the Aries Group (the “Realty Minority Shareholders”) agreed to a
      sale of our headquarters facility to a buyer (the “Real Estate Buyer”)
      controlled by Yair Ben-Moshe and David Maimon (the “May 2004 Agreements”). The
      May 2004 Agreements were intended to terminate a Sale and Leaseback Agreement
      we
      entered into in December 2002 with the Realty Minority Shareholders, which
      included Zvi Kurtzman and other former members of our management. In June 2004
      the Realty Minority Shareholders sent notice to the company that we had
      defaulted on the agreement as that pertained to the settlement with the Realty
      Minority Shareholders and terminated the agreement. In August 2004, Noy Hayun,
      one of the members of the Realty Minority Shareholders, filed a lawsuit against
      us seeking full payment of the $1.0 million note held by the Realty Minority
      Shareholders issued by us in December, 2002, in connection with an earlier
      proposed sale-leaseback transaction between us and the Realty Minority
      Shareholders. We have recorded the full amount of this note and related accrued
      interest on our financial statements at February 28, 2005.





Through
      December 31, 2004, Messrs. Ben-Moshe and Maimon advanced us $0.45 million,
      which
      was principally used, together with other funds provided by the Company, to
      cure
      all existing defaults with the mortgagor as of May 2004 and bring the note
      current. Such payment was to be applied to the purchase price and, in the event
      closing of such sale did not occur, would be deemed to be an unsecured loan
      to
      us bearing interest at 10% per annum and payable in 24 equal monthly payments,
      and convertible, at the option of the holder, into Series B Preferred Stock.
      Also advanced to us by Messrs. Ben-Moshe and Maimon was $0.8 million which
      was
      then used to off-set the $.67 million security deposit and the remainder applied
      to the building repairs and recorded on the Aura Reality balance sheet as a
      vendor advance and off-set to deposits respectively.




21




The
      sales
      price of the property was $7.8 million, of which approximately $5.0 million
      would be used to repay the existing mortgage, $1.6 million was to be paid to
      the
      Realty Minority Shareholders, and $0.8 million would be credited to the Real
      Estate Buyer for deposits. In addition to the subject real estate, the Real
      Estate Buyer received 220,000 units of the Series B Placement and ten-year
      warrants to purchase 15,000,000 shares of the Company’s common stock at an
      exercise price of $0.07. At closing of the sale, we were to lease back a portion
      of the premises (the warehouse and the first floor of the office building)
      for a
      period of four years at a monthly rent of $56,000, triple net. Also at closing,
      (i) the Realty Minority Shareholders were to cancel the existing $1.0 million
      note issued by us on December 1, 2002, and receive from us a new note in the
      amount of $0.25 million, bearing interest at 12.3% and payable over 24 months,
      (ii) a note receivable with a balance due of approximately $2.0 million as
      of
      July 30, 2004, which had been assigned to the Realty Minority Shareholders,
      would be reassigned to the Real Estate Buyer, and (iii) the Realty Minority
      Shareholders would receive shares of Series B Preferred Stock with a liquidation
      preference of $0.15 million. We were obligated to pay the Realty Minority
      Shareholders $40,582 per month for continued use of the facility pending closing
      of the sale. Upon closing of the transactions described above, the Realty
      Minority Shareholders would release any further claims they have related to
      Aura
      Realty and the December 1, 2002 Sale/Leaseback Agreement.





By
      January 31, 2005, the Real Estate Buyer, controlled by Yair Ben Moshe and David
      Maimon, failed to close the real estate purchase transaction. In February 2005,
      Yair Ben Moshe, David Maimon, an entity controlled by Terry Turner an investor,
      and Izar Fernbach failed to provide their funding obligations under the Series
      B
      Placement. We subsequently filed a suit against Yair Ben Moshe and David Maimon
      to enforce their Series B Placement subscription obligations and they in turn
      filed countersuits against us and other investors claiming damages from the
      failed real estate transaction. On April 20, 2005 we received a notice of
      default from the Aries Group on the cash settlement portion of the 2004
      Recapitalization Transactions due to our failure to make certain required
      payments. The failure by Yair Ben Moshe and David Maimon to pay the Series
      B
      placement subscription price when required by the terms of their promissory
      notes caused severe financial pressure on us that triggered numerous payment
      demands which we were unable to meet.




*Chapter
      11 Reorganization.* Accordingly,
      on June 24, 2005, we filed for reorganization under Chapter 11 of the U.S.
      Bankruptcy Code in the United States Bankruptcy Court, Central District of
      California, (Case Number LA 05-24550-SB). We secured a Debtor in Possession
      (“DIP”) loan from Blue Collar Films LLC for one million dollars and secured an
      additional $1.2 million DIP loan from AGP Lender LLC. In addition a group of
      individual investors provided an additional $1.16 million in DIP financing.
      We
      submitted a reorganization plan (“Plan”) that was approved by the court and
      voted and approved by the DIP lenders, the secured creditors, the unsecured
      creditors, the shareholders and the new money investors. The Plan became
      effective on January 31, 2006 (the “Effective Date”). Under the Plan (i) the
      secured creditor retained $2.5 million in a secured note payable over 48 months
      at 7% annual interest with the first payment starting 12 months after the
      reorganization, which continued to be secured by a lien on substantially all
      of
      our assets, (ii) the Series B Preferred Stock holders received new common shares
      calculated by dividing the total cash invested in the Series B Placement by
      $3.37, (iii) the Series A Preferred Stock holders converted each 1.8 shares
      of
      Series A Preferred Stock into one new common share, (iv) the common shareholders
      converted each 338 of their shares into one new share, (v) the DIP lenders
      converted their loans into approximately 6.07 million new shares of common
      stock, and (vi) all the unsecured creditors received new shares of common stock
      valued at one share per $1.75 of unsecured debt. An additional 5.89 million
      shares of common stock were issued for the new money and reorganization related
      fees. Warrants to purchase a total of approximately 3,807,319 shares of common
      stock were issued under the Plan to the new money investors, the DIP Lenders,
      holders of unsecured claims, holders of Series A and Series B Preferred Stock
      and the Aries Group. These warrants entitled the warrant holder to purchase
      Common Stock at a price of $3.00 per share during the first 12 months following
      the Effective Date, $3.50 per share during the second 12 months following the
      Effective Date, and $4.00 per share thereafter. In addition, warrants to
      purchase a total of 259,900 shares of common stock were issued under the Plan
      to
      the holders of the Secured Notes, entitling the warrant holder to purchase
      common stock at a price of $2.00 per share during the first 12 months following
      the Effective Date, $2.50 per share during the second 12 months following the
      Effective Date, and $3.00 per share thereafter. The Plan also provided for
      the
      reservation by the Company of warrants for 500,000 shares for the Company’s
      management and 500,000 shares for the Company’s Board of Directors.




22




All
      of
      the outstanding litigation and disputes were settled during the bankruptcy.
      The
      real estate was sold to an unrelated third party in December 2005 and all
      disputes regarding the real estate were settled. We emerged from the Chapter
      11
      effective January 31, 2006.




**Contractual
      Obligations**




The
      table
      below describes the Company’s future contractual obligations, including items
      not included in the consolidated balance sheet, as of February 28, 2005:




**Payments
                Due by Period****Contractual
                Obligations**
            
            **Total**
            
            **Less Than 1 Year**
            
            **1-3 Years**
            
            **3-5 Years**
            
            **More Than 5 Years**Long
                Term Debt
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0Capital
                lease obligations
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0Operating
                leases (a)
            
            $
            6,498,000
            
            $
            820,800
            
            $
            2,462,400
            
            $
            2,462,400
            
            $
            752,400Minimum
                license commitment
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0Fixed
                asset and inventory purchase commitments
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            0Total
                contractual cash obligations
            
            $
            6,498,000
            
            $
            820,800
            
            $
            2,462,400
            
            $
            2,462,400
            
            $
            752,400




(a)
      Consists of the lease on our facilities




**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




We
      are
      exposed to various market risks, including changes in interest rates. Market
      risk is the potential loss arising from adverse changes in market rates and
      prices. We consider our exposure to market risks to be immaterial. Historically,
      we have not entered into derivative financial instrument transactions to manage
      or reduce market risk or for speculative purposes. Our long term debt
      obligations all bear interest at fixed rates and, therefore, have no exposure
      to
      interest rate fluctuations. Our risk related to foreign currency fluctuations
      is
      not material at this time, as any accounts we have in foreign denominations
      are
      not in themselves material.





As
      we
      anticipate needing to use the cash we held at year end within a short period,
      we
      have invested it in money market accounts, and we do not expect that the amount
      of fluctuation in interest rates will expose us to any significant risk due
      to
      market fluctuation.




**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**




See
      Index
      to Consolidated Financial Statements at page F-1.




**ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**




Not
      applicable.




**ITEM
      9A. CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**




23




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 February 28, 2005, that they
      were not effective in view of our delinquent filing of this report.





As
      of
      February 28, 2005, we did not have adequate financial resources to engage our
      outside auditors and ensure the timely filing of this Form 10-K, as subsequently
      disclosed in Form 12b-25 filed with the SEC on May 26, 2005. In June 2005 we
      were forced to seek protection from creditors under Chapter 11 of the U.S.
      Bankruptcy Code.





**Changes
      in Internal Control over Financial Reporting**





There
      have been no changes in our internal control over financial reporting during
      our
      fiscal quarter ended February 28, 2005, that have materially affected or are
      reasonably likely to materially affect our internal control over financial
      reporting.




**PART
      III**




**ITEM
      10. DIRECTORS AND EXECUTIVE OFFICERS**




*Directors
      and Officers*




As
      of May
      31, 2005, our Directors were Raymond Yu (Chairman), Billy Anders, Sandra Ferro
      and Yolanda Parker. Officers consisted of Mr. Yu, our CEO and President, and
      Ms.
      Sandra Ferro, our CFO and Joe Lam, Vice President. In June 2005 we filed for
      protection under Chapter 11 of the U.S. Bankruptcy Code, and emerged under
      a
      Plan of Reorganization effective January 31, 2006. Each of these individuals
      was
      replaced as of February 2006, in connection with the implementation of our
      Chapter 11 Bankruptcy Plan of Reorganization.





Following
      is information regarding our current officers and directors as of the date
      of
      filing this Report in March, 2008.




**Melvin
      Gagerman -** Mr.
      Gagerman has been the CEO and CFO of the Company since we emerged from Chapter
      11 proceedings on January 31, 2006. He has many years of experience in all
      aspects of managing companies and a very strong background in accounting and
      finance. Mr. Gagerman was the President of Hollywood Trading Co., a distributor
      of novelty items, from 2000 until February 2006, when he became CEO of the
      Company. Prior to that Mr. Gagerman was the CEO of Surface Protection Industries
      from 1976 to 1977, where he successfully reorganized key management positions;
      established relationships with new distributors and upgraded manufacturing
      abilities, developed aggressive marketing programs to revitalize mature product
      lines and identified new market opportunities to increase sales and profits.
      From 1973 to 1975 Mr. Gagerman was the Chairman and CEO of Applause, where
      he
      successfully reorganized a world famous designer, manufacturer and distributor
      of licensed and generic stuffed toys which had sales of $137 million per year,
      700 employees and losses of 12 million dollars a year. By aggressively altering
      product lines, adding new lines, cutting overhead, restructuring several key
      management positions, the company produced a $4.5 million profit within one
      year. Mr. Gagerman has also served as Managing Partner of Good, Gagerman &
Berns, an accounting firm, National Audit Partner for Laventhol and Horwath
      and
      Audit Supervisor at Coopers and Lybrand.




**Arthur
      J. Schwartz, PhD** - Dr.
      Schwartz has been CTO and a director of the Company since it emerged from
      Chapter 11 proceedings on January 31, 2006. From 2002 to 2006 Dr. Schwartz
      was a
      principal in the business consulting firm Aries Group Ltd. Dr. Schwartz is
      one
      of the founders of the Company and was a member of Aura’s management from1987
      until 2002 as Executive Vice President, CTO and director. Dr. Schwartz has
      been
      has been involved in all technical aspects of the Company and has been
      instrumental in many of our government programs. Prior to founding Aura, Dr.
      Schwartz worked at Hughes Aircraft Company as a senior scientist on classified
      programs. Dr. Schwartz has a Ph.D in Physics.




24




**Dr.
      Maurice Zeitlin** - Dr.
      Maurice Zeitlin has been a director of the Company since it emerged from Chapter
      11 proceedings on January 31, 2006. Since 1985, Dr Zeitlin has been the
      President and owner of Maurice A. Zeitlin M.D., a Medical Corporation. He
      currently practices administrative medicine and is the medical director for
      several Los Angeles area hospitals. Dr. Zeitlin was a Major in the USAF from
      1972 until 1974 He attended the University of Chicago and received his M.D
      in
      1967.




**Warren
      Breslow** - Mr.
      Breslow has been a director and Chairman of the Audit Committee since it emerged
      from Chapter 11 bankruptcy proceedings on January 31, 2006. Mr. Breslow is
      the
      General Partner and Chief Financial Officer of Goldrich & Kest Industries
      (“G & K Industries”), a property management firm. He joined G & K
      Industries in 1972 as controller and assumed his current position as General
      Partner and Chief Financial Officer in 1974. As General Partner and Chief
      Financial Officer of G & K, Mr. Breslow oversees the financial aspects of G
& K’s construction activity, as well as their management operations and
      information systems center. He is also past president and lifetime member of
      the
      board of directors of the Stephen S. Wise Temple, and supports numerous
      charitable and civic organizations. Prior to his association with Goldrich
&
Kest Industries, Mr. Breslow was a manager with the International Accounting
      firm of Laventhol & Horwath. He is a CPA and graduated from the Bernard
      Baruch School of Business Administration.




**Salvador
      Diaz-Verson, Jr.** is a
      director of the Company and has served in this capacity since June, 2007. He
      previously served as a director of the Company from 1997 to 2005. Mr.
      Diaz-Verson is the founder, Chairman and President of Diaz-Verson Capital
      Investments, Inc., an Investment Adviser registered with the SEC, where he
      has
      served since 1991. Mr. Diaz-Verson served as President and member of the Board
      of Directors of American Family Corporation (AFLCAC Inc.) a publicly held
      insurance holding company, from 1979 until 1991. Mr. Diaz-Verson also served
      as
      Executive Vice President and Chief Investment Officer of American Family Life
      Assurance Company, subsidiary of AFLAC Inc., from 1976 through 1991. He is
      currently a Director of the board of Miramar Securities, Clemente Capital Inc.,
      Regions Bank of Georgia and The Philippine Strategic Investment Holding Limited.
      Since 1992, Mr. Diaz-Verson has also been a member of the Board of Trustees
      of
      the Christopher Columbus Fellowship Foundation, appointed by President George
      H.W. Bush in 1992, and re-appointed by President Clinton in early 2000. Mr.
      Diaz-Verson is a graduate of Florida State University.





**Yedidia
      Cohen** - Mr.
      Cohen has been employed by us since July, 2001, developing numerous magnetic
      applications, and has been our VP of Engineering since May, 2006. Prior to
      being
      appointed VP of Engineering he was the lead engineer on the AuraGen mechanical
      tasks. Mr. Cohen has extensive experience in designing and building highly
      reliable and durable weapon systems. He spent much of his professional carrier
      at Raphael (Weapon development and testing facility for the Israeli Army).
      In
      addition to his vast experience in weapon systems, Mr. Cohen worked for
      Electric **** Power
      Corporation in Haifa, Israel, where he specialized in conceptual design of
      power
      generation plane, thermodynamic calculations, design of boilers, pressure
      vessels and heat exchangers. In addition to his engineering skills Mr. Cohen
      has
      experience in building and managing teams of engineers working on complex tasks.
      Mr. Cohen has a M.S.E.E degree in Mechanical Engineering from the Technion
      in
      Haifa, Israel






*Section
      16(a) Beneficial Ownership Reporting Compliance*




Section
      16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
      requires our officers and Directors, and beneficial owners of more than ten
      percent of the common stock, to file with the Securities and Exchange Commission
      and the National Association of Securities Dealers, Inc. reports of ownership
      and changes in ownership of the common stock. Copies of such reports, or written
      representations that no reports were required, are required to be furnished
      us.
      Based solely upon a review of Forms 3 and 4 and amendments thereto furnished
      to
      us during our fiscal year ended February 28, 2005, and Form 5 and amendments
      thereto furnished to us covering the 2005 fiscal year filed under Section 16(a)
      of the Securities Exchange Act of 1934, no person who was an officer or director
      or beneficial owner of more than 10% of our common stock failed to file on
      a
      timely basis, as disclosed in such Forms, the reports required by Section 16(a)
      of the Exchange Act during such fiscal year or prior fiscal years.




25




*Code
      of Ethics*





We
      have a
      Code of Ethics for all of our employees, including our Chief Executive Officer,
      Chief Financial Officer and Principal Accounting Officer. The purpose of the
      Code is to ensure that our business is conducted in a consistently legal and
      ethical matter. A copy of our Code of Ethics is included as an exhibit to this
      Annual Report on Form 10-K.





*Audit
      Committee*





The
      Audit
      Committee of our Board of Directors recommends selection of independent public
      accountants to our Board, reviews the scope and results of the year-end audit
      with management and the independent auditors, reviews our accounting principles
      and our system of internal accounting controls and reviews our annual and
      quarterly reports before filing with the SEC. As of March, 2008, the members
      of
      our Audit Committee were Mr. Warren Breslow, (Chairman), Maurice Zeitlin and
      Salvador Diaz-Verson. Our Board has determined that all members of the Audit
      Committee were independent directors under the rules of the SEC and the listing
      standards of NASDAQ. Our Board also determined that Mr. Breslow is an “audit
      committee financial expert” in accordance with applicable SEC
      regulations.




**ITEM
      11. EXECUTIVE COMPENSATION**




*Executive
      Compensation*




The
      following table summarizes all compensation paid during the three fiscal years
      ended February 28, 2005, to the two individuals who served as our chief
      executive officer during fiscal 2005, and the other most highly compensated
      executive officer who earned more than $100,000 in salary and bonus during
      fiscal 2005 (together, the "Named Executive Officers"). Information is presented
      only for years in which an individual served as an officer of the
      Company.


****
              
              ****
              
              **Annual Compensation**
              
              **Long Term**
                **Compensation**
              
              ******Name and**
                **Principal Position**
              
              **Fiscal Year ended**
                **February 28/29**
              
              **Salary**
              
              **Other Annual**
                **Compensation**
              
              **Securities Underlying**
                **Options/SARs
                  (3)**
              
              **All Other**
                **Compensation**Raymond
                  Yu (2)
              
              
              2005
              
              $
              88,462
              
              
              -
              
              
              -
              
              
              -CEONeal
                  Meehan (2)
              
              
              2005
              
              $
              105,000
              
              $
              0
              
              
              10,000,000
              
              $
              180,000
              (6)Chief
                  Executive
              
              
              2004
              
              $
              176,148
              
              $
              0
              
              
              6,500,000
              
              $
              25,990
              (5)Officer
                  and President
              
              
              2003
              
              $
              105,000
              
              $
              0
              
              
              6,125,000
              (4)
              $
              45,584
              (5)Jacob
                  Mail
              
              
              2005
              
              $
              191,539
              
              $
              0
              
              
              -
              
              
              -Senior
                  Vice
              
              
              2004
              
              $
              164,285
              
              $
              0
              
              
              -
              
              
              -President-Operations
              
              
              2003
              
              $
              173,753
              
              $
              0
              
              
              -
              
              
              -and
                  Chief OperatingOfficer




(1)
      Mr.
      Yu was elected CEO, President and a director effective September 20, 2004.




(2)
      Mr.
      Meehan was elected Chairman, Chief Executive Officer and President effective
      July 2002. He resigned as President and CEO effective September
      2004.




(3)
      Amounts indicated are number of options granted during the fiscal year.




(4)
      Excludes 264,100 unexpired option shares that were returned to the Company
      in
      fiscal 2004 for redistribution to other employees.




(5)
      Represents travel and living expenses away from home.




(6)
      Represents severance pay accrued in 2005, of which $90,000 was paid




No
      long-term incentive payments or restricted stock awards were granted to the
      above individuals during the three fiscal years ended February 28, 2005.




26




**OPTIONS/SAR
      GRANTS IN LAST FISCAL YEAR**




The
      following table summarizes certain information regarding option grants to
      purchase common stock of the Company to the Named Executive Officers.


**Individual
                  Grants**
              
              ****
              
              ******Name**
              
              **Number
                  of**
                **Securities**
                **Underlying**
                **Options/**
                **SARs Granted**
                **(#)**
              
              **% of Total**
                **Options/**
                **SARs**
                **Granted to**
                **Employees In**
                **Fiscal Year**
              
              **Exercise Or**
                **Base Price**
                **($/Sh)**
              
              **Expiration**
                **Date**
              
              **Potential Realizable**
                **Value****at
                  Assumed**
                **Annual Rates of****Stock**
                **Price Appreciation****For**
                **Option Term*****5%
                  ($**)****
              
              
              **10%
                  ($**)****Neal
                  Meehan
              
              
              10,000,000
              
              
              100
              %
              $
              0.02
              
              
              11/11
              
              $
              205,600
              
              $
              587,500Jacob
                  Mail
              
              
              -Raymond
                  Yu
              
              
              -




*
      Based
      on the average high and low reported prices of the Company's common stock on
      February 28, 2005.




The
      following table summarizes certain information regarding the number and value
      of
      all options to purchase common stock of the Company held by the Named Executive
      Officers as of February 28, 2005.




**AGGREGATED
      OPTION EXERCISES IN LAST FISCAL YEAR**


**AND
      FISCAL YEAR-END OPTION VALUES**





**Name**
            
            **Shares**
              **Acquired**
              **On
                Exercise**
            
            **Value
                Realized**
              **($)**
            
            **Number
                of Securities**
              **Underlying**
              **Unexercised**
              **Options/SARs
                At**
              **Fiscal
                Year End**
              **Exercisable/**
              **Unexercisable**
            
            **Value
                of**
              **Unexercised**
              **In-the-Money**
              **Options/SARs**
              **At
                Fiscal Year**
              **End($)***
              **Exercisable/**
              **Unexercisable**Raymond
                Yu
            
            **-**
            
            **-**
            
            -
            
            -Neal
                Meehan
            
            **-**
            
            **-**
            
            -
            
            -Jacob
                Mail
            
            **-**
            
            **-**
            
            -
            
            -





(*)
      Based
      on the closing price of our common stock on the last trading day of the fiscal
      year ended February 28, 2005.




No
      options were exercised by the above individuals during the fiscal year ended
      February 28, 2005.




*Employment
      Contracts and Termination of Employment and Change in Control
      Agreements*




We
      had
      employment agreements in effect in fiscal 2005 with respect to the following
      executive officers.




27





*Sandra
      Ferro.* On
      September 28, 2004, the Company entered into an Employment Agreement with Sandra
      Ferro (the “Ferro Agreement”), pursuant to which, effective October 21, 2004,
      Ms. Ferro became Chief Financial Officer of the Company. The Ferro Agreement
      provided (i) for Ms. Ferro’s starting annual salary of $120,000; and (ii) that
      if she were terminated by the Company without cause during the first two years
      of her employment, she would be entitled to receive a severance payment equal
      to
      30 days’ salary. In addition, the Ferro Agreement provided that she would be
      granted options to purchase 1,000,000 shares of the Company’s Common Stock at an
      exercise price of $0.057 per share. Such options were to vest 50% on the first
      anniversary of her employment and 50% on the second anniversary.




*Joe
      Lam.* On
      October 18, 2004, ** the
      Company entered into an employment arrangement with Joe Lam, pursuant to which
      he became Vice President of the Company. Mr. Lam’s arrangement with the Company
      provided for a starting annual salary of $150,000. In addition, the arrangement
      provided that Mr Lam would be granted options to purchase 2,000,000 shares
      of
      the Company’s Common Stock at an exercise price of $0.061 per share. Such
      options were to vest 50% on the first anniversary of his employment and 50%
      on
      the second anniversary.




We
      had
      the following change in control or severance agreements with our executive
      officers in fiscal 2005:




·
            Mr.
                Meehan had an employment agreement, established in February 2004,
                providing for a lump sum payment of one year's salary upon a termination
                of his employment for any reason other than his commission of a felony
                against the Company.




·
            Mr.
                Mail has an employment contract providing for payment of three years'
                salary upon a termination of his employment without cause.




·
            Under
                our employment agreement with Sandra Ferro, which was in effect as
                of
                October 21, 2004, she was entitled to a severance payment of one
                month’s
                salary if she was terminated without cause during the first two years
                of
                her employment.




*Compensation
      of Directors*




Directors
      are reimbursed for travel expenses incident to their service as a director
      but
      do not receive cash compensation.




In
      fiscal
      2005, the Company's director compensation policy was to provide each new
      Director an initial membership grant of 500,000 stock options and each
      non-employee Director an annual grant of 500,000 stock options (550,000 for
      members of the Audit and Compensation Committees and 600,000 for the Chairperson
      of each committee), with the exercise price set at or above market as of the
      date of grant and all grants vesting six months plus one day from the date
      of
      grant. All grants under this policy are priced at or above the market price
      as
      of the date of grant.




*Compensation
      Committee Interlocks and Insider Participation*




During
      the fiscal year ended February 28, 2005, Salvador Diaz-Verson, Jr., Harry E.
      Soyster and Lawrence Diamant served on the Compensation Committee. None of
      the
      members of the Compensation Committee ever served as an employee of the Company.
      Decisions regarding compensation of executive officers for the fiscal year
      ended
      February 28, 2005 were made by the outside, disinterested Directors of the
      Board
      of Directors, after reviewing recommendations of the Compensation Committee
      and
      discussing the matter with the executive officer.




**ITEM
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT** ** **AND
      RELATED STOCKHOLDER MATTERS**




*Common
      Stock*




The
      following table sets forth, to the extent of our knowledge, certain information
      regarding our Common Stock owned as of December 31, 2007 (i) by each person
      who
      is the beneficial owner of more than five percent (5%) of our outstanding Common
      Stock, (ii) by each of our Directors and the Named Executive Officers, and
      (iii)
      by all Directors and executive officers as a group. The share amounts in the
      table have been adjusted to give effect to the 1:338 reverse stock split
      effected on January 31, 2006, as part of the Chapter 11 Plan of
      Reorganization:




28




**Beneficial
                  Owner**
              
              **Number of Shares**
                **of****Common Stock**
              
              **Percent of**
                **Common Stock (1))**ICM
                  Asset Management, Inc. (2)(3)
              
              
              1,492,388
              
              
              4.1
              %James
                  M. Simmons (2)(4)
              
              
              1,612,012
              
              
              4.4
              %Koyah
                  Ventures, LLC (2)(5)
              
              
              1,541,238
              
              
              4.2
              %Koyah
                  Leverage Partners, L.P. (2)(6)
              
              
              1,260,978
              
              
              3.4
              %Raymond
                  Yu
              
              
              -
              
              
              -Neal
                  Meehan
              
              
              -
              
              
              -Jacob
                  Mail
              
              
              -
              
              
              -Melvin
                  Gagerman (7)
              
              
              611,501
              
              
              1.7
              %Arthur
                  Schwartz (8)
              
              
              728,659
              
              
              2.0
              %Maurice
                  Zeitlin (9)
              
              
              1,116,260
              
              
              3.0
              %Warren
                  Breslow (10)
              
              
              1,488,378
              
              
              4.1
              %Salvador
                  Diaz-Verson, Jr. (11)
              
              
              115,934
              
              
              *All
                  current executive officers and Directors as a group (eight)
              
              
              4,060,732
              
              
              11.1
              %
  *
        Less
        than 1% of outstanding shares.
  (1)
                Beneficial
                    ownership is determined in accordance with rules of the U.S.
                    Securities
                    and Exchange Commission. The calculation of the percentage of
                    beneficial
                    ownership is based upon 36,670,820 shares of common stock outstanding
                    on
                    December 31, 2007. In computing the number of shares beneficially
                    owned by
                    any shareholder and the percentage ownership of such shareholder,
                    shares
                    of common stock which may be acquired by a such shareholder upon
                    exercise
                    or conversion of warrants or options which are currently exercisable
                    or
                    exercisable within 60 days of December 31, 2007, are deemed to
                    be
                    exercised and outstanding. Such shares, however, are not deemed
                    outstanding for purposes of computing the beneficial ownership
                    percentage
                    of any other person. Shares issuable upon exercise of warrants
                    and options
                    which are subject to shareholder approval are not deemed outstanding
                    for
                    purposes of determining beneficial ownership. Except as indicated
                    by
                    footnote, to our knowledge, the persons named in the table above
                    have the
                    sole voting and investment power with respect to all shares of
                    common
                    stock shown as beneficially owned by them.
 (2)
                Based
                    upon information contained in Schedule 13G jointly filed with
                    the SEC on
                    February 13, 2008, by ICM Asset Management, Inc., Koyah Ventures,
                    LLC,
                    Koyah Leverage Partners, L.P. and James M. Simmons. The business
                    address
                    of these filers is601
                    W. Main Avenue, Suite 600, Spokane, Washington 99201.ICM
                    Asset Management, Inc., James M. Simmons and Koyah Ventures,
                    LLC
                    constitute a group sharing beneficial ownership within the meaning
                    of Rule
                    13d-5(b)(1), but are not part of a group with any other person.
                    Koyah
                    Leverage Partners, L.P. expressly disclaims membership in a group
                    and
                    disclaims beneficial ownership of the common stock covered by
                    the Schedule
                    13G. ICM Asset Management, Inc. is a registered investment adviser
                    whose
                    clients have the right to receive or the power to direct the
                    receipt of
                    dividends from, or the proceeds from the sale of, the common
                    stock. James
                    M. Simmons is the Chief Executive Officer and controlling shareholder
                    of
                    ICM Asset Management, Inc. and the manager and controlling owner
                    of Koyah
                    Ventures, LLC. Koyah Ventures, LLC is the general partner of
                    Koyah
                    Leverage Partners, L.P. and other investment limited partnerships
                    of which
                    ICM Asset Management, Inc. is the investment adviser. No individual
                    client
                    of ICM, other than Koyah Leverage Partners, L.P., holds more
                    than five
                    percent of the outstanding common stock.
 (3)
                Includes
                    sole dispositive and voting power of 862 shares and shared voting
                    and
                    dispositive power of 1,491,526
                    shares.
 (4)
                Includes
                    sole dispositive and voting power of 7,771 shares and shared
                    voting and
                    dispositive power of 1,612,012
                    shares.
 (5)
                Includes
                    sole dispositive and voting power of 119,503 shares and shared
                    voting and
                    dispositive power of 1,421,735
                    shares.
 (6)
                Includes
                    shared dispositive and voting power of 1,260,678
                    shares.
 (7)
                Includes
                    446,639 warrants and options exercisable within 60 days of December
                    31,
                    2007.
 (8)
                    Includes
                        157,433 warrants and options exercisable within 60 days of
                        December 31,
                        2007.
 (9)
                    Includes
                        157,757 warrants and options exercisable within 60 days of
                        December 31,
                        2007.
 (10)
                Includes
                    279,313 warrants and options exercisable within 60 days of December
                    31,
                    2007.
 (11)
                    Includes
                        60,989 warrants and options exercisable within 60 days of
                        December 31,
                        2007.
  29




The
      mailing address for the officers and directors is c/o Aura Systems, Inc., 2330
      Utah Avenue, El Segundo, CA 90245.




**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**




During
      fiscal 2005 we entered into a number of agreements with persons who were
      directors, officers or beneficial owners of more than 5% of any class of our
      voting securities. These agreements related to financing transactions, including
      the 2004 Recapitalization Transactions, the settlement of litigation, and the
      proposed sale and leaseback of our headquarters in fiscal 2005. For a discussion
      of these transactions, see “Item 7 - Liquidity and Capital
      Resources.”




**ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES**




The
      Audit
      Committee regularly reviews and determines whether specific non-audit projects
      or expenditures with our independent auditors potentially affect their
      independence. The Audit Committee’s policy is to pre-approve all audit and
      permissible non-audit services provided by our independent auditors.
      Pre-approval is generally provided by the Audit Committee for up to one year,
      as
      detailed as to the particular service or category of services to be rendered,
      as
      is generally subject to a specific budget. The Audit Committee may also
      pre-approve additional services of specific engagements on a case-by-case basis.





The
      following table sets forth the aggregate fees billed to us by Kabani & Co.
      and Singer Lewak Greenbaum and Goldstein LLP for the years ended February 28,
      2005 and 2004, respectively:





**Year
                Ended February****28,
                2005**
            
            **29,
                2004**Audit
                Fees(1)
            
            $
            82,500
            
            $
            118,000Audit-related
                fees(2)Tax
                feesAll
                other feesTotal
            
            $
            82,500
            
            $
            118,000




(1)
            
            Included
                fees for professional services rendered for the audit of our annual
                financial statements and review of our annual report on Form 10-K
                and for
                reviews of the financial statements included in our quarterly reports
                on
                Form 10-Q for the first three quarters of the years ended February
                28,
                2005 and 2004.(2)
            
            Includes
                fees for professional services rendered in connection with our evaluation
                of internal controls.




30




**PART
      IV**




**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**




Documents
      filed as part of this Form 10-K:




***1.     
      Financial Statements***




See
      Index
      to Consolidated Financial Statements at page F-1




***2.     
      Financial Statement Schedules***




See
      Index
      to Consolidated Financial Statements at page F-1




***3.     
      Exhibits***




See
      Exhibit Index ****




**INDEX
      TO EXHIBITS**




**Description
      of Documents**




2.1
            First
                Amended Plan of Reorganization of Aura Systems, Inc.(2)3.1
            Amended
                and Restated Certificate of Incorporation of Aura Systems, Inc..
                (1)3.2
            Amended
                and Restated Bylaws of Aura Systems, Inc. as amended to date.
                (1)10.1
            Form
                of Unsecured Creditor Warrants issued under First Amended Plan of
                Reorganization of the Company.10.2
            Form
                of Management Warrants issued under First Amended Plan of Reorganization
                of Aura Systems, Inc.10.3
            Form
                of Director Warrants issued under First Amended Plan of Reorganization
                of
                t Aura Systems, Inc.10.4
            Aura
                Systems, Inc. 2006 Stock Option Plan.10.5
            Form
                of Aura Systems, Inc. Non-Statutory Stock Option
                Agreement.10.6
            Employment
                Agreement dated January 4, 2007, by and between the Company and Melvin
                Gagerman.10.7
            Full
                Release dated as of January 31, 2006, by Aura Systems, Inc. for the
                benefit of Koyah Leverage Partners, L.P., Koyah Partners, L.P. Koyah
                Ventures LLC, Raven Partners, L.P., Koyah Microcap Partners Master
                Fund,
                L.P. and James M. Simmons.10.8
            Consolidated,
                Amended and Restated Security Agreement dated as of January 31, 2006,
                by
                Aura Systems, Inc. for the benefit of Koyah Leverage Partners, L.P.,
                Koyah
                Partners, L.P. Koyah Ventures LLC, Raven Partners, L.P., and Koyah
                Microcap Partners Master Fund, L.P.10.9
            Consolidated,
                Amended and Restated Stock Pledge Agreement dated as of January 31,
                2006,
                by Aura Systems, Inc. for the benefit of Koyah Leverage Partners,
                L.P.,
                Koyah Partners, L.P. Koyah Ventures LLC, Raven Partners, L.P., and
                Koyah
                Microcap Partners Master Fund, L.P.10.10
            Amended
                and Restated Intercreditor Agreement dated as of January 31, 2006,
                by and
                among Aura Systems, Inc., Koyah Leverage Partners, L.P., Koyah Partners,
                L.P. Koyah Ventures LLC, Raven Partners, L.P., and Koyah Microcap
                Partners
                Master Fund, L.P.10.11
            Amended
                and Restated Promissory Note dated January 31, 2006, by Aura Systems,
                Inc.
                in favor of Raven Partners, L.P.10.12
            Amended
                and Restated Promissory Note dated January 31, 2006, by Aura Systems,
                Inc.
                in favor of Koyah Ventures, LLC10.13
            Consolidated,
                Amended and Restated Promissory Note dated January 31, 2006, by Aura
                Systems, Inc. in favor of Koyah Partners, L.P.10.14
            Consolidated,
                Amended and Restated Promissory Note dated January 31, 2006, by Aura
                Systems, Inc. in favor of Koyah Microcap Partners Master Fund,
                L.P.10.15
            Consolidated,
                Amended and Restated Promissory Note dated January 31, 2006, by Aura
                Systems, Inc. in favor of Koyah Leverage Partners, L.P.10.16
            Lease
                between Aura Systems Inc., and Alliance Commercial
                Partners10.17
            Lease
                between Aura Systems Inc., and Derek Lidow as Trustee for the Lidow
                Family
                Trust and Alexander Lidow14.1
            Code
                of Ethics31.1
            CEO
                Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
                200231.2
            CFO
                Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
                200232.1
            Certification
                pursuant to 18 U.S.C. Section 1350(1)
            Incorporated
                by reference from the Company's Report on Amendment to Form 8-A filed
                with
                the SEC on January 31, 2006.(2)
            Incorporated
                by reference from the Company’s Current Report on Form 8-K filed with the
                SEC on January 20, 2006.




31




Pursuant
      to the requirements of Section 13 or 15 (d) 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.




Dated:
            March 25,
                2008By:
            /s/
                Melvin GagermanMelvin
                GagermanChief
                Executive Officer




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the date indicated.


Signatures
              
              Title
              
              Date/s/
                  Melvin Gagerman
                Melvin
                  Gagerman
              
              Chief
                  Executive Officer, Acting Chief Financial Officer Director and
                  Chairman of
                  the Board (Principal Executive Officer, Principal Financial Officer,
                  Principal Accounting Officer)
              
              March 25,
                  2008/s/
                  Arthur Schwartz
              
              Director
              
              March 25,
                  2008Arthur
                  Schwartz/s/
                  Maurice Zeitlin
              
              Director
              
              March 25,
                  2008Maurice
                  Zeitlin/s/
                  Warren Breslow
              
              Director
              
              March 25,
                  2008Warren
                  Breslow/s/Salvador
                  Diaz-Verson, Jr.
              
              Director
              
              March 25,
                  2008Salvador
                  Diaz-Verson, Jr.Director
              
              March 25,
                  2008




32




**Index
      to Consolidated Financial Statements**




Report
                of INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - Kabani & Company,
                Inc.Report
                of INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - Singer Lewak Greenbaum
                & Goldstein LLPConsolidated
                Balance Sheets - February 28, 2005 and February 29, 2004
            F-4Consolidated
                Statements of Operations - Years ended February 28, 2005, February
                29,
                2004 and February 28, 2003
            F-5Consolidated
                Statements of Stockholders' Equity - Years ended February 28, 2005,
                February 29, 2004 and February 28, 2003
            F-6Consolidated
                Statements of Cash Flows - Years ended February 28, 2005, February
                29,
                2004 and February 28, 2003
            F-7
                to F-8Notes
                to Consolidated Financial Statements
            F-9 to
                F-29Consolidated
                Financial Statement Schedule II: Valuation and Qualifying
                Accounts
            F-30
                to F-31







**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




To
      the
      Board of Directors and Stockholders




Aura
      Systems, Inc. and subsidiaries




We
      have
      audited the accompanying consolidated balance sheet of Aura Systems, Inc. (a
      Delaware corporation) and subsidiaries as of February 28, 2005, and the related
      consolidated statements of operations, stockholders' equity (deficit), and
      cash
      flows for the year ended February 28, 2005. These financial statements are
      the
      responsibility of the Company's management. Our responsibility is to express
      an
      opinion on these financial statements based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.




In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Aura Systems, Inc. and
      subsidiaries as of February 28, 2005, and the results of their operations and
      their cash flows for the year ended February 28, 2005 in conformity with
      accounting principles generally accepted in the United States of
      America.




The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 2 to the
      consolidated financial statements, the Company has generated significant losses
      from operations and defaulted on certain debt obligations. The Company filed
      for
      reorganization under Chapter 11 of the U.S. Bankruptcy Code, in the United
      States Bankruptcy Court, Central District of California, (Case Number LA
      05-24550-SB). They secured a Debtor in Possession (“DIP”) loan. They submitted a
      reorganization plan that was approved by the court and voted and approved by
      the
      DIP lenders, the secured creditors, the unsecured creditors, the shareholders
      and the new money investors. 254,127 additional shares were issued to
      shareholders to settle their claims in excess of the bankruptcy court approval.
      All of the outstanding litigation and disputes were settled during the
      bankruptcy. The real estate was sold to an unrelated third party in December
      2005 for gross proceeds of $8,750,000. After satisfaction of the mortgage
      liabilities and payment of the costs of the sale, approximately $2.9 million
      was
      due to the Company. From this amount, $1.9 million was paid to the minority
      shareholder, approximately $470,000 was used to satisfy outstanding legal bills,
      and the balance of $595,000 was received by the Company in March of 2006. All
      disputes regarding the real estate were settled. The Company emerged from the
      Chapter 11 effective January 31, 2006.




/s/
      Kabani & Company, Inc.


**Certified
      Public Accountants**




Los
      Angeles, California


May
      24,
      2007







**REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 To
        the
        Board of Directors and Stockholders
 Aura
        Systems, Inc. and subsidiaries
 
 We
        have
        audited the consolidated balance sheet of Aura Systems, Inc. (a Delaware
        corporation) and subsidiaries as of February 29, 2004, and the related
        consolidated statements of operations, stockholders’ equity (deficit), and cash
        flows for each of the two years in the period ended February 29, 2004. Our
        audits also included the financial statement schedule of Aura Systems, Inc.
        and
        subsidiaries listed in Item 15(a). These financial statements and the financial
        statement schedule are the responsibility of the Company's management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Aura Systems, Inc. and
        subsidiaries as of February 29, 2004, and the results of their operations
        and
        their cash flows for each of the two years in the period ended February 29,
        2004, in conformity with U.S. generally accepted accounting principles. Also,
        in
        our opinion, the related financial statement schedule, when considered in
        relation to the basic consolidated financial statements taken as a whole,
        presents fairly in all material respects the information set forth
        therein.
 
 The
        accompanying consolidated financial statements have been prepared assuming
        that
        the Company will continue as a going concern. The Company has generated
        significant losses from operations and defaulted on certain debt obligations.
        These factors raise substantial doubt about the Company’s ability to continue as
        a going concern. The consolidated financial statements do not include any
        adjustments that might result from the outcome of this uncertainty.
 
 SINGER
        LEWAK GREENBAUM & GOLDSTEIN LLP
 
 Los
        Angeles, California
 July
        10,
        2004







**AURA
      SYSTEMS, INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**AS
      OF FEBRUARY 28, 2005 AND 2004**




**2005**
            
            **2004****ASSETS**Current
                assetsCash
                and cash equivalents
            
            $
            61,376
            
            $
            83,200Accounts
                receivable, net of allowance for doubtful accounts of $178,134 and
                $2,188,340
            
            
            637,436
            
            
            682,302Current
                inventories
            
            
            802,003
            
            
            809,659Other
                current assets
            
            
            696,157
            
            
            259,089Total
                current assets
            
            
            2,196,972
            
            
            1,834,250Property,
                plant, and equipment, net
            
            
            6,588,996
            
            
            6,939,429Non-current
                inventories net of allowance for obsolete inventories of $4,038,047
                and
                $2,032,000
            
            
            4,519,809
            
            
            7,496,484Long-term
                investments, net
            
            
            -
            
            
            286,061Patents
                and trademarks, net
            
            
            -
            
            
            610,238Other
                assets
            
            
            -
            
            
            594,271Total
                assets
            
            $
            13,305,777
            
            $
            17,760,733**LIABILITIES
                AND STOCKHOLDERS' EQUITY (DEFICIT)**Current
                liabilitiesAccounts
                payable
            
            $
            3,322,137
            
            $
            2,778,366Current
                portion of notes payable (including $1,149,525 and $1,000,000 to
                related
                parties)
            
            
            8,730,982
            
            
            4,273,052Convertible
                notes payable
            
            
            5,686,527
            
            
            6,400,973Accrued
                expenses
            
            
            2,376,346
            
            
            2,232,229Derivative
                liability
            
            
            16,254,502
            
            
            -Deferred
                income
            
            
            164,625
            
            
            160,875Total
                current liabilities
            
            
            36,535,119
            
            
            15,845,495Notes
                payable, net of current portion
            
            
            -
            
            
            4,871,804Total
                liabilities
            
            
            36,535,119
            
            
            20,717,299Minority
                interest in consolidated subsidiary
            
            
            653,891
            
            
            657,859Commitments
                and contingencies
            
            
            -
            
            
            -Stockholders'
                deficitSeries
                A Convertible, Redeemable Preferred Stock, $0.005 par value, 1,500,000
                shares authorized, 591,110 shares issued and outstanding
            
            
            2,956
            
            
            2,956Series
                B Convertible, Preferred Stock, $0.005 par value, 1,971,273 shares
                issued
                and outstanding at February 28, 2005
            
            
            9,857
            
            
            -Common
                stock, $0.005 par value, 500,000,000 shares authorized 439,074,474
                shares
                issued and outstanding
            
            
            2,195,301
            
            
            2,154,544Committed
                common stock, 21,942,248 shares at February 28, 2005 and February
                29,
                2004
            
            
            3,102,958
            
            
            3,102,958Additional
                paid-in capital
            
            
            316,662,653
            
            
            308,182,035Accumulated
                deficit
            
            
            (345,856,958
            )
            
            (317,056,918
            )Total
                stockholders' deficit
            
            
            (23,883,233
            )
            
            (3,614,425
            )Total
                liabilities and stockholders' deficit
            
            $
            13,305,777
            
            $
            17,760,733




The
      accompanying footnotes are an integral part of these financial
      statements




F-4




**AURA
      SYSTEMS, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**FOR
      THE YEARS ENDED FEBRUARY 28, 2005, 2004 AND 2003**





2005
            
            2004
            
            2003Net
                revenues
            
            $
            2,525,431
            
            $
            1,864,325
            
            $
            1,103,770Cost
                of goods sold
            
            
            1,573,116
            
            
            934,769
            
            
            571,099Inventory
              write down
            
            
            2,088,703
            
            
            550,968
            
            
            -Gross
                profit
            
            
            (1,136,388
            )
            
            378,588
            
            
            532,671Operating
                expensesEngineering,
                research and development
            
            
            2,482,668
            
            
            2,135,061
            
            
            3,956,886Selling,
                general, and administrative
            
            
            6,886,542
            
            
            7,191,925
            
            
            7,374,961Legal
                settlements
            
            
            2,765,192
            
            
            -
            
            
            233,259Impairment
                losses on long-lived assets
            
            
            544,510
            
            
            2,000,398
            
            
            2,300,000Severance
                expense
            
            
            -
            
            
            -
            
            
            241,243Total
                operating expenses
            
            
            12,678,912
            
            
            11,327,384
            
            
            14,106,349Loss
                from operations
            
            
            (13,815,300
            )
            
            (10,948,796
            )
            
            (13,573,678
            )Other
                income (expense)Impairment
                of investments
            
            
            (286,061
            )
            
            (500,000
            )
            
            (818,019
            )Loss
                on sale of minority interest in Aura Realty
            
            
            -
            
            
            (231,000
            )
            
            (626,676
            )Gain
                on sale of investments
            
            
            -
            
            
            201,061
            
            
            -Interest
                expense
            
            
            (18,965,852
            )
            
            (2,409,732
            )
            
            (2,656,592
            )Other
                income (expense), net
            
            
            166,345
            
            
            (129,337
            )
            
            362,096Change
                in derivative liability
            
            
            4,622,235
            
            
            -
            
            
            -Total
                other expense
            
            
            (14,463,333
            )
            
            (3,069,008
            )
            
            (3,739,191
            )Net
                loss before minority interest in subsidiary and
                extraordinary item
            
            $
            (28,278,633
            )
            $
            (14,017,804
            )
            $
            (17,312,869
            )Minority
                Interest
            
            
            3,970
            
            
            365,514
            
            
            (14,018
            )Extraordinary
                item:Gain
                on extinguishment of debt, net of income taxes of $0
            
            
            -
            
            
            67,415
            
            
            1,186,014Net
                loss
            
            $
            (28,274,663
            )
            $
            (13,584,875
            )
            $
            (16,140,873
            )Preferred
                stock dividend
            
            
            525,377
            
            
            -
            
            
            -Net
                loss applicable to common stock holders
            
            $
            (28,800,040
            )
            $
            (13,584,875
            )
            $
            (16,140,873
            )Basic
                and diluted loss per shareBefore
                extraordinary item
            
            $
            (0.06
            )
            $
            (0.03
            )
            $
            (0.05
            )Extraordinary
                item
            
            
            -
            
            
            -
            
            
            0.01Total
                basic and diluted loss per share
            
            $
            (0.06
            )
            $
            (0.03
            )
            $
            (0.04
            )Weighted-average
                shares outstanding
            
            
            435,294,451
            
            
            430,923,150
            
            
            415,863,637




Weighted
      average number of dilutive shares has not been calculated since the effect
      of
      dilutive shares is anti-dilutive




The
      accompanying footnotes are an integral part of these financial
      statements




F-5




**AURA
      SYSTEMS, INC.**


**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS' EQUITY/DEFICIT**


**FOR
      THE YEARS ENDED FEBRUARY 28, 2005, 2004 AND 2003**




Preferred
                Stock Shares
            
            Preferred
                Stock Amount
            
            Common
              Stock
                Shares
            
            Common
              Stock
                Amount
            
            Committed
                Common
              Stock
            
            Additional
                Paid-In Capital
            
            Accumulated
              Deficit
            
            Total
                Stockholders' Equity (Deficit)Balance,
                February 28, 2002
            
            
            
            
            
            
            
            
            387,690,068
            
            $
            1,938,379
            
            $
            3,310,650
            
            $
            295,083,428
            
            $
            (287,679,724
            )
            $
            12,652,733Issuance
                of common stock:In
                private placements
            
            
            
            
            
            
            
            
            41,700,830
            
            
            208,504
            
            
            
            
            
            5,485,497
            
            
            
            
            
            5,694,001From
                committed stock
            
            
            
            
            
            
            
            
            923,077
            
            
            4,615
            
            
            (207,692
            )
            
            203,077
            
            
            
            
            
            -To
                satisfy liabilities
            
            
            
            
            
            
            
            
            659,175
            
            
            3,296
            
            
            
            
            
            166,444
            
            
            
            
            
            169,740Common
                stock returned
            
            
            
            
            
            
            
            
            (50,000
            )
            
            (250
            )
            
            
            
            
            (29,750
            )
            
            
            
            
            (30,000
            )Beneficial
                conversion feature on convertible notes payable
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,484,837
            
            
            
            
            
            1,484,837Issuance
                of stock options:As
                compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            53,076
            
            
            
            
            
            53,076As
                consulting expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            192,404
            
            
            
            
            
            192,404Issuance
                of warrants
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            659,321
            
            
            
            
            
            659,321Offering
                costs
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (23,063
            )
            
            
            
            
            (23,063
            )Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (16,140,873
            )
            
            (16,140,873
            )Balance,
                February 28, 2003
            
            
            
            
            
            
            
            
            430,923,150
            
            
            2,154,544
            
            
            3,102,958
            
            
            303,275,271
            
            
            (303,820,597
            )
            $
            4,712,176Warrants
                issued to debt holders
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            494,265
            
            
            
            
            
            494,265Beneficial
                conversion feature on convertible notes payable
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            827,375
            
            
            
            
            
            827,375Issuance
                of Series A Preferred StockIn
                private placements
            
            
            57,090
            
            $
            285
            
            
            
            
            
            
            
            
            
            
            
            259,215
            
            
            
            
            
            259,500For
                conversion of notes payable
            
            
            534,020
            
            
            2,671
            
            
            
            
            
            
            
            
            
            
            
            3,674,464
            
            
            
            
            
            3,677,135Prior
                period adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (348,555
            )
            
            348,555
            
            
            -Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (13,584,875
            )
            
            (13,584,875
            )Balance,
                February 29, 2004
            
            
            591,110
            
            $
            2,956
            
            
            430,923,150
            
            $
            2,154,544
            
            $
            3,102,958
            
            $
            308,182,035
            
            $
            (317,056,918
            )
            $
            (3,614,425
            )Reclassification
                of warrants to liability
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,617,403
            )
            
            
            
            
            (1,617,403
            )Penalty
                shares issued on global settlement
            
            
            
            
            
            
            
            
            8,151,324
            
            
            40,757
            
            
            
            
            
            251,515
            
            
            
            
            
            292,272Issuance
                of Series B for note conversion
            
            
            500,000
            
            
            2,500
            
            
            
            
            
            
            
            
            
            
            
            2,497,500
            
            
            
            
            
            2,500,000Issuance
                of Series B for global settlement
            
            
            91,717
            
            
            459
            
            
            
            
            
            
            
            
            
            
            
            458,124
            
            
            
            
            
            458,583Issuance
                of Series B creditors settlement
            
            
            290,311
            
            
            1,452
            
            
            
            
            
            
            
            
            
            
            
            1,450,103
            
            
            
            
            
            1,451,555Series
                B issued in private placement
            
            
            1,089,245
            
            
            5,446
            
            
            
            
            
            
            
            
            
            
            
            5,440,779
            
            
            
            
            
            5,446,225Net
                Loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (28,800,040
            )
            
            (28,800,040
            )Balance,
                February 28, 2005
            
            
            2,562,383
            
            $
            12,813
            
            
            439,074,474
            
            $
            2,195,301
            
            $
            3,102,958
            
            $
            316,662,653
            
            $
            (345,856,958
            )
            $
            (23,883,233
            )




The
      accompanying footnotes are an integral part of these financial
      statements





F-6




**AURA
      SYSTEMS, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**FOR
      THE YEARS ENDED FEBRUARY 28, 2005, 2004 AND 2003**




2005
            
            2004
            
            2003Cash
                flows from operating activitiesNet
                loss
            
            $
            (28,800,040
            )
            $
            (13,584,876
            )
            $
            (16,140,873
            )Adjustments
                to reconcile net loss to net cash used in operating
                activitiesDepreciation
                and amortization
            
            
            416,161
            
            
            571,734
            
            
            966,852(Gain)
                loss on disposition of assets
            
            
            -
            
            
            (201,061
            )
            
            21,348Loss
                on sale of minority interest Aura Realty
            
            
            -
            
            
            231,000
            
            
            626,676Change
                in allowance for doubtful accounts
            
            
            32,134
            
            
            -
            
            
            94,310Reserve
                for Note Receivable
            
            
            -
            
            
            2,042,340
            
            
            -Change
                in reserve for inventory obsolescence
            
            
            2,088,703
            
            
            550,968
            
            
            (117,411
            )Impairment
                of long-lived assets and investments
            
            
            830,571
            
            
            2,500,397
            
            
            3,118,019Gain
                on extinguishment of debt
            
            
            (17,221
            )
            
            (65,594
            )
            
            (1,186,014
            )Minority
                interest in net income of consolidated subsidiary
            
            
            (3,970
            )
            
            (365,514
            )
            
            14,018Stock
                options issued as compensation expense
            
            
            -
            
            
            -
            
            
            53,075Stock
                options issued as consulting expense
            
            
            -
            
            
            -
            
            
            192,404Change
                in derivative liability
            
            
            (4,622,235
            )
            
            -
            
            
            -Beneficial
                conversion feature on convertible debt
            
            
            19,259,334
            
            
            1,090,639
            
            
            1,484,837Operating
                expenses satisfied with stock
            
            
            750,855
            
            
            -
            
            
            169,740(Increase)
                decrease inAccounts
                receivable
            
            
            12,732
            
            
            (271,585
            )
            
            (437,534
            )Inventories
            
            
            895,628
            
            
            130,614
            
            
            636,110Other
                current assets
            
            
            (437,068
            )
            
            (92,500
            )
            
            62,169Other
                assets
            
            
            594,271
            
            
            131,364
            
            
            (562,265
            )Increase
                (decrease) inAccounts
                payable and accrued expenses, net of effect of settlements and sale
                of
                minority interest in Aura Realty
            
            
            2,156,666
            
            
            609,437
            
            
            1,063,477Deferred
                income
            
            
            3,750
            
            
            375
            
            
            160,500Net
                cash used in operating activities
            
            
            (6,839,729
            )
            
            (6,722,272
            )
            
            (9,780,562
            )Cash
                flows from investing activitiesPayments
                received on notes receivable
            
            
            -
            
            
            174,053
            
            
            181,725Purchase
                of property, plant, and equipment
            
            
            -
            
            
            (24,684
            )
            
            (6,491
            )Proceeds
                from disposal of property, plant, and equipment
            
            
            -
            
            
            -
            
            
            57,591Proceeds
                from sale of investments
            
            
            -
            
            
            415,000
            
            
            -Proceeds
                from sale of minority interest in Aura Realty
            
            
            -
            
            
            -
            
            
            1,463,000Net
                cash provided by investing activities
            
            
            -
            
            
            564,369
            
            
            1,695,825


F-7




**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**




2005
            
            2004
            
            2003Cash
                flows from financing activitiesProceeds
                from notes payable and convertible notes payable
            
            
            2,150,000
            
            $
            6,366,080
            
            $
            2,510,746Payments
                on notes payable
            
            
            (778,320
            )
            
            (548,170
            )
            
            (1,046,650
            )Net
                proceeds from issuance of preferred stock
            
            
            5,446,225
            
            
            259,500
            
            
            -Net
                proceeds from issuance of common stock
            
            
            -
            
            
            -
            
            
            5,640,938Net
                cash provided by financing activities
            
            
            6,817,905
            
            
            6,077,410
            
            
            7,105,034Net
                decrease in cash and cash equivalents
            
            
            (21,824
            )
            
            (80,493
            )
            
            (979,703
            )Cash
                and cash equivalents, beginning of year
            
            
            83,200
            
            
            163,693
            
            
            1,143,396Cash
                and cash equivalents, end of year
            
            $
            61,376
            
            $
            83,200
            
            $
            163,693Supplemental
                disclosures of cash flow informationInterest
                paid
            
            $
            -
            
            $
            324,872
            
            $
            621,047Income
                taxes paid
            
            $
            -
            
            $
            -
            
            $
            -




Supplemental
      schedule of non-cash financing and investing activities:




During
      the year ended February 28, 2005, we:




-
            issued
                290,311 shares of Series B convertible preferred stock in satisfaction
                of
                $1,451,555 in liabilities




-
            issued
                500,000 shares of Series B convertible preferred stock upon conversion
                of
                $2,500,000 of notes payable




During
      the year ended February 29, 2004, we:




-
            issued
                $125,811 of convertible notes payable in satisfaction of $125,811
                in
                contractual obligations arising from the sale of the convertible
                notes
                payable.




During
      the year ended February 28, 2003, we:




-
            issued
                659,175 shares of common stock in satisfaction of $169,740 in liabilities
                and contractual obligations.




-
            issued
                923,077 shares of common stock that were committed at February 28,
                2002
                valued at $207,692.




F-8




**AURA
      SYSTEMS, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**FEBRUARY
      28, 2005**




**NOTE
      1 - ORGANIZATION AND OPERATIONS**




**General**




Aura
      Systems, Inc., ("Aura" or the "Company") a Delaware corporation, was founded
      to
      engage in the development, commercialization, and sales of products, systems,
      and components, using its patented and proprietary electromagnetic and
      electro-optical technology. Aura develops and sells AuraGen ® mobile
      induction power systems to the industrial, commercial, and defense mobile power
      generation markets. In addition, we hold patents for other technologies that
      have not been commercially exploited.




**Recapitalization**




The
      2004
      Recapitalization Transactions




In
      September 2004, we entered into agreements with a group of investors and holders
      of secured debt in order to recapitalize the company. These agreements are
      referred to as the "2004 Recapitalization Transactions" or “2004
      Recapitalization” and are described in more detail below under "Liquidity and
      Capital Resources - The 2004 Recapitalization Transactions". Completion of
      the
      2004 Recapitalization Transactions was intended to provide us with a more stable
      financial condition by infusing new capital of up to $15million through the
      sale
      of units comprising Series B Preferred Stock and common stock warrants,
      conversion of $3.5 million of secured debt into Series B Preferred Stock and
      warrants and extension of the maturity of the remaining $2.1 million of secured
      debt to August 2005, and the settlement of legal claims with former management.
      However, we continued to require further financing to remain solvent.
      Accordingly, subsequent to the end of fiscal 2005, in June 2005 we filed for
      protection under Chapter 11 of the U.S. Bankruptcy Code, and emerged on January
      31, 2006 under a plan of reorganization.




**NOTE
      2 - GOING CONCERN**




Our
      accompanying consolidated financial statements have been prepared on the basis
      that we are 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 and default on certain of our obligations
      (see Note 9), there is substantial doubt about our ability to continue as a
      going concern.




Our
      long-term 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 financing sources to meet our obligations.
      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 consolidation and
      reduction of the scope of our operations has resulted in reductions in the
      value
      of our assets.




On
      June
      24, 2005 we filed for reorganization under Chapter 11 of the U.S. Bankruptcy
      Code, in the United States Bankruptcy Court, Central District of California,
      (Case Number LA 05-24550-SB). We secured a Debtor in Possession (“DIP”) loan
      from Blue Collar Films LLC (“BCF”) for one million dollars and secured an
      additional $1.2 million DIP loan from AGP Lender LLC. In addition a group of
      individual investors provided an additional $1.16 million in DIP financing.
      We
      submitted a reorganization plan that was approved by the court and voted and
      approved by the DIP lenders, the secured creditors, the unsecured creditors,
      the
      shareholders and the new money investors. Under the reorganization plan (i)
      the
      secured creditor retained $2.5 million in a secured note payable over 48 months
      at 7% annual interest with the first payment starting 12 months after the
      reorganization, (ii) the Series B Preferred Stock holders received new common
      shares calculated by dividing the total cash invested in the Series B Placement
      by $3.37, (iii) the Series A Preferred Stock holders converted their 1.8 Series
      A Preferred Stock for one new common share, (iv) the common shareholders
      converted 338 of their shares for one new share, and (v) the DIP loans converted
      their loans into approximately 6.07 million new shares of common stock, and
      (vi)
      all the unsecured creditors received new shares of common stock valued at one
      share per $1.75 in claim. An additional 5.89 million shares of common stock
      were
      issued for the new money and reorganization related fees.254,127 additional
      shares were issued to shareholders to settle their claims in excess of the
      bankruptcy court approval.




F-9




All
      of
      the outstanding litigation and disputes were settled during the bankruptcy.
      The
      real estate was sold to an unrelated third party in December 2005 for gross
      proceeds of $8,750,000. After satisfaction of the mortgage liabilities and
      payment of the costs of the sale, approximately $2.9 million was due us. From
      this amount, $1.9 million was paid to the minority shareholder, approximately
      $470,000 was used to satisfy outstanding legal bills, and the balance of
      $595,000 was received by the Company in March of 2006. All disputes regarding
      the real estate were settled.




We
      emerged from the Chapter 11 effective January 31, 2006.




**NOTE
      3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**




**Principles
      of Consolidation**




The
      consolidated financial statements include the accounts of Aura and subsidiary,
      Aura Realty, Inc. (see Note 4). 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.




**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 collectibility 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.




**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.




**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. We maintain our cash deposits at multiple banks located in
      California. Deposits at each bank are insured by the Federal Deposit Insurance
      Corporation up to $100,000. As of February 28, 2005 and February 29, 2004,
      there
      were no uninsured portions of the balances. We have not experienced any losses
      in such accounts and believe we are not exposed to any significant risk on
      cash
      and cash equivalents.




F-10




**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. During the year ended February 28,
      2005, the Company provided an additional allowance of $32,134 on the doubtful
      debts. The Company also wrote off the Ceramic Note receivable of $2,042,340
      against the allowance created on the note in prior years. (See Note
      6)




**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. As of February 28, 2005 and
      February 29, 2004, $4,519,809, and $7,496,484, respectively, of inventories
      have
      been classified as long-term assets. See Note 5.




**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:




Buildings
            40
                yearsMachinery
                and equipment
            5
                to 10 yearsFurniture
                and fixtures
            7
                years




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.




**Long-Term
      Investments**




We
      account for all investments where we hold less than a 20% voting interest,
      cannot exercise significant influence, and where the fair market value of those
      securities is not readily determinable under the cost basis. Investments in
      voting interests between 20% and 50% where we can exercise significant influence
      are accounted for under the equity method of accounting, and investments greater
      than 50% are generally consolidated for the purposes of financial reporting.
      As
      we do not hold a sufficient interest in our investments to exercise significant
      influence, and the fair market value of the investments are not readily
      determinable, long-term investments have been accounted for under the cost
      method. A decline in the value of any investment below cost that is deemed
      other
      than temporary is charged to earnings. As of February 28, 2005, the Company
      had
      investments in the stocks of another company. These certificates were lost
      and
      the Company wrote off the investments of $286,061 as of February 28, 2005.




**Patents
      and Trademarks**




We
      capitalize the costs of obtaining or acquiring patents and trademarks.
      Amortization of patent and trademark costs is provided for by the straight-line
      method over the shorter of the legal or estimated economic life. Amortization
      expense was $65,728, $187,028, and $308,329 for the years ended February 28,
      2005, February 29, 2004 and February 28, 2003, respectively. Accumulated
      amortization was $1,228,061 and $694,295 as of February 28, 2005 and February
      29, 2004, respectively. If a patent or trademark is rejected, abandoned, or
      otherwise invalidated, the unamortized cost is expensed in that period. During
      fiscal 2004, we recorded a $2,000,398 long-lived asset impairment charge
      resulting from the write off of some of our patents and trademarks. We
      reevaluated our intentions with regard to our patents and trademarks related
      to
      products outside our core business and wrote-off the carrying value of patents
      not related to products in production. During fiscal 2005, due to continued
      low
      sales volume, we recorded an asset impairment charge of $544,510 against the
      book value of our patents.




F-11




**Valuation
      of Long-Lived Assets**




We
      review
      long-lived assets and identifiable intangibles in accordance with SFAS No.
      144,
      "Accounting for the Impairment or Disposal of Long-Lived Assets," on at least
      an
      annual basis or whenever events or circumstances indicate that the carrying
      amount of such assets may not be fully recoverable. During the years ended
      February 28, 2005 and February 28, 2004, we recorded asset impairment charges
      on
      certain of our long-lived assets (see Note 8).




**Stock-Based
      Compensation**




SFAS
      No.
      123, "Accounting for Stock-Based Compensation," establishes and encourages
      the
      use of the fair value based method of accounting for stock-based compensation
      arrangements under which compensation cost is determined using the fair value
      of
      stock-based compensation determined as of the date of grant and is recognized
      over the periods in which the related services are rendered. The statement
      also
      permits companies to elect to continue using the current implicit value
      accounting method specified in Accounting Principles Board ("APB") Opinion
      No.
      25, "Accounting for Stock Issued to Employees," to account for stock-based
      compensation. We have elected to use the implicit value based method and to
      disclose the pro forma effect of using the fair value based method to account
      for its stock-based compensation.




If
      we had
      elected to recognize compensation expense based upon the fair value at the
      grant
      date for awards under this plan consistent with the methodology prescribed
      by
      SFAS No. 123, our net loss and loss per share would be reduced to the pro forma
      amounts indicated below for the years ended February 28, 2005 and February
      29,
      2004 and February 28, 2003:




2005
            
            2004
            
            2003Net
                loss, As reported
            
            $
            (28,800,040
            )
            $
            (13,584,875
            )
            $
            (16,140,873
            )Intrinsic
                value expense
            
            
            -
            
            
            -
            
            
            53,076Stock-based
                employee compensation expense determined under fair value presentation
                for
                all options
            
            
            -
            
            
            (1,965,275
            )
            
            (2,224,102
            )Pro
                forma net loss
            
            $
            (28,800,040
            )
            $
            (15,550,150
            )
            $
            (18,311,899
            )Basic
                loss per common share:As
                reported
            
            $
            (0.06
            )
            $
            (0.03
            )
            $
            (0.04
            )Pro
                forma
            
            $
            (0.06
            )
            $
            (0.04
            )
            $
            (0.04
            )




For
      purposes of computing the pro forma disclosures required by SFAS No. 123, the
      fair value of each option granted to employees and directors is estimated using
      the Black-Scholes option-pricing model with the following weighted-average
      assumptions for the years ended February 29, 2004 and February 28, 2003:
      dividend yields of 0%, 0%, and 0%, respectively; expected volatility of 98%
      and
      70%, respectively; risk-free interest rates of 2.3% and 4.9%, respectively;
      and
      expected lives of 2.0 and 2.14 years, respectively. There were no options
      granted during the year ended February 28, 2005.




The
      weighted-average fair value of options granted in fiscal 2004 was $0.040, and
      the weighted-average exercise price was $0.065.




The
      Black-Scholes option valuation model was developed for use in estimating the
      fair value of traded options which do not have vesting restrictions and are
      fully transferable. In addition, option valuation models require the input
      of
      highly subjective assumptions, including the expected stock price volatility.
      Because our employee stock options have characteristics significantly different
      from those of traded options, and because changes in the subjective input
      assumptions can materially affect the fair value estimate, in management's
      opinion, the existing models do not necessarily provide a reliable single
      measure of the fair value of its employee stock options.




F-12




**Fair
      Value of Financial Instruments**




Our
      financial instruments include cash and cash equivalents, accounts receivable,
      and notes receivable, long-term investments, accounts payable, and accrued
      expenses. The carrying amounts of these instruments approximate their fair
      value
      due to their short maturities.




**Minority
      Interest**




Minority
      interest represents the proportionate share of the equity of the consolidated
      subsidiary owned by our minority stockholders in that subsidiary **.**




**Advertising
      Expense**




Advertising
      costs are charged to expense as incurred and were immaterial for the years
      ended
      February 28, 2005, February 29, 2004 and February 28, 2003.




**Research
      and Development**




Research
      and development costs are expensed as incurred. These costs include the expenses
      incurred in the development of the 200amp ECU, the Tamgen (dual generator),
      and
      the eight inch generator.




**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.




We
      have
      significant income tax net operating losses; however, due to the uncertainty
      of
      the realizability of the related deferred tax asset, a reserve equal to the
      amount of deferred income taxes has been established at February 28, 2005 and
      February 29, 2004.




**Loss
      per Share**




The
      consolidated net loss per common share is based on the weighted-average number
      of common shares outstanding during the year. Common share equivalents have
      been
      excluded since inclusion would dilute the reported loss per share.




**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.




F-13




**Major
      Customers**




During
      the year ended February 28, 2005, we conducted business with four customers
      whose sales comprised 44% of net sales. As of February 28, 2005, these four
      (4)
      customers accounted for $139,117, or 22% of net accounts receivable.




**Recently
      Issued Accounting Pronouncements**




In
      November 2004, the FASB issued SFAS No. 151, entitled Inventory Costs - An
      Amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB
      No.
      43, Chapter 4, entitled Inventory Pricing [June 1953], to clarify the accounting
      for "abnormal amounts" of idle facility expense, freight, handling costs, and
      wasted material [spoilage]. Before revision by SFAS No. 151, the guidance that
      existed in ARB No. 43 stipulated that these type items may be "so abnormal"
      that
      the appropriate accounting treatment would be to expense these costs as incurred
      [i.e., these costs would be current-period charges]. SFAS No. 151 requires
      that
      these type items be recognized as current-period charges without regard to
      whether the "so abnormal" criterion has been met. Additionally, SFAS No. 151
      requires that allocation of fixed production overheads to the costs of
      conversion be based on the normal capacity of the production facilities. The
      adoption of SFAS 151 did not impact the consolidated financial
      statements.





In
      December 2004, the FASB issued SFAS No. 152, entitled Accounting for Real Estate
      Time-Sharing Transactions -- An Amendment of FASB Statements No. 66 and 67.
      SFAS
      No. 152 amends SFAS No. 66 to reference the financial accounting and reporting
      guidance for real estate time-sharing transactions that is provided in AICPA
      Statement of Position 04-2. SFAS No. 152 also amends SFAS No. 67 to state that
      the guidance for (a) incidental operations and (b) costs incurred to sell real
      estate projects does not apply to real estate time-sharing transactions. The
      accounting for those operations and costs is subject to the guidance of SOP
      04-2. This statement is effective for financial statements for fiscal years
      beginning after June 15, 2005. The adoption of SFAS 152 did not impact the
      consolidated financial statements.





In
      December 2004, the FASB issued SFAS No. 153, entitled Exchanges of Nonmonetary
      Assets -- An Amendment of APB Opinion No.29. SFAS No. 153 amends Opinion 29
      to
      eliminate the exception for nonmonetary exchanges of nonmonetary assets that
      do
      not have commercial substance. A nonmonetary exchange has commercial substance
      if the future cash flows of the entity are expected to change significantly
      as a
      result of the exchange. The adoption of SFAS 153 did not impact the consolidated
      financial statements.





In
      December 2004, the FASB issued SFAS No. 123 (Revised), entitled Share-Based
      Payment. This revised Statement eliminates the alternative to use APB Opinion
      No. 25's intrinsic value method of accounting that was provided in SFAS No.
      123
      as originally issued. Under Opinion 25, issuing stock options to employees
      generally resulted in recognition of no compensation cost. This Statement
      requires entities to recognize the cost of employee services received in
      exchange for awards of equity instruments based on the grant-date fair value
      of
      those awards. For public companies that file as a small business issuer, this
      Statement is effective as of the beginning of the first interim or annual
      reporting period that begins after December 15, 2005. The adoption of SFAS
      123
      (Revised) will not impact the consolidated financial statements as the Company
      has not granted any equity instruments to employees.





In
      May
      2005, the FASB issued SFAS No. 154, entitled Accounting Changes and Error
      Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3.
      This
      Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement
      No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes
      the requirements for the accounting for and reporting of a change in accounting
      principle. This Statement applies to all voluntary changes in accounting
      principle. It also applies to changes required by an accounting pronouncement
      in


the
      unusual instance that the pronouncement does not include specific transition
      provisions. Opinion 20 previously required that most voluntary changes in
      accounting principle be recognized by including in net income of the period
      of
      the change the cumulative effect of changing to the new accounting principle.
      This Statement requires retrospective application to prior periods' financial
      statements of changes in accounting principle, unless it is impracticable to
      determine either the period-specific effects or the cumulative effect of the
      change. This Statement defines retrospective application as the application
      of a
      different accounting principle to prior accounting periods as if that principle
      had always been used or as the adjustment of previously issued financial
      statements to reflect a change in the reporting entity. This Statement also
      redefines restatement as the revising of previously issued financial statements
      to reflect the correction of an error. The adoption of SFAS 154 did not impact
      the consolidated financial statements.




F-14





In
      February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid
      Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for
      Derivative Instruments and Hedging Activities", and SFAF No. 140, "Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities".  SFAS No. 155, permits fair value remeasurement for any
      hybrid financial instrument that contains an embedded derivative that otherwise
      would require bifurcation, clarifies which interest-only strips and
      principal-only strips are not subject to the requirements of SFAS No. 133,
      establishes a requirement to evaluate interest in securitized financial assets
      to identify interests that are freestanding derivatives or that are hybrid
      financial instruments that contain an embedded derivative requiring bifurcation,
      clarifies that concentrations of credit risk in the form of subordination are
      not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition
      on the qualifying special-purpose entity from holding a derivative financial
      instrument that pertains to a beneficial interest other than another derivative
      financial instrument.  This statement is effective for all financial
      instruments acquired or issued after the beginning of the Company's first fiscal
      year that begins after September 15, 2006.  The Company has not evaluated
      the impact of this pronouncement in its financial statements.





In
      March
      2006 FASB issued SFAS 156 'Accounting for Servicing of Financial Assets' this
      Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing
      of Financial Assets and Extinguishments of Liabilities, with respect to the
      accounting for separately recognized servicing assets and servicing liabilities.
      This Statement:




1.
      Requires an entity to recognize a servicing asset or servicing liability each
      time it undertakes an obligation to service a financial asset by entering into
      a
      servicing contract.




2.
      Requires all separately recognized servicing assets and servicing liabilities
      to
      be initially measured at fair value, if practicable.




3.
      Permits an entity to choose 'Amortization method' or 'Fair value measurement
      method' for each class of separately recognized servicing assets and servicing
      liabilities.




4.
      At its
      initial adoption, permits a one-time reclassification of available-for-sale
      securities to trading securities by entities with recognized servicing rights,
      without calling into question the treatment of other available-for-sale
      securities under Statement 115, provided that the available-for-sale securities
      are identified in some manner as offsetting the entity's exposure to changes
      in
      fair value of servicing assets or servicing liabilities that a servicer elects
      to subsequently measure at fair value.




5.
      Requires separate presentation of servicing assets and servicing liabilities
      subsequently measured at fair value in the statement of financial position
      and
      additional disclosures for all separately recognized servicing assets and
      servicing liabilities.




This
      Statement is effective as of the beginning of the Company's first fiscal year
      that begins after September 15, 2006. Management believes that this statement
      will not have a significant impact on the consolidated financial
      statements.





In
      September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
      defines fair value, establishes a framework for measuring fair value in
      generally accepted accounting principles (GAAP), and expands disclosures about
      fair value measurements. This Statement applies under other accounting
      pronouncements that require or permit fair value measurements, the Board having
      previously concluded in those accounting pronouncements that fair value is
      the
      relevant measurement attribute. Accordingly, this Statement does not require
      any
      new fair value measurements. However, for some entities, the application of
      this
      Statement will change current practice. This Statement is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years. The management is currently
      evaluating the effect of this pronouncement on financial
      statements.





In
      July 2006, the Financial Accounting Standards Board ("FASB") issued FASB
      Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an
      Interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 seeks to reduce
      the diversity in practice associated with certain aspects of measuring and
      recognition in accounting for income taxes. In addition, FIN 48 requires
      expanded disclosure with respect to the uncertainty in income taxes and is
      effective as of the beginning of the 2008 fiscal year. Management is currently
      evaluating the effect of this pronouncement on financial
      statements.




F-15




In
      September 2006, FASB issued SFAS No. 158 “Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements
      No. 87, 88, 106, and 132(R)”. This Statement improves financial reporting by
      requiring an employer to recognize the over funded or under funded status of
      a
      defined benefit postretirement plan (other than a multiemployer plan) as an
      asset or liability in its statement of financial position and to recognize
      changes in that funded status in the year in which the changes occur through
      comprehensive income of a business entity or changes in unrestricted net assets
      of a not-for-profit organization. This Statement also improves financial
      reporting by requiring an employer to measure the funded status of a plan as
      of
      the date of its year-end statement of financial position, with limited
      exceptions. An employer with publicly traded equity securities is required
      to
      initially recognize the funded status of a defined benefit postretirement plan
      and to provide the required disclosures as of the end of the fiscal year ending
      after December 15, 2006. An employer without publicly traded equity securities
      is required to recognize the funded status of a defined benefit postretirement
      plan and to provide the required disclosures as of the end of the fiscal year
      ending after June 15, 2007. However, an employer without publicly traded equity
      securities is required to disclose the following information in the notes to
      financial statements for a fiscal year ending after December 15, 2006, but
      before June 16, 2007, unless it has applied the recognition provisions of this
      Statement in preparing those financial statements:




·
            A
                brief description of the provisions of this Statement




·
            The
                date that adoption is required




·
            The
                date the employer plans to adopt the recognition provisions of this
                Statement, if earlier.




The
      requirement to measure plan assets and benefit obligations as of the date of
      the
      employer’s fiscal year-end statement of financial position is effective for
      fiscal years ending after December 15, 2008. Management is currently evaluating
      the effect of this pronouncement on financial statements.




In
      February 2007, FASB issued FASB Statement No. 159, The Fair Value Option for
      Financial Assets and Financial Liabilities. FAS 159 is effective for fiscal
      years beginning after November 15, 2007. Early adoption is permitted subject
      to
      specific requirements outlined in the new Statement. Therefore, calendar-year
      companies may be able to adopt FAS 159 for their first quarter 2007 financial
      statements.




The
      new
      Statement allows entities to choose, at specified election dates, to measure
      eligible financial assets and liabilities at fair value that are not otherwise
      required to be measured at fair value. If a company elects the fair value option
      for an eligible item, changes in that item's fair value in subsequent reporting
      periods must be recognized in current earnings. FAS 159 also establishes
      presentation and disclosure requirements designed to draw comparison between
      entities that elect different measurement attributes for similar assets and
      liabilities. Management is currently evaluating the effect of this pronouncement
      on financial statements.





In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
      Consolidated Financial Statements”. This Statement amends ARB 51 to establish
      accounting and reporting standards for the noncontrolling (minority) interest
      in
      a subsidiary and for the deconsolidation of a subsidiary. It clarifies that
      a
      noncontrolling interest in a subsidiary is an ownership interest in the
      consolidated entity that should be reported as equity in the consolidated
      financial statements. SFAS No. 160 is effective for the Company’s fiscal year
      beginning October 1, 2009. Management is currently evaluating the effect of
      this
      pronouncement on financial statements.





In
      December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”. This
      Statement replaces SFAS No. 141, Business Combinations. This Statement retains
      the fundamental requirements in Statement 141 that the acquisition method of
      accounting (which Statement 141 called the purchase method) be used for all
      business combinations and for an acquirer to be identified for each business
      combination. This Statement also establishes principles and requirements for
      how
      the acquirer: a) recognizes and measures in its financial statements the
      identifiable assets acquired, the liabilities assumed, and any noncontrolling
      interest in the acquiree; b) recognizes and measures the goodwill acquired
      in
      the business combination or a gain from a bargain purchase and c) determines
      what information to disclose to enable users of the financial statements to
      evaluate the nature and financial effects of the business combination. SFAS
      No.
      141(R) will apply prospectively to business combinations for which the
      acquisition date is on or after Company’s fiscal year beginning October 1, 2009.
      While the Company has not yet evaluated this statement for the impact, if any,
      that SFAS No. 141(R) will have on its consolidated financial statements, the
      Company will be required to expense costs related to any acquisitions after
      September 30, 2009.




F-16




**NOTE
      4 - SALE OF AURA REALTY**




On
      December 1, 2002, we consummated the initial closing under an Agreement for
      Sale
      and Leaseback, (together with the agreements contemplated thereby, the
      "Agreement") with a group of individuals (the "Purchasers") pursuant to which
      we
      sold our Aura Realty, Inc. ("Aura Realty") subsidiary to the Purchasers and
      entered into a new 10-year lease of the properties owned by Aura Realty (the
      "Lease").




The
      Agreement provided for the $7,350,000 purchase price for the Aura Realty stock,
      arrived at in arm's length negotiations, to be partially funded by Purchasers'
      assumption or refinancing of the current mortgage note secured by the
      properties. Net of the principal balance of this mortgage note of approximately
      $5,083,000, certain security deposits and prepayments totaling $564,000, the
      partial payment of past due amounts owed to certain of the individual
      purchasers, as described below, of approximately $135,000, and Purchasers'
      fees
      of $105,000, we received approximately $1,463,000. $878,750 of this amount
      was
      advanced to us by the Purchasers prior to the December 1, 2002 closing under
      the
      Agreement.




At
      the
      December 1, 2002 closing under the Agreement, we transferred 49.9% of our stock
      in Aura Realty to the Purchasers, delivered a $1,000,000 note payable to the
      Purchasers (the "Aura Note"), and granted the Purchasers a security interest
      in
      the Ceramic Note (see Note 6) to secure certain aspects of its performance
      under
      the Agreement and the Lease.




In
      connection with the sale, the Purchasers also received warrants to purchase
      15,000,000 shares of our common stock within five years from December 1, 2002
      at
      exercise prices ranging from $0.15 to $0.25 per share. The value of the warrants
      was calculated at $659,321 using the Black-Scholes method of valuation. In
      addition, the Purchasers subscribed to purchase 21,366,347 shares of our common
      stock for approximately $1. We were required to issue 8,151,324 additional
      shares of common stock, which have been issued in fiscal 2005, and issued,
      in
      fiscal 2004, warrants to purchase 5,500,000 shares of common stock to the
      Purchasers because of our failure to register the shares for resale (see Note
      12). The additional warrants were valued at $231,000 using the Black-Scholes
      pricing model and have been recorded, in fiscal 2004, as an additional loss
      on
      the sale of the minority interest in Aura Realty.




Of
      the 16
      Purchasers, five were members of our former management, who separated at the
      end
      of February 2002 (the "Former Management"). We paid a fee of $50,000 to a member
      of the Former Management in connection with the Agreement. We also paid to
      the
      Former Management approximately $135,000 from the funds it received at closing,
      representing a portion of unpaid severance contractually due at December 1,
      2002
      per the Former Management's separation agreements (see Note 15).




The
      assets and liabilities of Aura Realty at February 28, 2005 and February 29,
      2004
      consisted of the following:




2005
            
            2004Current
                assets
            
            $
            176,010
            
            $
            21,673Property
                and equipment, net
            
            
            6,452,474
            
            
            6,672,583Other
                assets
            
            
            754,713
            
            
            108,165Total
                assets
            
            $
            7,383,197
            
            $
            6,802,421Total
                liabilities
            
            $
            5,133,103
            
            $
            5,473,973Total
                equity
            
            $
            2,250,094
            
            $
            1,328,448




F-17




The
      loss
      on the sale of a minority interest in the Aura Realty subsidiary recorded in
      fiscal 2003 is calculated as follows:




Net
                cash received
            
            $
            1,463,000Deposits
                held back by the Purchasers
            
            
            564,000Fees
            
            
            105,000Less
                execution of note payable
            
            
            (1,000,000
            )Total
                sale price
            
            
            1,132,000Value
                of warrants issued
            
            
            (659,321
            )Net
                book value of minority interest in Aura Realty at date of sale
            
            
            (1,099,355
            )Loss
                on sale of minority interest in Aura Realty
            
            $
            (626,676
            )




In
      June
      2003, the mortgage note holder had not consented to the transaction, and Aura
      failed to make certain payments to the Purchasers as required under the
      Agreement. At that time, we entered into a forbearance agreement with the
      Purchasers which requires us to:




1.
      Use
      our best efforts to affect a registration of all warrants previously issued
      to
      the Purchasers per the Agreement;




2.
      Execute and deliver an assignment of its interest in the Alpha Ceramic Note
      (see
      Note 6) to the Purchasers;




3.
      Enter
      into an exclusive listing agreement for the sale of it real estate property;
      and




4.
      Take
      necessary action to stop the pending foreclosure and arrange for payment of
      any
      arrearages under the mortgage.




In
      June
      2004, we paid the remaining arrearages under the mortgage note, which cured
      the
      defaults and halted the foreclosure proceedings. The Aura Note became due and
      payable per its terms on May 31, 2004. As of July 31, 2004, we had not paid
      the
      Aura Note and the Purchasers had not presented a formal demand for payment
      /
      notice of default. In conjunction with the 2004 Recapitalization Agreements,
      we
      were in negotiations with the Purchasers to approve a sale of the buildings
      to
      different purchasers, which would, among other things, terminate our obligations
      under the Agreement including payment of the Aura Note (see Note 18). There
      can
      be no guarantee that we and the Purchasers will reach an agreement, in which
      case, our obligations under the Agreement and the Aura Note would
      continue.




In
      December, 2005, we sold the buildings owned by Aura Realty to an unrelated
      third
      party for total consideration of $8,750,000. In conjunction with the sale,
      all
      outstanding claims related to the buildings were settled. After satisfying
      the
      mortgage liability, including late fees and penalties, with the lender, there
      were net proceeds of $2,898,657 due to us from the sale. Of this amount,
      $1,900,000 was used to settle claims with the minority shareholders, $595,000
      was received by us in March of 2006, and the balance was used to pay legal
      fees
      and miscellaneous expenses associated with the sale, pursuant to the Court
      order
      approving the settlement and mutual release agreement.




**NOTE
      5 - INVENTORIES**




Inventories
      at February 28, 2005 and February 29, 2004 consisted of the
      following:




2005
            
            2004Raw
                materials
            
            $
            3,720,204
            
            $
            4,004,785Finished
                goods
            
            
            5,639,655
            
            
            6,333,3589,359,859
            
            
            10,338,143Reserve
                for potential product obsolescence
            
            
            (4,038,047
            )
            
            (2,032,000
            )5,321,812
            
            
            8,306,143Non-current
                portion
            
            
            4,519,809
            
            
            7,496,484Current
                portion
            
            $
            802,003
            
            $
            809,659




F-18




Inventories
      consist primarily of components and completed units for the Company's
      AuraGen ® product.




Early
      in
      its AuraGen ® program,
      we determined it was most cost-effective to outsource production of components
      and subassemblies to volume-oriented manufacturers, rather than produce these
      parts in house. As a result of this decision, and based on then anticipated
      sales, we purchased, prior to fiscal 2001, a substantial inventory of components
      at volume prices, most of which was then assembled into finished
      AuraGen ® units.
      Since sales did not meet such expectations, we have been selling product from
      this inventory for several years. Management has analyzed its inventories based
      on its current business plan, current orders for future delivery, and pending
      proposals with prospective customers and has determined we do not expect to
      realize all of its inventories within the next year. The net inventories as
      of
      February 28, 2005 and February 29, 2004, which are not expected to be realized
      within a 12-month period, have been reclassified as long term.




We
      assessed the net realizability of these assets, and the potential obsolescence
      of inventory. In accordance with this assessment, management has recorded a
      reserve of $4,038,047 and $2,032,000 at February 28, 2005 and February 29,
      2004,
      respectively.




**NOTE
      6 - OTHER CURRENT ASSETS**




Other
      current assets of $696,157 as of February 28, 2005 comprise of the $118,927
      of
      prepaid insurance, $39,607 of prepaid taxes, $13,000 of employee advances,
      $42,816 of other current assets and 481,807 due from the sale of a minority
      interest in a building




**NOTE
      7 - NOTES RECEIVABLE**




In
      March
      2000, we received a $2,500,000 note bearing interest at 8% per annum and due
      on
      October 1, 2007 from the purchaser of its ceramics facility. This note was
      assigned in connection with the Aura Realty Transaction. No payments have been
      made under this note since November 2003. The remaining $2,042,340 principal
      balance of the Ceramics Note has been reserved as uncollectible as of February
      29, 2004 and is included in bad debt expense in Selling, General and
      Administrative expenses in the accompanying financial statements. During the
      year ended February 28, 2005, the Company wrote off the note against the
      allowance.




**NOTE
      8 - PROPERTY, PLANT, AND EQUIPMENT**




Property,
      plant, and equipment at February 28, 2005 and February 29, 2004 consisted of
      the
      following:




2005
            
            2004Land
            
            $
            3,187,997
            
            $
            3,187,997Buildings
            
            
            6,408,796
            
            
            6,408,796Machinery
                and equipment
            
            
            1,798,485
            
            
            1,823,285Furniture
                and fixtures
            
            
            2,308,023
            
            
            2,308,023Leasehold
                improvements
            
            
            135,935
            
            
            135,93513,839,286
            
            
            13,864,036Less
                accumulated depreciation and amortization
            
            
            7,250,240
            
            
            6,924,607Property,
                plant and equipment, net
            
            $
            6,588,996
            
            $
            6,939,429




F-19




Depreciation
      and amortization expense was $416,161, $641,246, and $658,523 for the years
      ended February 28, 2005, February 29, 2004 and February 28, 2003,
      respectively.




**NOTE
      9 - LONG-TERM INVESTMENTS**




We
      have
      made long-term investments in the common stock of three companies as follows:
      Aquajet-$923,835; Algo Technology-$1,348,652 and Telemac-$715,153. As of
      February 29, 2004, we had written off our investment in Aquajet and Algo
      Technology, and had a net book value in our Telemac investment of $286,061.
      As
      of February 2005, we wrote off the entire balance of our investment in Telemac
      as no value could be realized out of the investment.




**NOTE
      10 - NOTES PAYABLE AND CONVERTIBLE NOTES PAYABLE**




Notes
      payable and convertible notes payable at February 28, 2005 and February 29,
      2004
      consisted of the following:




2005
            
            2004Convertible
                notes payable (a)
            
            $
            5,061,527
            
            $
            5,775,973Convertible
                notes payable (b)
            
            
            625,000
            
            
            625,000Notes
                payable - buildings (c)
            
            
            4,838,904
            
            
            4,952,531Note
                payable - related party (d)
            
            
            1,149,525
            
            
            1,000,000Litigation
                payable (e)
            
            
            2,742,553
            
            
            2,201,604Trade
                debt (f)
            
            
            ---
            
            
            983,345Notes
                payable - equipment (g)
            
            
            ---
            
            
            7,37614,417,509
            
            
            15,545,829Less
                current portion
            
            
            14,417,509
            
            
            10,674,024Long-term
                portion
            
            $
            -
            
            $
            4,871,805




(a) Represents
      secured notes payable (the "Secured Notes") on June 15, 2004, bearing interest
      at 10% per annum and convertible at the option of the holder into new debt
      or
      equity securities 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 15% premium. Repayment of the Secured Notes is secured
      by
      substantially of our assets (with limited exceptions). The beneficial conversion
      feature of these notes was valued at $348,555 and has been recorded as interest
      expense in the accompanying financial statements.




In
      connection with the foregoing financing, primarily as inducements to the lender
      to continue to provide interim funding, we agreed to issue warrants to purchase
      an aggregate of 3,200,000 shares of common stock at a price per share of $0.11,
      exercisable through January 7, 2011, and additional warrants (with a net
      exercise feature) to purchase an aggregate of 10,209,878 shares of common stock
      at a price per share of $0.024. These warrants were valued at $195,200 and
      have
      been recorded as interest expense in the accompanying financial
      statements.




Pursuant
      to the 2004 Recapitalization Transactions, the maturity of such notes was
      extended to June 30, 2005, the conversion discount / prepayment premium was
      eliminated, and a portion of such notes were converted into Series B Preferred
      Stock (see Note 18).




(b) Convertible
      notes payable carry an 8% interest rate and are convertible into common stock
      at
      various conversion rates (the "8% Convertible Notes"). In fiscal 2004,
      $1,125,000 these notes were adjusted to be convertible into shares of
      convertible, redeemable preferred stock, and such conversion was completed
      (see
      Note 12). We recorded interest expense of $316,619 related to the original
      conversion feature on the debt in fiscal 2003.




F-20




(c) Notes
      payable - buildings consist of a First Trust Deed on two buildings in California
      used as our headquarters bearing interest at 7.625% per annum. A final balloon
      payment is due in fiscal 2009. In April 2003, we defaulted on these notes
      payable and, in June 2004, cured such defaults. As such, at February 28, 2003,
      these notes payable were classified as current liabilities.




(d) Notes
      payable - related parties consist of two separate notes: a $1,000,000 note
      payable, dated December 1, 2002, which was entered into in connection with
      the
      sale of a minority interest in Aura Realty, as more fully described in our
      Form
      10-K for the year ended February 29, 2004 as filed with the SEC (the “$1M Note”)
      and a $150,000 demand note, dated August 6, 2004, which was issued in exchange
      for a $150,000 cash advance from an employee (the $150K Note”).




The
      $1M
      Note bears interest at 12.3% per annum and is secured by a security interest
      in
      a certain note receivable. We were required to make interest only payments
      for
      the first 17 months of the term, and the $1,000,000 principal was due on May
      31,
      2004. We were unable to make the principal payment as demanded by the Purchasers
      and the note is now in default. In August 2004, one of the minority shareholders
      of Aura Realty filed a lawsuit against us seeking full payment of this Note.




The
      $150K
      Note includes a fixed charge of $15,000 for interest, which was recorded as
      interest expense in August 2004, and is secured by our accounts receivable.
      The
      holders of the Secured Notes have subordinated their security interest in our
      accounts receivable to allow us to grant this security interest.




(e) The
      litigation payable of $2,168,704 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. We are in default with
      respect to payments required under these settlements.




Litigation
      payable of $573,847 comprises of the balance of the promissory note payable
      as
      part of the Mutual Settlement Agreement and Release. This was a litigation
      between Aries Group and the Company wherein the Aries Group had alleged among
      other things, the breach of numerous provisions of the Termination of Employment
      Agreements. (See Note 13).




(f) Restructured
      trade debt with payment terms over a three-year period with interest at 8%
      per
      annum commencing in January 2000. We are in default with respect to payments
      required under these restructuring agreements.




During
      fiscal 2003, we settled $1,456,213 of this trade debt, including accrued
      interest of $198,000, for $385,142. The total gain on the extinguishment of
      debt
      of $1,050,995 is reflected as an extraordinary item in the accompanying
      consolidated financial statements and resulted in extraordinary income per
      share
      of less than $0.01. In addition, as part of the transaction, we entered into
      a
      convertible note payable agreement with a group of investors for $307,862.
      This
      note was converted into Series A convertible preferred stock in fiscal 2004
      (see
      Note 12).




(g) Notes
      payable - equipment consists of a note maturing in February 2005 with an
      interest rate of 8.45%.




Future
      maturities of notes payable at February 28, 2005 were as follows:




Year
                Ending February,2006
            
            $
            14,417,509




F-21




**NOTE
      11 - ACCRUED EXPENSES**




Accrued
      expenses at February 28, 2005 and February 29, 2004 consisted of the
      following:




2005
            
            2004Accrued
                payroll and related expenses
            
            $
            352,836
            
            $
            421,158Accrued
                interest
            
            
            856,662
            
            
            726,212Accrued
                severance
            
            
            -
            
            
            250,750Customer
                advances
            
            
            343,081
            
            
            -Accrued
                accounting fees
            
            
            170,000
            
            
            -Accrued
                insurance
            
            
            95,251
            
            
            -Other
            
            
            558,516
            
            
            834,109Total
            
            $
            2,376,346
            
            $
            2,232,229




**NOTE
      12 - COMMITMENTS AND CONTINGENCIES**




**Leases**




At
      February 28, 2005, we did not have any significant long-term operating leases.
      Rent expense charged to operations amounted to $838,458, $412,531, and $956,951
      for the years ended February 28, 2005, February 29, 2004 and February 28, 2003,
      respectively.




**Litigation**




**Barovich/Chiau
      et. al. v. Aura Systems, Inc. et. al. (Case No. CV
      -95-3295).**




As
      previously reported in our fiscal 2000 report on Form 10-K, we settled
      shareholder litigation in the referenced matter in January 1999. On November
      20,
      1999, the parties entered into an Amended Stipulation of Settlement, requiring
      that we make payment of $2,260,000 (plus interest) in thirty-six equal monthly
      installments of $70,350. On October 22, 2002, after we had failed to make
      certain monthly payments, Plaintiffs applied for and obtained a judgment against
      us for $935,350, representing the balance due. We have subsequently made only
      two monthly payments of $70,350 each, reducing the amount owed to $794,650
      (plus
      interest) as of February 28, 2005. Subsequent to year end, the bankruptcy court
      (see footnote 18) approved the settlement of this claim in the amount of
      approximately $820,000, to be satisfied by the issuance of approximately 465,000
      shares of common stock in the recapitalized company. Plaintiffs appealed the
      settlement claiming they are a secured creditor entitled to full payment in
      cash
      over a period of five years. The appellate court upheld the settlement
      provisions, and Plaintiffs have appealed this decision. The appeal is
      pending.




**NOTE
      13 - STOCKHOLDERS' EQUITY**




**Convertible,
      Redeemable Preferred Stock**




The
      Board
      of Directors is authorized to issue from time to time up to 10,000,000 shares
      of
      preferred stock, in one or more series, and the Board of Directors is authorized
      to fix the dividend rates, any conversion rights or rights of exchange, any
      voting right, any rights and terms of redemption (including sinking fund
      provisions), the redemption price, liquidation preferences and any other rights,
      preferences, privileges and restrictions of any series of preferred
      stock.




On
      March
      25, 2003, our Board of Directors authorized 1,500,000 shares of Series A
      convertible, redeemable preferred stock (the "Series A") with a par value of
      $0.005. Each Series A share is convertible into common stock at $0.08 per share.
      The Series A can be converted at the option of the holder provided that we
      do
      not exercise the mandatory conversion on any date on or after March 31, 2004.
      We
      may exercise our right to mandatory conversion provided that the current market
      value of our common stock equals or exceeds 120% of the then prevailing
      conversion price.




F-22




The
      Series A has liquidation preference of $10 per share. In addition, the holders
      of the Series A 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.




During
      the year ended February 29, 2004, we issued 591,110 shares of Series
      A:




·
            57,090
                of these shares were issued for cash totaling $259,500 in private
                offerings to various third parties at an average price of $4.55 per
                share
                of Series A or an effective average price per common share of $0.036
                on an
                "if converted" basis;




·
            522,238
                of these shares were issued in conversion of $2,499,509 of principal
                and
                accrued interest of the 5% Convertible Notes (see Note 9) to various
                third
                parties at an average price of $4.79 per share of Series A or an
                effective
                average price per common share of $0.038 on an "if converted" basis;
                and




·
            11,782
                of these shares were issued in conversion of $1,178,167 of principal
                and
                accrued interest of the 8% Convertible Notes (see Note 9) to various
                third
                parties at an average price of $10.00 per share of Series A or an
                effective average price per common share of $0.08 on an "if converted"
                basis.




On
      March
      26, 2004, our Board of Directors authorized 8,000,000 shares of Series B
      convertible preferred stock (the “Series B”) with a par value of $0.001. Each
      Series B share is convertible into common stock at $0.02 per share. The Series
      B
      can be converted at any time at the option of the holder, provided there are
      sufficient common shares authorized.




The
      Series B has a liquidation preference of $5 per share. In addition, the holders
      of the Series B are entitled to receive cumulative dividends at a rate of 8%
      per
      annum. Dividends are payable in arrears on the first day of each quarter,
      commencing 90 days after the issuance date. Dividends are payable in cash,
      or,
      at the option of a majority of the holders of the Series B, in shares of common
      stock.




During
      the year ended February 28, 2005, we issued 1,971,273 shares of Series
      B:




1,089,245
      of these shares were issued for cash totaling $5,446,225




500,000
      of these shares were issued in conversion of $2,500,000 of notes
      payable




91,717
                of these shares were issued as part of the Mutual Settlement and
                Release
                Agreement totaling $458,583 (See Note 10 and Common Stock
                issuance)




290,311
      of these shares were issued in settlement of liabilities totaling
      $1,451,555




**Common
      Stock**




At
      February 28, 2005 and February 29, 2004, we had 500,000,000 shares of $0.005
      par
      value common stock authorized for issuance.




As
      described below, as of February 28, 2005 and February 29, 2004, we have
      commitments to issue, in exchange for consideration already received,
      approximately 22 million shares of common stock. This is in addition to
      outstanding stock options, warrants and convertible securities.




During
      the year ended February 28, 2005, we issued 8,151,324 common shares as penalty
      shares as part of the Mutual Settlement Agreement and Release. This was a
      litigation between Aries Group and the Company wherein the Aries Group had
      alleged among other things, the breach of numerous provisions of the Termination
      of Employment Agreements. (See Note 10 and Preferred stock
      issuance).




F-23




During
      the year ended February 29, 2004 we did not issue any shares of common
      stock.




During
      the year ended February 28, 2003, we issued 41,700,830 shares of common stock
      for cash totaling $5,694,001 in private offerings to various third party
      investors and issued 923,077 shares of common stock totaling $207,692 from
      committed stock.




During
      the year ended February 28, 2003, the purchasers of a minority interest in
      Aura
      Realty purchased 21,366,347 shares of our common stock for $1,493,000, an
      average price of $0.07 per share. During the year ended February 28, 2005 we
      issued 8,151,324 additional shares to the Purchasers as a result of our failure
      to timely file a registration statement covering such shares (see Note 4).




**Debt
      Extinguishments and Settlements for Common Stock**




During
      the year ended February 28, 2003, we issued 659,175 shares of common stock
      in
      satisfaction of $169,740 in liabilities and contractual
      obligations.




**Director
      Stock Options**




We
      have
      granted nonqualified stock options to certain directors. Options were granted
      at
      fair market value at the date of grant, vested immediately, and were exercisable
      at any time within a 10-year period from the date of grant.




A
      summary
      of our outstanding options and activity under the director's plan is as
      follows:




Number
                of Shares
            
            Weighted-Average
                Exercise PriceOutstanding,
                February 29, 2004 and February 28, 2005
            
            
            450,000
            
            $
            2.06
                - 2.30Exercisable,
                February 28, 2005
            
            
            450,000
            
            $
            2.06
                - 2.30




**Employee
      Stock Options**




The
      1989
      Stock Option Plan has granted the maximum allowable number of options
      authorized. In March 2000, our Board of Directors adopted the 2000 Stock Option
      Plan, a non-qualified plan which was subsequently approved by the stockholders.
      The 2000 Stock Option Plan authorizes the grant of options to purchase up to
      10%
      of our outstanding common shares.




During
      the year ended February 29, 2004, we:




·
            issued
                stock options to employees to purchase 10,126,302 of our common stock,
                1,876,302 of these shares were a reallocation of shares granted to
                employees in January 2003 that terminated their employment prior
                to
                vesting in these options.




·
            issued
                stock options to various Board members and consultants to purchase
                12,150,000 of our common stock.




Options
      issued to employees and employee directors were issued with an exercise price
      equal to the fair market value of our common stock and the value of these
      options were determined by the Black-Scholes model.




F-24




Activity
      in the employee stock option plans was as follows:




1989
                Plan
            
            2000
                PlanNumber
                of Shares
            
            Weighted-Average
                Exercise Price
            
            Number
                of Shares
            
            Weighted-Average
                Exercise PriceOutstanding,
                February 28, 2002
            
            
            5,405,000
            
            $
            1.79
                - 7.31
            
            
            35,844,251
            
            $
            0.31
                - 0.64Granted
            
            
            -
            
            $
            -
            
            
            17,201,400
            
            $
            0.24Canceled
            
            
            (4,438,000
            )
            $
            1.79
                - 7.31
            
            
            (14,409,750
            )
            $
            0.32Outstanding,
                February 28, 2003
            
            
            967,000
            
            $
            1.79
                - 7.31
            
            
            38,635,901
            
            $
            0.31
                - 0.64Granted
            
            
            -
            
            $
            -
            
            
            28,676,302
            
            $
            0.05
                - 0.12Canceled
            
            
            (253,000
            )
            $
            1.79
                - 7.31
            
            
            (1,911,799
            )
            $
            0.08
                - 0.64Outstanding,
                February 29, 2004
            
            
            714,000
            
            $
            1.79
                - 7.31
            
            
            55,400,404
            
            $
            0.05
                - 0.64Exercisable,
                February 29, 2004
            
            
            714,000
            
            $
            1.79
                - 7.31
            
            
            52,534,727
            
            $
            0.05
                - 0.64Outstanding,
                February 28, 2005
            
            
            714,000
            
            $
            1.79
                - 7.31
            
            
            55,400.404
            
            $
            0.05
                - 0.64Exercisable,
                February 28, 2005
            
            
            714,000
            
            $
            1.79
                - 7.31
            
            
            52,534,727
            
            $
            0.05
                - 0.64




The
      weighted-average remaining contractual life of the employee options outstanding
      at February 28, 2005 was 6.64 years. The exercise prices for the options
      outstanding at February 28, 2005 ranged from $0.05 to $7.31, and information
      relating to these options is as follows:




Range
                of ExercisePrices
            
            Stock
                OptionsOutstanding
            
            Stock
                OptionsExercisable
            
            Weighted-Average
                Remaining ContractualLife
            
            Weighted-Average
                Exercise Price of OptionsOutstanding
            
            Weighted-Average
                Exercise Price of Options Exercisable$
            0.05
                - 0.35
            
            
            33,891,403
            
            
            31,075,726
            
            
            7.59
                years
            
            $
            0.07
            
            $
            0.08$
            0.36
                - 3.00
            
            
            22,114,001
            
            
            22,064,001
            
            
            6.81
                years
            
            $
            0.57
            
            $
            0.58$
            3.01
                - 7.31
            
            
            109,000
            
            
            109,000
            
            
            3.05
                years
            
            $
            3.47
            
            $
            3.4756,114,404
            
            
            53,248,727




**Warrants**




During
      the year ended February 29, 2004, in connection with the Intercreditor Secured
      Debt financing (see Note 9), primarily as inducements to the lenders to continue
      to provide interim funding, we issued warrants to purchase an aggregate of
      3,200,000 shares of common stock at a price per share of $0.11, exercisable
      through January 7, 2011. Subsequent to year-end, we issued warrants (with a
      net
      exercise feature) to purchase an aggregate of 10,209,878 shares of common stock
      at a price per share of $0.024 to the same lenders, again as inducements to
      continue to provide interim funding.




During
      the year ended February 28, 2003 and in relation to the Agreement entered into
      on December 1, 2002 (see Note 4), we issued warrants to purchase 15,000,000
      shares of our common stock as incentive for the Purchasers to enter into the
      Agreement.




Per
      the
      Agreement, the warrants expire in five years, and the exercise prices are as
      follows:




·
            $0.15
                per share during the first 24 months after closing - $0.20 per share
                from
                the 25th month after closing




·
            $0.25
                per share from the 37th month after closing




F-25




We
      agreed
      to file a registration statement with the SEC within 60 days of closing under
      the Agreement and issued 5,500,000 additional warrants to the Purchasers during
      fiscal 2004 because it failed to do (see Note 4). These warrants were valued
      at
      $231,000, using the Black-Scholes pricing model, which is recorded in the
      accompanying fiscal 2004 financial statements as an additional loss on the
      sale
      of the minority interest in Aura Realty.




At
      February 29, 2004 and February 28, 2003, there were warrants outstanding to
      purchase 44,247,312 **** and
      48,956,727 shares, respectively, of our common stock, exercisable at an average
      price of $0.44 and $0.38, respectively, per share.




As
      of
      February 29, 2004, the aggregate number of outstanding options, warrants, and
      common share equivalents was significantly in excess of the authorized but
      unissued number of shares of our common stock. Management intends to seek
      shareholder approval of an increase in the Company's authorized shares
      sufficient to satisfy all existing commitments and create available shares
      for
      potential future investments. However, such approval has not been granted.
      Hence, the management determined that the value of the warrants is required
      to
      be classified as a liability under the provisions of EITF 00-19 - Accounting
      for
      Derivative Financial Instruments Indexed To and Potentially Settled In a
      Company's Own Stock. As of February 28, 2005, we have reclassified the value
      of
      the warrants to a derivative liability amounting to $16,254,502.




Activity
      in issued and outstanding warrants was as follows:




Number
                of Shares
            
            Exercise
                PricesOutstanding,
                February 28, 2002
            
            
            37,605,327
            
            $
            0.20
                - 2.25Issued
            
            
            15,000,000
            
            $
            0.15Exercised
            
            
            -
            
            $
            -Expired
            
            
            -
            
            $
            -Outstanding,
                February 28, 2003
            
            
            52,605,327
            
            $
            0.15
                - 2.54Issued
            
            
            11,800,000
            
            $
            0.05
                - 0.15Exercised
            
            
            -
            
            $
            -Expired
            
            
            20,258,015
            
            $
            0.20
                - 0.48Outstanding,
                February 29, 2004
            
            
            44,247,312
            
            $
            0.05
                - 2.54Issued
            
            
            150,000,000
            
            $
            0.02
                - 0.05Exercised
            
            
            -
            
            $
            -Expired
            
            
            -
            
            
            -Outstanding
                February 28, 2005
            
            
            194,243,312
            
            $
            0.02
                - 2.54




**NOTE
      13 - INCOME TAXES**




We
      have
      not incurred any income tax expense since inception. The actual tax benefit
      differs from the expected tax benefit computed by applying the United States
      federal corporate tax rate of 34% to loss before income taxes as follows for
      the
      years ended February 28, 2005 and February 29, 2004 and February 28, 2003:




2005
            
            2004
            
            2003Expected
                tax benefit
            
            
            34.0
            %
            
            34.0
            %
            
            34.0
            %State
                income taxes, net of federal benefit
            
            
            6.0
            
            
            6.0
            
            
            6.0Changes
                in valuation allowance
            
            
            (40.0
            )
            
            (40.0
            )
            
            (40.0
            )Total
            
            
            -
            %
            
            -
            %
            
            -
            %




F-26




The
      following table summarizes the significant components of our deferred tax asset
      at February 28, 2005 and February 29, 2004:




2005
            
            2004Deferred
                tax assetProperty,
                plant, and equipment and other
            
            
            6,350,000
            
            $
            6,100,000Net
                operating loss carryforward
            
            
            112,400,000
            
            
            107,700,000Valuation
                allowance
            
            
            (118,750,000
            )
            
            (113,800,000
            )Net
                deferred tax asset
            
            $
            -
            
            $
            -




We
      recorded an allowance of 100% of our net operating loss carryforward due to
      the
      uncertainty of its realization.




A
      provision for income taxes has not been provided in these financial statements
      due to the net loss. At February 28, 2005, we had operating loss carryforwards
      of approximately $297,000,000, which expire through 2020.




**NOTE
      14 - EMPLOYEE BENEFIT PLANS**




We
      sponsor two employee benefit plans: The Employee Stock Ownership Plan (the
      "ESOP") and a 401(k) plan. In addition, the options granted under the 1989
      and
      2000 Stock Option Plans are valid and subject to exercise.




The
      ESOP
      is a qualified discretionary employee stock ownership plan that covers
      substantially all employees. We did not make any contributions to the ESOP
      during the years ended February 28, 2005, February 29, 2004 and February 28,
      2003.




We
      sponsor a voluntary, defined contribution 401(k) plan. The plan provides for
      salary reduction contributions by employees and matching contributions by us
      of
      20% of the first 7% of the employees' pre-tax contributions. The matching
      contributions included in selling, general, and administrative expenses were
      $17,863, $21,253, and $44,720 for the years ended February 28, 2005, February
      29, 2004 and February 28, 2003, respectively.




**NOTE
      15 - RELATED PARTY TRANSACTIONS**




In
      February 2003, we entered into convertible notes payable agreements with a
      group
      of investors, which included five members of our former management. The notes
      payable bear interest at 8% per annum, mature at various dates, and are
      convertible into shares of our convertible, redeemable preferred stock at a
      rate
      of $1 for each $2.20 of convertible, redeemable preferred shares (see Note
      9 and
      Note 18).




On
      December 1, 2002, we entered into a Sale and Leaseback Agreement with a group
      of
      individuals, including five individuals who were members of our former
      management, who separated at the end of February 2002, pursuant to which we
      agreed to sell Aura Realty to the Purchasers and enter into a 10-year lease
      of
      the properties owned by Aura Realty (see Note 4).




**NOTE
      16 - SEGMENT INFORMATION**




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 years ended
      February 28, 2005, February 29, 2004 and February 28, 2003:




2005
            
            2004
            
            2003United
                States
            
            $
            2,420,136
            
            $
            1,841,325
            
            $
            996,770Canada
            
            
            43,523
            
            
            1,000
            
            
            27,000Europe
            
            
            7,826
            
            
            3,000
            
            
            21,000Asia
            
            
            53,946
            
            
            19,000
            
            
            59,000Total
            
            $
            2,525,431
            
            $
            1,864,325
            
            $
            1,103,770




F-27




**NOTE
      17 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**




The
      following tables list our quarterly financial information for the years ended
      February 28, 2005, February 29, 2004 and February 28, 2003:




2005





First
              Quarter
            
            Second
                Quarter
            
            Third
              Quarter
            
            Fourth
              Quarter
            
            Total
              YearNet
                revenues
            
            $
            685,834
            
            $
            599,443
            
            $
            631,774
            
            $
            608,380
            
            $
            2,525,431Gross
                profit
            
            $
            416,836
            
            $
            470,024
            
            $
            377,300
            
            $
            (2,400,548
            )
            $
            (1,136,388
            )Loss
                from operations
            
            $
            (1,491,525
            )
            $
            (3,810,130
            )
            $
            (2,024,533
            )
            $
            (6,489,112
            )
            $
            (13,815,300
            )Net
                income (loss)
            
            $
            (2,571,476
            )
            $
            (11,690,737
            )
            $
            (16,504,722
            )
            $
            1,966,895
            
            $
            (28,800,040
            )Basic
                and diluted loss per share
            
            $
            (0.006
            )
            $
            (0.027
            )
            $
            (0.038
            )
            $
            0.011
            
            $
            (0.06
            )





2004





First
              Quarter
            
            Second
                Quarter
            
            Third
              Quarter
            
            Fourth
              Quarter
            
            Total
              YearNet
                revenues
            
            $
            97,612
            
            $
            519,679
            
            $
            726,692
            
            $
            520,342
            
            $
            1,864,325Gross
                profit
            
            
            30,829
            
            
            230,730
            
            
            424,229
            
            
            276,574
            
            
            378,588Loss
                from operations
            
            
            (1,643,011
            )
            
            (3,271,243
            )
            
            (1,429,628
            )
            
            (4,605,143
            )
            
            (10,948,796
            )Net
                loss
            
            
            (2,225,284
            )
            
            (3,536,450
            )
            
            (1,886,177
            )
            
            (5,936,964
            )
            
            (13,584,875
            )Basic
                and diluted loss per share
            
            $
            (0.005
            )
            $
            (0.008
            )
            $
            (0.005
            )
            $
            (0.014
            )
            $
            (0.032
            )





2003




First
              Quarter
            
            Second
                Quarter
            
            Third
              Quarter
            
            Fourth
              Quarter
            
            Total
              YearNet
                revenues
            
            $
            183,739
            
            $
            272,978
            
            $
            423,066
            
            $
            223,987
            
            $
            1,103,770Gross
                profit
            
            $
            102,753
            
            $
            127,858
            
            $
            223,912
            
            $
            78,148
            
            $
            532,671Loss
                from operations
            
            $
            (3,290,539
            )
            $
            (5,219,668
            )
            $
            (2,238,263
            )
            $
            (2,825,208
            )
            $
            (13,573,678
            )Net
                loss
            
            $
            (3,958,201
            )
            $
            (5,694,039
            )
            $
            (2,334,550
            )
            $
            (4,154,083
            )
            $
            (16,140,873
            )Basic
                and diluted loss per share
            
            $
            (0.01
            )
            $
            (0.01
            )
            $
            -
            
            $
            (0.01
            )
            $
            (0.04
            )




F-28




**NOTE
      18 - SUBSEQUENT EVENTS**




*Chapter
      11 Reorganization.*




On
      June
      24, 2005 we filed for reorganization under Chapter 11 of the U.S. Bankruptcy
      Code, in the United States Bankruptcy Court, Central District of California,
      (Case Number LA 05-24550-SB). We secured a Debtor in Possession (“DIP”) loan
      from Blue Collar Films LLC (“BCF”) for one million dollars and secured an
      additional $1.2 million DIP loan from AGP Lender LLC. In addition a group of
      individual investors provided an additional $1.16 million in DIP financing.
      We
      submitted a reorganization plan that was approved by the court and voted and
      approved by the DIP lenders, the secured creditors, the unsecured creditors,
      the
      shareholders and the new money investors. Under the reorganization plan (i)
      the
      secured creditor retained $2.5 million in a secured note payable over 48 months
      at 7% annual interest with the first payment starting 12 months after the
      reorganization, (ii) the Series B Preferred Stock holders received new common
      shares calculated by dividing the total cash invested in the Series B Placement
      by $3.37, (iii) the Series A Preferred Stock holders converted their 1.8 Series
      A Preferred Stock for one new common share, (iv) the common shareholders
      converted 338 of their shares for one new share, and (v) the DIP loans converted
      their loans into approximately 6.07 million new shares of common stock, and
      (vi)
      all the unsecured creditors received new shares of common stock valued at one
      share per $1.75 in claim. An additional 5.89 million shares of common stock
      were
      issued for the new money and reorganization related fees. 254,127 additional
      shares were issued to shareholders to settle their claims in excess of the
      bankruptcy court approval.




All
      of
      the outstanding litigation and disputes were settled during the bankruptcy.
      The
      real estate was sold to an unrelated third party in December 2005 for gross
      proceeds of $8,750,000. After satisfaction of the mortgage liabilities and
      payment of the costs of the sale, approximately $2.9 million was due us. From
      this amount, $1.9 million was paid to the minority shareholder, approximately
      $470,000 was used to satisfy outstanding legal bills, and the balance of
      $595,000 was received by the Company in March of 2006. All disputes regarding
      the real estate were settled.




We
      emerged from the Chapter 11 effective January 31, 2006.




*Capital
      Transactions*




In
      the
      year ended February 28, 2006, we issued 24,282,710 shares of common stock as
      follows:




-
            1,134,000
                shares upon conversion of $2,900,000 of secured debt


-
            2,766,786
                shares for administrative claims arising out of the bankruptcy
                filing


-
            837,375
                shares as penalty shares for failure to timely file a registration
                statement


-
            4,611,247
                shares in satisfaction of $8,125,939 of unsecured
                debt


-
            1,300,172
                shares in exchange for the old common
                stock


-
            3,573,530
                shares for cancelled preferred
                stock


-
            6,065,699
                shares for DIP financing


-
            3,349,500
                shares for new money contribution


-
            644,401
                shares issued for legal settlements




In
      the
      year ended February 28, 2007, we issued 4,412,928 shares of common stock for
      net
      proceeds of $3,965,156.




In
      the
      nine months ended November 30, 2007, we issued 5,614,650 shares of common stock
      for net proceeds of $5,377,080. We also issued 183,532 shares of common stock
      upon conversion of $183,532 of secured notes payable.




F-29




**SUPPLEMENTAL
      INFORMATION**




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




To
      the
      Board of Directors and Stockholders




Aura
      Systems, Inc. and subsidiaries




Our
      audits were conducted in accordance with the standards of the Public Company
      Accounting Oversight Board (United States) and were made for the purpose of
      forming an opinion on the basic consolidated financial statements taken as
      a
      whole. The consolidated supplemental schedule II is presented for purposes
      of
      complying with the Securities and Exchange Commission's rules and is not a
      part
      of the basic consolidated financial statements. This schedule has been subjected
      to the auditing procedures applied in our audits of the basic consolidated
      financial statements and, in our opinion, is fairly stated in all material
      respects in relation to the basic consolidated financial statements taken as
      a
      whole.




Our
      report covering the basic financial statements indicates that there is
      substantial doubt as to the Company's ability to continue as a going concern,
      the outcome of which cannot presently be determined and that the financial
      statements do not include any adjustments that might result from the outcome
      of
      this uncertainty.




Los
      Angeles, California




_____________,
      2008




F-30




**VALUATION
      AND QUALIFYING ACCOUNTS - SCHEDULE II**




**Balance,
                Beginning of Year**
            
            **Additions
                charged to Operations**
            
            **Deductions**
              **from**
              **Reserve**
            
            **Balance,**
              **End
                of**
              **Year****Reserve
                for doubtful accounts (see Note 3 and 6)**February
                28, 2005
            
            $
            2,188,340
            
            $
            86,537
            
            $
            54,403
            
            $
            2,220,474February
                29, 2004
            
            $
            244,310
            
            $
            2,042,340
            
            $
            98,310
            
            $
            2,188,340February
                28, 2003
            
            $
            150,000
            
            $
            94,310
            
            $
            -
            
            $
            244,310**Reserve
                for obsolete inventories (see Note 5)**February
                28, 2005
            
            $
            2,032,000
            
            $
            2,006,047
            
            $
            -
            
            $
            4,038,047February
                29, 2004
            
            $
            1,678,000
            
            $
            354,000
            
            $
            -
            
            $
            2,032,000February
                28, 2003
            
            $
            1,795,411
            
            $
            -
            
            $
            (117,411
            )
            $
            1,678,000**Reserve
                for investment (see Note 8)**February
                28, 2005
            
            $
            2,701,579
            
            $
            286,061
            
            $
            -
            
            $
            2,987,640February
                29, 2004
            
            $
            2,522,487
            
            $
            500,000
            
            $
            320,908
            
            $
            2,701,579February
                28, 2003
            
            $
            1,822,487
            
            $
            700,000
            
            $
            -
            
            $
            2,522,487





F-31