**U. S. Securities and Exchange Commission**

**Washington, D.C.  20549**

 

 

## **Form 10-QSB**

 

 

ý           **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES****EXCHANGE ACT OF 1934**

 

**For the quarterly period endedDecember 31, 2003**

 

**For the transition period from           to          **

 

**Commission filenumber  0-28604**

 

 

**ENCISION INC.**

(Exact name of small business issuer as specified inits charter)

 

| **Colorado**                                                     |   | **84-1162056**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **4828 Sterling Drive, Boulder,  Colorado**  **80301**      |
| (Address of  principal executive offices)                        |
|                                                             |   |                                  |
| **(303) 444-2600**                                               |
| (Registrant’s  telephone number)                            |

 

**Checkwhether the issuer (1) filed all reports required to be filed by Section 13 of15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.**

**Yes   ****ý   No   ****o**

 

**State the number of shares outstanding of each of theissuer’s classes of common equity, as of the latest practicable date:**

 

| **Common Stock, No par****value** |   | **5,818,148****Shares**            |
|-----------------------------------|--------|------------------------------------|
| Class                             |   | (outstanding at  January 31, 2004) |

 

**Transitional Small Business Disclosure Format**

 

**Yes    ****o   No   ****ý**

 

 

----

 

**ENCISION INC.**

 

**FORM 10-QSB**

 

**For the Quarter Ended December 31,2003**

 

**INDEX**

 
| **PART I.**  | **UNAUDITEDFINANCIAL INFORMATION** |   |                                                                                        |
|--------------|------------------------------------|--------|---------------------------------------------------------------------------------------------|
|         |                               |   |                                                                                        |   |   |
|         | **ITEM1**                          | -      | Condensed Interim Financial  Statements:                                                    |   |   |
|         |                               | -      | Condensed  Balance Sheets as of  December 31, 2003 and March 31, 2003                       |   |
|         |                               | -      | Condensed Statements  of Operations for  the Three Months Ended December 31, 2003 and 2002  |   |
|         |                               | -      | Condensed Statements of Operations  for  the Nine Months Ended December 31, 2003 and 2002   |   |
|         |                               | -      | Condensed Statements  of Cash Flows for  the Nine Months Ended December 31, 2003 and 2002   |   |
|         |                               | -      | Notes to  Condensed Interim Financial Statements                                            |   |   |
|         |                               |   |                                                                                        |   |   |
|         | **ITEM 2**                         | -      | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   |
|         |                               |   |                                                                                        |   |   |
|         | **ITEM 3**                         | -      | Controls and Procedures                                                                     |   |   |
|         |                               |   |                                                                                        |   |   |
| **PART II.** | **OTHER INFORMATION**              |   |                                                                                        |
|         |                               |   |                                                                                        |   |   |
|         | **ITEM 6**                         | -      | Exhibits and Reports on Form 8-K                                                            |   |   |
|         |                               |   |                                                                                        |   |   |
|         | **SIGNATURE**                      |   |                                                                                        |

 

2

----

 

**PARTI****                  FINANCIALINFORMATION**

 

**ITEM 1********-CONDENSED INTERIM FINANCIAL STATEMENTS**

 

ENCISION INC.

 

CONDENSED BALANCE SHEETS

(Unaudited)

 
|                                                                                                                  |   | **December  31,  2003** |      | **March 31,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|---------------------|--------|
| ASSETS                                                                                                                |   |                    |      |                |   |
| CURRENT  ASSETS:                                                                                                      |   |                    |      |                |   |
| Cash and cash equivalents                                                                                             |   | $                       | 1,212,333 |                | $      | **585,552** |   |
| Accounts  receivable, net of allowance for doubtful accounts of $19,000 and $25,000,  respectively                    |   | 953,460                 |      | 959,808             |   |
| Inventory,  net of reserve for obsolescence of $90,000 and $68,000, respectively                                      |   | 1,144,110               |      | 931,323             |   |
| Prepaid  expenses                                                                                                     |   | 185,891                 |      | 46,929              |   |
| Total  current assets                                                                                                 |   | 3,495,794               |      | 2,523,612           |   |
|                                                                                                                  |   |                    |      |                |   |
| EQUIPMENT,  at cost:                                                                                                  |   |                    |      |                |   |
| Furniture,  fixtures and equipment                                                                                    |   | 770,398                 |      | 818,392             |   |
| Customer-site  equipment                                                                                              |   | 419,457                 |      | 306,381             |   |
| Less  - accumulated depreciation                                                                                      |   | (833,117                | )         | (858,144            | )      |
|                                                                                                                  |   |                    |      |                |   |
| Equipment,  net                                                                                                       |   | 356,738                 |      | 266,629             |   |
| PATENTS,  net of accumulated amortization of $64,988 and $55,871, respectively                                        |   | 120,799                 |      | 129,916             |   |
| OTHER  ASSETS                                                                                                         |   | 12,972                  |      | 12,972              |   |
| Total  assets                                                                                                         |   | $                       | 3,986,303 |                | $      | 2,933,129 |   |
|                                                                                                                  |   |                    |      |                |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                            |   |                    |      |                |   |
|                                                                                                                  |   |                    |      |                |   |
| CURRENT  LIABILITIES:                                                                                                 |   |                    |      |                |   |
| Accounts  payable                                                                                                     |   | $                       | 388,962   |                | $      | 416,848 |   |
| Accrued  compensation                                                                                                 |   | 147,299                 |      | 150,607             |   |
| Other  accrued liabilities                                                                                            |   | 348,783                 |      | 359,326             |   |
| Total  current liabilities                                                                                            |   | 885,044                 |      | 926,781             |   |
|                                                                                                                  |   |                    |      |                |   |
|                                                                                                                  |   |                    |      |                |   |
| LONG-TERM  LIABILITIES:                                                                                               |   |                    |      |                |   |
| Lease  payable                                                                                                        |   | 19,613                  |      | —              |   |
|                                                                                                                  |   |                    |      |                |   |
| SHAREHOLDERS’  EQUITY:                                                                                           |   |                    |      |                |   |
| Preferred  stock, no par value, 10,000,000 shares authorized, no shares issued or  outstanding                        |   | —                  |      | —              |   |
| Common  stock, no par value, 100,000,000 shares authorized, 5,816,972 (2004) and  5,430,026 (2003) shares outstanding |   | 18,273,100              |      | 17,267,684          |   |
| Accumulated  deficit                                                                                                  |   | (15,191,454             | )         | (15,261,336         | )      |
| Total  shareholders’ equity                                                                                      |   | 3,081,646               |      | 2,006,348           |   |
| Total  liabilities and shareholders’ equity                                                                      |   | $                       | 3,986,303 |                | $      | 2,933,129 |   |

 

The accompanyingnotes are an integral part of these condensed financial statements.

 

3

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ENCISION INC.

 

CONDENSED STATEMENTS OFOPERATIONS

(Unaudited)

 
|                                                                           |   | **For the Three Months  Ended December 31,** |      |
|--------------------------------------------------------------------------------|--------|----------------------------------------------|-----------|
|                                                                           |   | **2003**                                     |      | **2002** |   |
|                                                                           |   |                                         |      |   |   |
| REVENUE, NET                                                                   |   | $                                            | 1,790,849 |   | $ | 1,812,053 |   |
|                                                                           |   |                                         |      |   |   |
| COST  OF SALES                                                                 |   | 731,853                                      |      | 754,117 |   |
| Gross  profit                                                                  |   | 1,058,996                                    |      | 1,057,936 |   |
|                                                                           |   |                                         |      |   |   |
| OPERATING  EXPENSES:                                                           |   |                                         |      |   |   |
| Sales  and marketing                                                           |   | 639,563                                      |      | 599,080 |   |
| General  and administrative                                                    |   | 227,555                                      |      | 189,254 |   |
| Research  and development                                                      |   | 190,050                                      |      | 121,775 |   |
| Total  operating expenses                                                      |   | 1,057,168                                    |      | 910,109 |   |
|                                                                           |   |                                         |      |   |   |
| INCOME  FROM OPERATIONS                                                   |   | 1,828                                        |      | 147,827 |   |
|                                                                           |   |                                         |      |   |   |
| OTHER  INCOME (EXPENSE):                                                       |   |                                         |      |   |   |
| Interest  income                                                               |   | 2,033                                        |      | 1,034 |   |
| Other  (expense), net                                                          |   | (719                                         | )         | (499 | ) |
| NET  INCOME                                                                    |   | $                                            | 3,142     |   | $ | 148,362 |   |
|                                                                           |   |                                         |      |   |   |
| NET  INCOME PER SHARE:                                                         |   |                                         |      |   |   |
| Basic  and diluted net income per common share                                 |   | $                                            | 0.00      |   | $ | 0.03 |   |
|                                                                           |   |                                         |      |   |   |
| Diluted  net income per common share                                           |   | $                                            | 0.00      |   | $ | 0.03 |   |
|                                                                           |   |                                         |      |   |   |
| Weighted  average shares used in computing basic net income per common share   |   | 5,785,121                                    |      | 5,423,747 |   |
|                                                                           |   |                                         |      |   |   |
| Weighted  average shares used in computing diluted net income per common share |   | 6,254,499                                    |      | 5,858,960 |   |

 

The accompanyingnotes are an integral part of these condensed financial statements.

 

4

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ENCISION INC.

 

CONDENSED STATEMENTS OFOPERATIONS

(Unaudited)

 
|                                                                           |   | **For the Nine Months  Ended December 31,** |      |
|--------------------------------------------------------------------------------|--------|---------------------------------------------|-----------|
|                                                                           |   | **2003**                                    |      | **2002** |   |
|                                                                           |   |                                        |      |   |   |
| REVENUE, NET                                                                   |   | $                                           | 5,372,808 |   | $ | 4,908,318 |   |
|                                                                           |   |                                        |      |   |   |
| COST  OF SALES                                                                 |   | 2,236,571                                   |      | 1,952,973 |   |
| Gross  profit                                                                  |   | 3,136,237                                   |      | 2,955,345 |   |
|                                                                           |   |                                        |      |   |   |
| OPERATING  EXPENSES:                                                           |   |                                        |      |   |   |
| Sales  and marketing                                                           |   | 1,806,759                                   |      | 1,782,195 |   |
| General  and administrative                                                    |   | 685,177                                     |      | 662,845 |   |
| Research  and development                                                      |   | 570,474                                     |      | 361,642 |   |
| Total  operating expenses                                                      |   | 3,062,410                                   |      | 2,806,682 |   |
|                                                                           |   |                                        |      |   |   |
| INCOME  FROM OPERATIONS                                                        |   | 73,827                                      |      | 148,663 |   |
|                                                                           |   |                                        |      |   |   |
| OTHER  INCOME (EXPENSE):                                                       |   |                                        |      |   |   |
| Interest  income                                                               |   | 3,334                                       |      | 3,247 |   |
| Other  (expense) income, net                                                   |   | (7,279                                      | )         | 1,071 |   |
| NET  INCOME                                                                    |   | $                                           | 69,882    |   | $ | 152,981 |   |
|                                                                           |   |                                        |      |   |   |
| NET  INCOME PER SHARE:                                                         |   |                                        |      |   |   |
| Basic  and diluted net income per common share                                 |   | $                                           | 0.01      |   | $ | 0.03 |   |
|                                                                           |   |                                        |      |   |   |
| Diluted  net income per common share                                           |   | $                                           | 0.01      |   | $ | 0.03 |   |
|                                                                           |   |                                        |      |   |   |
| Weighted  average shares used in computing basic net income per common share   |   | 5,626,602                                   |      | 5,422,211 |   |
|                                                                           |   |                                        |      |   |   |
| Weighted  average shares used in computing diluted net income per common share |   | 6,081,853                                   |      | 5,895,458 |   |

 

The accompanyingnotes are an integral part of these condensed financial statements.

 

5

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ENCISION INC.

 

CONDENSED STATEMENTS OFCASH FLOWS

(Unaudited)

 
|                                                                                                 |   | **For the Nine Months  Ended December 31,** |      |
|------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|-----------|
|                                                                                                 |   | **2003**                                    |      | **2002** |   |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                               |   |                                        |      |   |   |
| Net  income (loss)                                                                                   |   | $                                           | 69,882    |   | $ | 152,981 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities- |   |                                        |      |   |   |
| Depreciation  and amortization                                                                       |   | 137,703                                     |      | 75,609 |   |
| Provision  for bad debts                                                                             |   | (6,000                                      | )         | 12,000 |   |
| Inventory  reserves                                                                                  |   | 22,000                                      |      | 8,000 |   |
| Non-cash,  stock-based, compensation charge                                                          |   | —                                      |      | 12,000 |   |
| Changes  in operating assets and liabilities-                                                        |   |                                        |      |   |   |
| Accounts  receivable                                                                                 |   | 12,348                                      |      | (43,969 | ) |
| Inventory                                                                                            |   | (234,787                                    | )         | (72,550 | ) |
| Other  assets                                                                                        |   | (138,962                                    | )         | (40,788 | ) |
| Accounts  payable                                                                                    |   | (27,886                                     | )         | 240,226 |   |
| Accrued  compensation and other accrued liabilities                                                  |   | 5,762                                       |      | 107,391 |   |
| Net  cash (used) provided by in operating activities                                                 |   | (159,940                                    | )         | 450,900 |   |
|                                                                                                 |   |                                        |      |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                               |   |                                        |      |   |   |
| Investment  in equipment                                                                             |   | (218,695                                    | )         | (267,299 | ) |
| Patent  costs                                                                                        |   | —                                      |      | (20,575 | ) |
|                                                                                                 |   |                                        |      |   |   |
| Net  cash used in investing activities                                                               |   | (218,695                                    | )         | (287,874 | ) |
|                                                                                                 |   |                                        |      |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                               |   |                                        |      |   |   |
| Proceeds  from the exercise of stock options                                                         |   | 49,513                                      |      | 6,320 |   |
| Proceeds  from the issuance of common stock                                                          |   | 1,000,002                                   |      | — |   |
| Cost  of the issuance of common stock                                                                |   | (44,099                                     | )         | — |   |
| Net  cash provided by financing activities                                                           |   | 1,005,416                                   |      | 6,320 |   |
|                                                                                                 |   |                                        |      |   |   |
| NET  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                |   | 626,781                                     |      | 169,346 |   |
|                                                                                                 |   |                                        |      |   |   |
| CASH  AND CASH EQUIVALENTS, beginning of period                                                      |   | 585,552                                     |      | 500,988 |   |
| CASH  AND CASH EQUIVALENTS, end of period                                                            |   | $                                           | 1,212,333 |   | $ | 670,334 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

6

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ENCISION INC.

 

NOTES TO CONDENSEDINTERIM FINANCIAL STATEMENTS

 

DECEMBER 31, 2003

(Unaudited)

 

(1)           ORGANIZATIONAND NATURE OF BUSINESS

 

Encision Inc. (the“Company”) is a medical device company that designs, develops, manufactures andmarkets patented surgical instruments that provide greater safety to patientsundergoing minimally-invasive surgery. The Company believes its patented AEM® surgical instrumenttechnology is changing the marketplace for electrosurgical devices andinstruments by providing a solution to a patient safety risk in laparoscopicsurgery.  The Company’s sales to datehave been made principally in the United States.

 

The Company achievedprofitable operations in fiscal 2003 but prior to that had incurred lossessince its inception and has an accumulated deficit of $15,191,454 at March 31,2003. Operations have been financed primarily through issuance of common stock.

 

During fiscal year 2003,the Company achieved annual net income and positive cash flow for the firsttime in its history.  The Company’sstrategic marketing and sales plan is designed to expand the use of the Company’sproducts in surgically active hospitals in the United States.  Management expects these efforts to resultin continued revenue increases for fiscal 2004 which, combined with plannedcontrolled operating expenses and consistent gross profit margins, are expectedto maintain profitable operations and conserve the Company’s cash resources.

 

On July 30, 2003 theCompany issued a total of 333,334 shares of its common stock to the WasatchMicro Cap Fund and the Wasatch Micro Cap Value Fund, for gross proceeds of$1,000,002.  Funds managed by WasatchAdvisors, Inc. held shares of the Company’s common stock, constituting lessthan 5% of the issued and outstanding shares of its common stock, prior to thattransaction.

 

(2)           SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Use of Estimates in thePreparation of Financial Statements

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions.  Such estimates andassumptions affect the reported amounts of assets and liabilities as well asdisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expense during the reportingperiod.  Actual results could differfrom those estimates.

 

Cash and Cash Equivalents

 

For purposes of reportingcash flows, the Company considers all cash and highly liquid investments withan original maturity of three months or less to be cash equivalents.

 

Fair Value of FinancialInstruments

 

The Company’s financialinstruments consist of cash and cash equivalents and short-term tradereceivables and payables.  The carryingvalues of cash and cash equivalents and short-term receivables and payablesapproximate their fair value due to their short maturities.

 

Concentration of CreditRisk

 

The Company has nosignificant off-balance sheet concentrations of credit risk such as foreignexchange contracts, options contracts or other foreign hedging arrangements.The Company maintains the majority of its cash balances with two financialinstitutions in the form of demand deposits and money market funds.

 

Accounts receivables aretypically unsecured and are derived from transactions with and from entities inthe healthcare industry primarily located in the United States. Accordingly,the Company may be exposed to credit risk generally associated with thehealthcare industry. The Company maintains allowances for doubtful accounts forestimated losses resulting from the inability of its customers to make requiredpayments.

 

7

----

 

The net accountsreceivable balance at December 31, 2003 of $953,460 included $107,344, orapproximately 11%, from one distributor. The net accounts receivable balance atMarch 31, 2003 of $959,808 included $227,178, or approximately 24%, from onedistributor.

 

Warranty Accrual

 

The Company provides forthe estimated cost of product warranties at the time revenue is recognized.While the Company engages in extensive product quality programs and processes,including actively monitoring and evaluating the quality of its componentsuppliers, the Company’s warranty obligation is based upon historicalexperience and is also affected by product failure rates and material usageincurred in correcting a product failure. Should actual product failure ratesor material usage costs differ from the Company’s estimates, revisions to theestimated warranty liability would be required.

 

Inventories

 

Inventories are stated atthe lower of cost (first-in, first-out basis) or market. The Company reducesinventory for estimated obsolete or unmarketable inventory equal to thedifference between the cost of inventory and the estimated market value basedupon assumptions about future demand and market conditions. If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required. Inventory consisted of the following:

 
|                            |   | **December 31,  2003** |      | **March 31,  2003** |   |
|---------------------------------|--------|------------------------|-----------|---------------------|--------|
|                            |   |                   |      |                |   |
| Raw materials                   |   | $                      | 911,408   |                | $      | 627,243 |   |
| Finished goods                  |   | 322,702                |      | 372,080             |   |
|                            |   | 1,234,110              |      | 999,323             |   |
| Less - Reserve for obsolescence |   | (90,000                | )         | (68,000             | )      |
|                            |   | $                      | 1,144,110 |                | $      | 931,323 |   |

 

Property and Equipment

 

Property and equipmentare stated at cost, with depreciation computed primarily on a double-decliningbasis over the estimated useful life of the asset, generally three to fiveyears. Company-owned AEM Monitors at customer sites are depreciated on adouble-declining basis for a period of 5 years. Leasehold improvements aredepreciated over the shorter of the remaining lease term or the estimateduseful life of the asset. Maintenance and repairs are expensed as incurred andmajor additions, replacements and improvements are capitalized.

 

Long-Lived Assets 

 

Long-lived assets arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. A long-lived assetis considered impaired when estimated future cash flows related to the asset,undiscounted and without interest, are insufficient to recover the carryingamount of the asset. If deemed impaired, the long-lived asset is reduced to itsestimated fair value. Long-lived assets to be disposed of are reported at thelower of their carrying amount or estimated fair value less cost to sell.

 

Patents

 

The costs of applying forpatents are capitalized and amortized on a straight-line basis over the lesserof the patent’s economic or legal life (17 years in the United States).Capitalized costs are expensed if patents are not granted. The Company reviewsthe carrying value of its patents periodically to determine whether the patentshave continuing value and such reviews could result in the conclusion that therecorded amounts have been impaired.

 

AccruedLiabilities

 

The Company has accrued$115,000 related to warranty claims and $69,278 related to sales commissionsand has included these amounts in accrued liabilities in the accompanyingbalance sheets as of December 31, 2003.

 

Income Taxes 

 

The Company accounts forincome taxes under the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 109, “Accounting for Income Taxes” (“SFAS No.109”). SFAS No. 109 requires recognition of deferred income tax assets andliabilities

 

8

----

 

for the expected future income tax consequences, based on enacted taxlaws, of temporary differences between the financial reporting and tax bases ofassets and liabilities. SFAS No. 109 also requires recognition of deferred taxassets for the expected future tax effects of all deductible temporarydifferences, loss carryforwards and tax credit carryforwards. Deferred taxassets are then reduced, if deemed necessary, by a valuation allowance for theamount of any tax benefits which, more likely than not based on currentcircumstances, are not expected to be realized. For the Nine months endedDecember 31, 2003, the Company utilized net operating loss carryforwards toentirely offset its tax liability. As a result, no tax provision is reflectedin the accompanying statements of operations. Should the Company achieve sufficient, sustained income in the future,the Company may conclude that some or all of the valuation allowance should bereversed.

 

Revenue Recognition

 

Revenue from productsales is recorded when the Company ships the product and title has passed tothe customer, provided that the Company has evidence of a customer arrangementand can conclude that collection is probable. The Company’s shipping policy isFOB Shipping Point.  The Companyrecognizes revenue from sales to stocking distributors when there is no rightof return, other than for normal warranty claims.  The Company has no ongoing obligations related to product sales,except for normal warranty.

 

Research and DevelopmentExpenses

 

The Company expensesresearch and development costs for products and processes as incurred.

 

Stock-Based Compensation  

 

The Company has adoptedthe disclosure-only provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” (“SFAS No. 123”), and applies Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), andrelated interpretations in accounting for stock options granted toemployees.  If the Company had accountedfor its stock-based compensation plans in accordance with SFAS 123, theCompany’s net income or loss and pro forma net income or loss per basic anddiluted common share for the three and Nine months ended December 31, 2003would have been reported as follows:

 

Three months endedDecember 31, 2003

 
| Net  Income (Loss)                                              |   |    |    |
|-----------------------------------------------------------------|--------|---------|---------|
| As  Reported                                                    |   | $       | 3,142   |   |
| Stock-based  compensation based upon estimated fair values      |   | (42,558 | )       |
| Pro  forma                                                      |   | $       | (39,416 | ) |
| Pro  Forma Net Income (Loss) Per Basic and Diluted Common Share |   |    |    |
| As  Reported                                                    |   | $       | 0.00    |   |
| Pro  Forma                                                      |   | $       | (0.01   | ) |

 

Nine months endedDecember 31, 2003
| Net Income (Loss)                                               |   |     |    |
|-----------------------------------------------------------------|--------|----------|---------|
| As Reported                                                     |   | $        | 69,882  |   |
| Stock-based  compensation based upon estimated fair values      |   | (123,022 | )       |
| Pro forma                                                       |   | $        | (53,140 | ) |
| Pro Forma Net  Income (Loss) Per Basic and Diluted Common Share |   |     |    |
| As Reported                                                     |   | $        | 0.01    |   |
| Pro Forma                                                       |   | $        | (0.01   | ) |

 

Segment Reporting

 

The Company has concludedthat it has one operating segment.

 

Basic and Diluted Incomeand Loss per Common Share

 

Net income or loss pershare is calculated in accordance with SFAS No. 128, “Earnings Per Share”(“SFAS No. 128”). Under the provisions of SFAS No. 128, basic net income orloss per common share is computed by dividing net income or loss for the periodby the weighted average number of common shares outstanding for the period.Diluted net income or loss per common share is computed by dividing the netincome or loss for the period by the weighted average number of common andpotential common shares outstanding during the period if the effect of thepotential common shares is dilutive.

 

9

----

 

The following is a tablethat reconciles the numerators and denominators of the basic and dilutedearnings per share:

 
|                                                                       |   | **For the Three Months Ended December 31, 2003** |   |
|----------------------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                                       |   | **Income  (Numerator)**                          |   | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
| Net  income                                                                |   |                                             |   |   |   |   |   |
| Basic  EPS Income available to common stockholders                         |   | $                                                | 3,142  |   | 5,785,121 |   | $ | 0.00 |   |
|                                                                       |   |                                             |   |   |   |   |   |
| Effect  of Dilutive Securities Stock Options                               |   |                                             |   | 469,378 |   |   |   |
|                                                                       |   |                                             |   |   |   |   |   |
| Diluted  EPS Income available to common stockholders + dilutive securities |   | $                                                | 3,142  |   | 6,254,499 |   | $ | 0.00 |   |

 

 
|                                                                       |   | **For the  Nine Months Ended December 31, 2003** |   |
|----------------------------------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                                       |   | **Income  (Numerator)**                          |   | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
| Net  income                                                                |   |                                             |   |   |   |   |   |
| Basic  EPS Income available to common stockholders                         |   | $                                                | 69,882 |   | 5,626,602 |   | $ | 0.01 |   |
|                                                                       |   |                                             |   |   |   |   |   |
| Effect  of Dilutive Securities Stock Options                               |   |                                             |   | 455,251 |   |   |   |
|                                                                       |   |                                             |   |   |   |   |   |
| Diluted  EPS Income available to common stockholders + dilutive securities |   | $                                                | 69,882 |   | 6,081,853 |   | $ | 0.01 |   |

 

Recently IssuedAccounting Standards

 

In August 2001, the FASB issued Statement of Financial AccountingStandards No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” (SFAS No. 144). SFAS No. 144 establishes a single accounting model forlong- lived assets to be disposed of by sale and requires that those long-livedassets be measured at the lower of carrying amount or fair value less cost tosell, whether reported in continuing operations or in discontinued operations.SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.The Company adopted SFAS No. 144 on April 1, 2002, and the adoption did nothave a material impact on the Company’s financial position or results ofoperations.

 

In December 2002, theFASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transitionand Disclosure” (“SFAS No. 148”), which (i) amends SFAS No. 123, “Accountingfor Stock-Based Compensation,” to provide alternative methods of transition foran entity that voluntarily changes to the fair value based method of accountingfor stock-based compensation (ii) amends the disclosure provisions of SFAS No.123 to require prominent disclosure about the effects on reported net income ofan entity’s accounting policy decisions with respect to stock-based employeecompensation and (iii) amends APB Opinion No. 28, “Interim FinancialReporting,” to require disclosure about those effects in interim financialinformation. Items (ii) and (iii) of the new requirements in SFAS No. 148 areeffective for financial statements for fiscal years ending after December 15,2002. We have included the requirements of item (ii) in Note 2 in the Notes toFinancial Statements and have included the requirements of item (iii) beginningin our first quarter of 2004.

 

In November 2002, theFASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (“FIN 45”), which requires that, for guarantees within the scope of FIN45 issued or amended after December 31, 2002, a liability for the fair value ofthe obligation undertaken in issuing the guarantee be recognized. FIN 45 doesnot apply to certain guarantee contracts, such as for a lessee’s residual valueguarantee embedded in a capital lease. FIN 45 also requires additionaldisclosures in financial statements for periods ending after December 15, 2002,

 

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which we have adopted.However, as of December 31, 2003, we believe that, other than product warranty,we have no material items subject to the new disclosure requirements.

 

(3)           COMMITMENTS ANDCONTINGENCIES

 

The Company currentlyleases its facilities under noncancelable lease agreements through October 31,2004. The minimum future lease payments are $27,893 for fiscal year ended March31, 2004 and $66,955 for fiscal year ended March 31, 2005.

 

The Company is subject toregulation by the United States Food and Drug Administration (“FDA”). The FDAprovides regulations governing the manufacture and sale of the Company’sproducts and regularly inspects the Company and other manufacturers todetermine their compliance with these regulations. As of December 31, 2003 theCompany believes it was in substantial compliance with all known regulations.The Company was last inspected in November 1998 and has not been notified ofany deficiencies from that inspection. FDA inspections are conductedperiodically at the discretion of the FDA.

 

The results of operationsfor the quarter ended December 31, 2003 should not be taken as an indication ofthe results of operations for all or any part of the balance of the year.

 

The accounts receivablebalance at December 31, 2003 of $953,460 included $42,730 (4%) frominternational customers.

 

(4)           MANAGEMENT’SREPRESENTATIONS

 

The condensed interimfinancial statements included herein have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the Securities and ExchangeCommission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted pursuant to such rules andregulations, although the Company believes that the disclosures made areadequate to make the information presented not misleading. The condensedinterim financial statements and notes thereto should be read in conjunctionwith the financial statements and the notes thereto, included in the Company’sAnnual Report to the Securities and Exchange Commission for the fiscal yearended March 31, 2003, filed on Form 10-KSB on June 12, 2003.

 

The accompanyingcondensed interim financial statements have been prepared, in all materialrespects, in conformity with the standards of accounting measurements set forthin Accounting Principles Board Opinion No. 28 and reflect, in the opinion ofmanagement, all adjustments necessary to summarize fairly the financialposition and results of operations for such periods in accordance withaccounting principles generally accepted in the United States of America.  All adjustments are of a normal recurringnature. The results of operations for the most recent interim period are notnecessarily indicative of the results to be expected for the full year.

 

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**ITEM2****–  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Certain statementscontained in this section on Management’s Discussion and Analysis are nothistorical facts, including statements about the Company’s strategies andexpectations about new and existing products, market demand, acceptance of newand existing products, technologies and opportunities, market and industrysegment growth, and return on investments in products and markets.  These statements are forward lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995 and involve substantial risks and uncertainties that may cause actualresults to differ materially from those indicated by the forward lookingstatements.  All forward lookingstatements in this section on Outlook are based on information available to theCompany on the date of this document, and the Company assumes no obligation toupdate such forward looking statements. Readers of this Form 10-QSB are strongly encouraged to review thesection entitled *“Factors Which May Affect Future Performance and Financial Condition.”*

 

**General**

 

Encision Inc. (“Encision”or “the Company”), a medical device company based in Boulder, Colorado, hasdeveloped and launched innovative technology that is emerging as a standard ofcare in minimally-invasive surgery. The Company believes its patented AEM®Surgical Instruments are changing the marketplace for electrosurgical devicesand laparoscopic instruments by providing a solution to a well documentedpatient safety risk in laparoscopic surgery.

 

Encision was founded toaddress market opportunities created by the increase in minimally-invasivesurgery (“MIS”) and the surgeons’ preference for using electrosurgery devicesin these procedures.  The productopportunity was created by surgeons’ continued widespread demand for usingmonopolar electrosurgery instruments which, when used in laparoscopic surgery,are susceptible to causing inadvertent collateral tissue damage outside thesurgeon’s field of view. The risk of unintended electrosurgical burn injury tothe patient in laparoscopic surgery has been well documented. This risk poses athreat to patient safety and creates liability exposure for surgeons andhospitals that do not adequately address the issue.

 

Encision’s patented AEMtechnology provides surgeons with the desired tissue effects, while preventingstray electrosurgical energy that can cause unintended and unseen tissueinjury. AEM Laparoscopic Instruments are equivalent to conventional instrumentsin size, shape, ergonomics and functionality but they incorporate “activeelectrode monitoring” technology to dynamically and continuously monitor theflow of electrosurgical current, thereby helping to prevent patient injury.With Encision’s “shielded and monitored” instruments, surgeons are able toperform electrosurgical procedures more safely and efficaciously than ispossible using conventional instruments. In addition, the AEM instruments arecost competitive with conventional “non-shielded, non-monitored”instruments.  The result is advancedpatient safety at comparable cost and with no change in surgeon technique.

 

AEM technology has beenrecommended and endorsed by sources from all groups involved inminimally-invasive surgery.  Surgeons,nurses, biomedical engineers, the medicolegal community, malpractice insurancecarriers and electrosurgical device manufacturers advocate the use of AEM technology.The breadth of endorsements continues to expand with the recognition of activeelectrode monitoring technology as an *AORN Recommended Practice* by theAssociation of periOperative Registered Nurses and with insurance andmedicolegal endorsements.

 

The Company has focusedits marketing strategies on expanding the market awareness of the AEMtechnology and its broad independent endorsements, and has continued efforts toexpand the AEM product line. With the broad array of AEM instruments nowavailable from the Company, the surgeon has a wide choice of instrument optionsand does not have to change surgical technique. This coincides with thecontinued expansion of independent endorsements for AEM technology.Recommendations from the malpractice insurance and medicolegal communitiescomplement the broad clinical endorsements AEM technology has garnered over thepast few years.

 

Adding furthercredibility to the benefits of Encision’s AEM technology are the Company’srecent supplier agreements with Novation and Premier, two of the largest GroupPurchasing Organizations (GPO) in the United States. Together, Novation andPremier represent over 3,000 hospitals and over 50% of all surgery in theU.S.  Management believes that these GPOsupplier agreements give further indication that AEM technology is gainingbroader acceptance in the market. Management believes that having the nation’sleading medical purchasing groups recognize the value of the Company’stechnology reflects the potential impact that AEM instruments products can havein the market and in advancing patient safety in surgery nationwide. Theseagreements do not involve purchase commitments but the Company expects theserelationships to expand the market visibility of AEM technology and smooth theprocurement and conversion process for new hospital customers.

 

When a hospital convertsto AEM technology it provides recurring revenue to the Company from sales ofreplacement instruments. There is a strong retention rate of customers who haveconverted to AEM technology. Management believes this indicates strong customersatisfaction and is further supported by the fact that there is no directlycompeting technology to supplant AEM products once the hospital has converted.The replacement market of reusable and disposable AEM products in convertedhospitals represents 

 

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over 65% of Encision’srevenue over the past twelve months and this revenue stream is expected to growas the base of newly converted hospitals continues to grow.

 

Until fiscal 2003, theCompany incurred annual losses since its inception, and has an accumulateddeficit of $15,191,454 at December 31, 2003. Operations have been financed primarily through issuance of equity. TheCompany’s liquidity has stabilized after a history of operating losses.  On July 30, 2003 the Company issued 333,334shares of its common stock to the Wasatch Micro Cap Fund and the Wasatch MicroCap Value Fund, for gross proceeds of $1,000,002.  Funds managed by Wasatch Advisors, Inc. held shares of the Company’scommon stock, constituting less than 5% of the issued and outstanding shares ofits common stock, prior to that transaction.

 

During the nine monthsended December 31, 2003, the Company used $159,940 in cash for operations andused $218,695 for investments in patents and equipment (primarily capitalequipment owned by the Company at customer locations). As of December 31, 2003,the Company had $1,212,333 in cash and cash equivalents available to fundfuture operations, an increase of $626,781 from March 31, 2003.  The Company’s working capital is $2,610,750at December 31, 2003.

 

**Historical Perspective**

 

The Company was organizedin 1991 and spent several years developing the AEM monitoring system andprotective sheaths to adapt to conventional electrosurgical instruments. Duringthis period, the Company conducted product trials and applied for patents withthe United States Patent Office and with the International patent agencies.Patents were issued in 1994, 1996, 1997, 1998 and 2002.

 

As the Company evolved,it was clear to the Company that its ‘active electrode monitoring’ technologyneeded to be integrated into the standard laparoscopic instrument design. Asthe development program proceeded, it also became apparent that the merging ofelectrical and mechanical engineering skills in the instrument developmentprocess for the Company’s patented, integrated electrosurgical instruments wasa complex and difficult task. As a result, instruments with integrated AEMtechnology were not completed for several years. Prior to offering a full rangeof laparoscopic electrosurgical instrumentation, it was difficult for hospitalsto commit to the AEM solution, as the Company did not have adequate comparablesurgical instrument options to match what the surgeon demanded. As of fiscal2001, a sufficiently broad product line was available to provide hospitaloperating rooms with AEM Instruments in most of the designs common forlaparoscopic surgery.

 

The launch of an expandedline of AEM Laparoscopic Instruments was accomplished over the past two years.With the broad array of AEM instruments now available, the surgeon has a widechoice of instrument options and does not have to change surgical technique.Since conversion to AEM technology is transparent to the surgeon, hospitals cannow universally convert to AEM technology, thus providing their laparoscopicsurgery patients a higher level of safety. This coincides with the continued expansion of independent endorsementsfor AEM technology.  Recommendationsfrom the malpractice insurance and medicolegal communities complement the broadclinical endorsements AEM technology has garnered over the past few years.

 

**Outlook**

 

*Installed Base of AEM Monitoring Equipment*:  The Company believes that the installed baseof AEM monitors has the potential for increasing as the inherent risksassociated with monopolar laparoscopic electrosurgery become more widelyacknowledged and as the network of independent sales representatives becomesmore adept at selling the AEM products to our customers. The Company expectsthat the replacement sales of electrosurgical instruments and accessories willincrease as additional hospitals are converted to AEM technology. The Companybelieves that the efforts to improve the quality of sales representativescarrying the AEM product line, along with increased marketing efforts and theintroduction of new products, may provide the basis for increased revenue andcontinuing profitable operations. However these measures, or any others that the Company may adopt, maynot result in either increased revenue or continuing profitable operations.

 

*Possibility of Continued Operating Losses: *Until fiscal 2003, theCompany had incurred losses from operations since inception and has anaccumulated deficit of $15,191,454 as of December 31, 2003.  The Company has made significant stridestoward improving its operating results. Approximately $627,000 of cash has been provided by the Company’sactivities in fiscal 2004. However, due to the ongoing need to develop, optimizeand train the independent sales rep network and the need to increase sustainedrevenues to a level adequate to cover fixed and variable operating costs, theCompany may operate at a net loss from time to time. On July 30, 2003 theCompany issued a total of 333,334 shares of its common stock to the WasatchMicro Cap Fund and the Wasatch Micro Cap Value Fund, for gross proceeds of$1,000,002.  Funds managed by WasatchAdvisors, Inc. held shares of the Company’s common stock, constituting lessthan 5% of the issued and outstanding shares of its common stock, prior to thattransaction.

 

*Revenue Growth*:  The Company expects to generate increased revenue in the U.S.from sales to new hospital customers as the network of independent salesrepresentatives becomes more proficient and expands the number of hospitalconversions to AEM Surgical Instruments. The Company believes that thevisibility and credibility of the independent clinical endorsements for AEMtechnology will contribute to new hospital conversions and increased revenuesin fiscal 2004.  The Company alsoexpects that supplier agreements with Novation and Premier, which togetherrepresent over 3,000 U.S. hospitals, will expose more hospitals to the benefitsof AEM technology and may stimulate new hospital conversions and increasedrevenues. The Company also expects to 

 

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increase market sharegains through promotional programs of placing Company-owned AEM monitors at nocharge into hospitals that commit to standardize on AEM instruments. Howeverthe Company’s efforts to increase market share and grow revenues will depend inpart on the Company’s ability to expand the efficiency and effective coveragerange of its independent sales representative network.

 

*Gross Profit and Gross Margins*:  Gross profit and gross margin can beexpected to fluctuate from quarter to quarter, as a result of product sales mixand sales volume. Gross margins on products manufactured or assembled by theCompany are expected to improve at higher levels of production and sales.

 

*Sales and Marketing Expenses*: We continueour efforts to expand domestic and international distribution capability and webelieve that sales and marketing expenses will decrease as a percentage of netrevenue with increasing sales volume.

 

*Research and Development Expenses*:Research and development expenses are expected to increase modestly to supportdevelopment of additions to our AEM product line, further expanding theinstrument options for the surgeon. New additions to the AEM product line areplanned for introduction in fiscal year 2004.

 

**Results of Operations**

 

*For the three months ended December 31, 2003 compared to thethree months ended December 31, 2002.*

 

*Net revenue*.  Revenue for the quarter ended December 31,2003, was $1,790,849, compared to $1,812,053 for the quarter ended December 31,2002, a decrease of 1%.  The decrease is attributable to a decrease in thenumber of new hospital conversion orders vs. one year ago.  The Company converted five new hospitals toAEM technology in the three months ended December 31, 2003.  The pipeline of new hospital prospects remains strong; however, progressthrough the sales continuum has slowed and we have seen a lower rate of newhospital conversions during the past nine months.  We believe this is due to a combination of factors, includinggeneral economic conditions.  However, we experienced a consistent level ofreplacement business from the installed base of users.  When a hospital converts to AEM technologythe Company earns revenue from replacement instrument purchases, which only theCompany can provide.  The Company isworking to expand the effective coverage range of its independent sales repnetwork.  These efforts are intended tohelp the Company increase new hospital conversions to AEM Instruments  The Company has trained 43 new reps in thepast 4 months.  While it will take anumber of months before they generate new hospital conversions, the combinationof the new rep additions and an expanded sales management team is intended toprovide the field focus necessary to achieve market gains

 

*Gross Profit*.  The gross profit for the quarter ended December 31, 2003 of$1,058,996 increased by 0% from the quarter ended December 31, 2002 grossprofit of $1,057,936. Gross profit as a percentage of revenue (gross margin)increased from 58% for the quarter ended December 31, 2002 to 59% in thequarter ended December 31, 2003.  Theincrease in gross margin was primarily the result of minor sales priceincreases compared with one year ago. For the three months ended December 31, 2003, the Company provided$23,889 in AEM monitors to customers at no-charge to newly converted hospitalsas part of a sales incentive program.

 

*Sales and marketing expenses*.  Sales and marketing expenses of $639,563 forthe quarter ended December 31, 2003 increased by 7% compared to $599,080 forthe quarter ended December 31, 2002. The increase was a result of increasedsales commissions on higher revenue. Sales expenses are under budget, though slightly increased versus oneyear ago.  We have taken recent actionsintended to lead to improved results commensurate with the special potential ofour AEM technology.  These actionsinclude adding personnel to our sales management team to more effectivelymanage the network of independent sales representatives and expand theeffective coverage range.  A largersales management team is focused on training, directing, motivating andmanaging the independent rep network to expand our effective coverage range andincrease the rate of new account conversions.

 

*General and administrative expenses*.  General and administrative expenses of$227,555 for the quarter ended December 31, 2003 increased by 20% compared to$189,254 for the quarter ended December 31, 2002. The increase is the result ofincreases in compensation, property &casualty insurance, legal fees and fees for outside Directors compared with oneyear ago.

 

*Research and development expenses*.  Research and development expenses of$190,050 for the quarter ended December 31, 2003 increased by 56% compared to$121,775 for the quarter ended December 31, 2002. The increase is a result ofadded headcount and expenses associated with initiatives to address design,manufacturing and cost improvements with several product lines.

 

*For the nine months ended December31, 2003 compared to the nine months ended December 31, 2002.*

 

*Net revenue.    *Revenue for the nine months ended December 31, 2003, were $5,372,808, comparedto $4,908,318 for the nine months ended December 31, 2002, an increase of 9%.The increase is attributable to the Company’s successful conversion of newhospitals utilizing AEM technology while maintaining strong ongoing businessand customer retention from hospitals that had previously converted toEncision’s technology.  The pipeline ofnew hospital prospects remains strong, however, progress through the salescontinuum has slowed and we have seen a lower rate of new hospital conversionsduring the past nine months.  We believethis is due to a combination of factors, including general economicconditions.  However, we experienced aconsistent level of replacement business from the installed base of users.  When a hospital converts to AEM technologythe Company earns revenue from replacement instrument purchases, which only theCompany can provide.  The Company is working to expand the effectivecoverage 

 

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range ofits independent sales rep network. These efforts are intended to help the Company increase new hospitalconversions to AEM Instruments  TheCompany has trained 43 new reps in the past 4 months.  While it will take a number of months before they generate newhospital conversions, the combination of the new rep additions and an expandedsales management team is intended to provide the field focus necessary toachieve market gains.

 

*Gross profit.*   Gross profit for the nine months ended December 31, 2003 of$3,136,237 increased by 6% from the nine months ended December 31, 2002 gross profitof $2,955,345.  Gross profit as apercentage of revenue (gross margin) decreased from 60% for the nine monthsended December 31, 2002 to 58% in the nine months ended December 31, 2003. Thedecrease in gross margin was primarily the result of increased depreciationexpense for no-charge AEM monitors placed in customer facilities, addedheadcount in Operations department, a shift in revenue mix (increased sales fora lower margin product family) and unfavorable foreign exchange rates comparedwith one year ago.  For the nine monthsended December 31, 2003, the Company provided $113,076 in AEM monitors tocustomers at no-charge to newly converted hospitals as part of a salesincentive program.

 

*Sales and marketing expenses.*   Sales and marketing expenses of $1,806,759for the nine months ended December 31, 2003 increased by 1% compared to$1,782,195 for the nine months ended December 31, 2002.  The sales commission programs are based onrevenue goals which include incentives for the sales team to grow revenue vianew hospital conversions to the Company’s AEM products.  Sales expenses are under budget, thoughslightly increased versus one year ago. Marketing expenses are decreased from one year ago due to the timingimpact of various marketing programs and initiatives.  We have taken recent actions intended to lead to improved resultscommensurate with the special potential of our AEM technology.  These actions include adding personnel toour sales management team to more effectively manage the network of independentsales representatives and expand the effective coverage range.  A larger sales management team is focused ontraining, directing, motivating and managing the independent rep network toexpand our effective coverage range and increase the rate of new accountconversions.

 

*General and administrative expenses.*  General and administrative expenses of$685,177 for the nine months ended December 31, 2003 increased by 3% comparedto $662,845 for the nine months ended December 31, 2002. The increase is theresult of increased compensation, property &casualty insurance, legal fees and fees for outside Directors compared with ayear ago.

 

*Research and development expenses.*   Research and development expenses of$570,474 for the nine months ended December 31, 2003 increased by 58% comparedto $361,642 for the nine months ended December 31, 2002. The increase is aresult of added headcount and expenses associated with initiatives to addressdesign, manufacturing and cost improvements with several product lines.

 

**Liquidity and Capital Resources**

 

To date, operating fundshave been provided primarily by sales of common stock and warrants to purchasethe Company’s common stock, which totaled $18,273,100 through December 31,2003, and, to a lesser degree, funds provided by sales of the Company’sproducts. On July 30, 2003 the Company issued a total of 333,334 shares of itscommon stock to the Wasatch Micro Cap Fund and the Wasatch Micro Cap ValueFund, for gross proceeds of $1,000,002. Funds managed by Wasatch Advisors, Inc. held shares of the Company’scommon stock, constituting less than 5% of the issued and outstanding shares ofits common stock, prior to that transaction.

 

The Company’s operationsused $159,940 of cash in the nine months ended December 31, 2003 on sales of$5,372,808 and generated $450,900 of cash in the nine months ended December 31,2002 on sales of $4,908,318. Prior to fiscal 2003, the use of cash in ouroperations resulted primarily from the funding of the Company’s annual netlosses. These amounts of cash generated from and used in operations are notindicative of the expected cash to be generated from or used in operations inFY 04. As of December 31, 2003, the Company had $1,212,333 in cash and cashequivalents available to fund future operations. Working capital was $2,610,750at December 31, 2003 compared to $1,596,831 at March 31, 2003. Currentliabilities were $885,044 at December 31, 2003, compared to $926,781 at March31, 2003.

 

Capital expenditures inthe nine months ended December 31, 2003 ($218,695) result primarily from thecapitalization of AEM monitors placed in hospitals under various promotionalprograms. Placing Company-owned AEM monitors into hospitals at no charge tofacilitate their use of AEM instruments is an initiative to accelerate newhospital conversions to AEM instruments. Under these promotional programs theCompany maintains ownership of the AEM monitor and the cost is capitalized anddepreciated as cost of sales over the projected five year life of the asset.

 

The Company’s fiscal year2004 (“FY 04”) operating plan is focused on increasing hospital conversions toAEM products, growing revenue, increasing gross profits and conserving cash.The Company can not predict with certainty the expected revenue, gross profit, netincome or loss and usage of cash and cash equivalents for FY 04. However,management believes that its cash resources will be sufficient to fund itsoperations for at least the next twelve months under its current operatingplan.  If management is unable to managethe Company’s business operations in line with budget expectations, it couldhave a material adverse effect on the Company’s business viability, financialposition, results of operations and cash flows. Further, if the Company is notsuccessful in sustaining profitability and remaining at least cash flowbreak-even, additional capital may be required to maintain ongoing operations.

 

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The Company believes theunique performance of the AEM technology and its breadth of independentendorsements provides an opportunity for continued market share growth. TheCompany believes that the market awareness of the AEM technology and itsendorsements is continually improving and that this will benefit the salesefforts in FY 04. The Company believes that the Company entered FY 04 havingachieved improvements in the clinical credibility of its technology. TheCompany’s objective in FY 04 is to maintain expense controls while optimizingsales execution in the field, expand market awareness of the AEM technology andmaximize the number of additional hospital conversions to AEM instruments.

 

**Income Taxes**

 

As of March 31, 2003, netoperating loss carryforwards totaling approximately $15,300,000 are availableto reduce taxable income in the future. The net operating loss carryforwardsexpire, if not previously utilized, at various dates beginning in the year2006. The Company has not paid income taxes since its inception. The Tax ReformAct of 1986 and other income tax regulations contain provisions which may limitthe net operating loss carryforwards available to be used in any given year, ifcertain events occur, including changes in ownership interests. The Company hasestablished a valuation allowance for the entire amount of its deferred taxasset since inception due to its history of losses. Should the Company achievesufficient, sustained income in the future, the Company may conclude that someor all of the valuation allowance should be reversed.

 

## **Contractual Obligations**

 

Aside from the operatinglease commitments, the Company does not have any material contractualcommitments requiring settlement in the future.

 

## **AtDecember 31, 2003, the Company’s commitments under these obligations were asfollows:**

 
|                     |   | **Operating Leases** |       |
|--------------------------|--------|----------------------|------------|
|                     |   |                 | ** ** |
| **Year ended March 31,** |   |                 | ** ** |
| **2004**                 |   | **$**                | **27,893** | ** ** |
| **2005**                 |   | **66,955**           | ** ** |
| ** **               |   |                 | ** ** |
|                     |   | **$**                | **94,848** |   |

## ** **

## **Critical Accounting Policies and Estimates**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenue and expenses, andrelated disclosure of contingent assets and liabilities. On an on-going basis,we evaluate our estimates, including those related to bad debts, inventories,sales returns, warranty, contingencies and litigation. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.  We believe the following critical accounting policies affect ourmore significant judgments and estimates used in the preparation of ourfinancial statements.

 

The Company maintainsallowances for doubtful accounts for estimated losses resulting from theinability of its customers to make required payments. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required, whichwould increase our expenses during the periods in which any such allowanceswere made.  The amount recorded as aprovision for bad debt in each period is based upon our assessment of thelikelihood that we will be paid on our outstanding receivables, based oncustomer-specific as well as general considerations.  To the extent that our estimates prove to be too high, and we ultimatelycollect a receivable previously determined to be impaired, we may record areversal of the provision in the period of such determination.

 

We provide for theestimated cost of product warranties at the time revenue is recognized. Whilewe engage in extensive product quality programs and processes, includingactively monitoring and evaluating the quality of its component suppliers, wehave experienced some costs related to warranty.  The warranty accrual is based upon historical experience and isadjusted based on current experience. Should actual warranty experience differfrom our estimates, revisions to the estimated warranty liability would berequired.

 

We reduce inventory forestimated obsolete or unmarketable inventory equal to the difference betweenthe cost of inventory and the estimated market value based upon assumptionsabout future demand and market conditions. If actual market conditions are lessfavorable than those projected by management, additional inventory write-downsmay be required. Any write-downs of inventory would reduce our reported netincome during the period in which such write-downs were applied.  To the extent that our estimates prove to betoo high, and 

 

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we ultimately utilize orsell inventory previously determined to be impaired, we may record a reversalof the provision in the period of such determination.

 

We recognize deferredincome tax assets and liabilities for the expected future income taxconsequences, based on enacted tax laws, of temporary differences between thefinancial reporting and tax bases of assets and liabilities. Deferred taxassets are then reduced, if deemed necessary, by a valuation allowance for theamount of any tax benefits which, more likely than not based on currentcircumstances, are not expected to be realized. Should we achieve sufficient,sustained income in the future, we may conclude that all or some of thevaluation allowance should be reversed

 

We depreciate ourproperty and equipment primarily on a double-declining basis over the estimateduseful life of the asset, generally three to five years. The Company-owned,consignment AEM Monitors are depreciated on a double-declining basis for aperiod of 5 years. Leasehold improvements are depreciated over the shorter ofthe remaining lease term or the estimated useful life of the asset. Maintenanceand repairs are expensed as incurred and major additions, replacements andimprovements are capitalized.

 

We amortize our patentcosts over their estimated useful lives, which is typically the remainingstatutory life.  From time to time, wemay be required to adjust these lives based on advances in technology,competitor actions, and the like.  Wereview the recorded amounts of patents at each period end to determine if theircarrying amount is still recoverable based on our expectations regarding salesof related products.  Such anassessment, in the future, may result in a conclusion that the assets areimpaired, with a corresponding charge against earnings.

 

**Factors Which May Affect Future Performance and FinancialCondition**:

 

You should carefullyconsider the risk factors described below. If any of the following risk factorsactually occur, the Company’s business, prospects, financial condition orresults of operations would likely suffer. In such case, the trading price ofthe Company’s common stock could fall resulting in the loss of all or part ofyour investment. You should look at all these risk factors in total. Some riskfactors may stand on their own. Some risk factors may affect (or be affectedby) other risk factors. You should not assume the Company has identified theseconnections. You should not assume that the Company will always update theseand future risk factors in a timely manner. The Company is not undertaking anyobligation to update these risk factors to reflect events or circumstancesafter the date of this report or to reflect the occurrence of unanticipatedevents.

 

Among the factors thatcould cause future results and financial condition to be materially differentfrom expectations are:

 

*1.**             Our products may notbe accepted by the market*.  Thesuccess of our products and our financial condition depends on the acceptanceof AEM products by the medical community in commercially viable quantitiesduring fiscal year 2004 and beyond. We cannot predict how quickly or howbroadly AEM products will be accepted by the medical community. We need tocontinually educate the marketplace about the**potential hazards involvedin the use of conventional electrosurgical products during minimally-invasivesurgical procedures and the expected benefits associated with the use of AEMproducts. If we are unsuccessful in educating the marketplace about ourtechnology and the hazards of conventional instruments, we will not createsufficient demand by hospitals and surgeons for AEM products and our financialcondition, results of operations and cash flows could be adversely affected.

 

*2.**             We need tocontinually develop and train our network of independent sales representativesand expand our distribution efforts in order to be successful.* Our attemptsto develop and train a network of independent sales representatives in the U.S.and to expand our international distribution efforts may take longer thanexpected and may result in considerable amounts of retraining effort as theindependent sales organizations change their product lines and personnel. Wemay not be able to obtain full coverage of the U.S. by independent salesrepresentatives as quickly as anticipated. The independent sales representativenetwork has inherent flaws and inefficiencies, which can include conflicts ofinterest and competing products. Optimizing the quality of the network and theperformance of independent sales representatives in the U.S. is an ongoingchallenge. We may also encounter difficulties in developing our internationalpresence due to regulatory issues and our ability to successfully developinternational distribution options. Our inability to expand our network ofindependent sales representatives and optimize their performance couldadversely affect our financial results.

 

*3.**             We may needadditional funding to support our operations.*  We were**formed in 1991 and have incurred lossesof over $15 million since that date. We have primarily financed research, development,and operational activities with sales of our common stock. At December 31,2003, we had $1,212,333 in cash available to fund future operations. We believethat we can maintain profitable operations in FY 2004 but there is no guaranteeof our ability to do so.  We may alsofind ourselves at a competitive disadvantage due to our constrained liquidity.

 

*4.**             We may not be able tocompete successfully against current manufacturers of conventional(“unshielded, unmonitored”) electrosurgical instruments or against competitorswho manufacture products that are based on surgical technologies that arealternatives to monopolar electrosurgery. *The electrosurgical products market is intensely competitive. Weexpect that manufacturers of “unshielded, unmonitored” electrosurgicalinstruments will resist any loss of market share that might result from thepresence of our “shielded and monitored” instruments in the marketplace. Wealso believe that manufacturers of products that are based upon surgicaltechnologies that are alternatives to monopolar electrosurgery are ourcompetitors. These technologies include bipolar 

 

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electrosurgery, theharmonic scalpel and lasers. The alternative technologies may gain market shareand new competitive technologies may be developed and introduced. Most of ourcompetitors and potential competitors have significantly greater financial,technical, product development, marketing and other resources. Most of ourcompetitors also currently have substantial installed customer bases in themedical products market and have significantly greater market recognition. As aresult of these factors, our competitors may be able to respond more quickly tonew or emerging technologies and changes in customer requirements or to devotegreater resources to the development, promotion and sale of their products. Itis possible that new competitors or new alliances among competitors may emergeand rapidly acquire significant market share. The competitive pressures we facemay materially adversely affect our financial position, results of operationsand cash flows, and this may hinder our ability to respond to competitivethreats.

 

*5.**             If we do notcontinually enhance our products and keep pace with rapid technologicalchanges, we may not be able to attract and retain customers.*****Ourfuture success and financial performance will depend in part on our ability tomeet the increasingly sophisticated needs of customers through the timelydevelopment and successful introduction of product upgrades, enhancements andnew products. These upgrades, enhancements and new products are subject tosignificant technical risks. The medical device market is subject to rapidtechnological change, resulting in frequent new product introductions andenhancements of existing products, as well as the risk of product obsolescence.While we are currently developing new products and enhancing our existingproduct lines, we may not be successful in completing the development of thenew products or enhancements. In addition, we must respond effectively totechnological changes by continuing to enhance our existing products toincorporate emerging or evolving standards. We may not be successful indeveloping and marketing product enhancements or new products that respond totechnological changes or evolving industry standards. We may experiencedifficulties that could delay or prevent the successful development,introduction and marketing of those products, and our new products and productenhancements may not adequately meet the requirements of the marketplace andachieve commercially viable levels of market acceptance. If any potential newproducts, upgrades, or enhancements are delayed, or if any potential newproducts, upgrades, or enhancements experience quality problems or do notachieve such market acceptance, or if new products make our existing productsobsolete, our financial position, results of operations and cash flows would bematerially adversely affected.

 

*6.**             If government regulationschange or if we fail to comply with existing and/or new regulations, we mightmiss market opportunities and experience increased costs and limited growth.*  The research, manufacturing, marketing anddistribution of our products in the United States and other countries aresubject to extensive regulation by numerous governmental authorities including,but not limited to, the Food and Drug Administration. Under the Federal Food,Drug and Cosmetic Act, medical devices must receive clearance from the Food andDrug Administration through the Section 510(k) pre-market notification processor through the more lengthy pre-market approval process before they can be soldin the United States. The process of obtaining required regulatory approvals islengthy and has required the expenditure of substantial resources. There can beno assurance that we will be able to continue to obtain the necessaryapprovals. As part of our strategy, we also intend to pursue commercializationof our products in international markets. Our products are subject toregulations that vary from country to country. The process of obtaining foreignregulatory approvals in certain countries can be lengthy and require theexpenditure of substantial resources. We may not be able to obtain necessaryregulatory approvals or clearances on a timely basis or at all, and delays inreceipt of or failure to receive such approvals or clearances, or failure tocomply with existing or future regulatory requirements would have a materialadverse effect on our financial position, results of operations and cash flows.

 

*7.**             If we fail to complywith the extensive regulatory requirements governing the manufacturing of ourproducts, we could be subject to fines, suspensions or withdrawals ofregulatory approvals, product recalls, suspension of manufacturing, operatingrestrictions and/or criminal prosecution.* The manufacturing of our productsis subject to extensive regulatory requirements administered by the Food andDrug Administration and other regulatory bodies. Inspection of ourmanufacturing facilities and processes can be conducted at any time, withoutprior notice, by the agencies. In addition, future changes in regulations orinterpretations made by the Food and Drug Administration or other regulatory bodies,with possible retroactive effect, could adversely affect us. Changes inexisting regulations or adoption of new regulations or policies could preventus from obtaining, or affect the timing of, future regulatory approvals orclearances. We may not be able to obtain necessary regulatory approvals orclearances on a timely basis in the future, or at all. Delays in receipt of,failure to receive such approvals or clearances and/or failure to comply withexisting or future regulatory requirements would have a material adverse effecton our financial position, results of operations and cash flows.

 

*8.**            **One of our directors controls anaggregate of approximately 33% of our common stock and our executive managementgroup owns a substantial percentage of our common stock.*  As ofDecember 31, 2003, Vern D. Kornelsen, a director of the Company, and an entitycontrolled by Mr. Kornelsen own an aggregate of 1,888,443 shares of our commonstock.  As a result, Mr. Kornelsen may be able to exert substantialinfluence over matters requiring action by our shareholders.  Our executive officers and directors as agroup beneficially own 3,092,484shares of ourcommon stock and as a group may be able to substantially influence the electionof our Board of Directors.  Such voting concentration could exertsubstantial influence over other matters requiring action by our shareholders.

 

*9.**             Our current patents,trade secrets and know-how may not provide a competitive advantage, the pendingapplications may not result in patents being issued, and our competitors maydesign around any patents issued to us.* Our success will continue to dependin part on our ability to maintain patent protection for our products andprocesses, to preserve our trade secrets and to operate without

 

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infringing theproprietary rights of third parties. We have four issued U.S. patents onseveral technologies embodied in our AEM Monitoring System, AEM Instruments andrelated accessories and we have applied for additional U.S. patents. Inaddition, we have four issued foreign patents. The validity and breadth ofclaims coverage in medical technology patents involve complex legal and factualquestions and may be highly uncertain. Also, patents may not protect ourproprietary information and know-how or provide adequate remedies for us in theevent of unauthorized use or disclosure of such information, and others may beable to develop, independently, such information. There has been substantiallitigation regarding patent and other intellectual property rights in themedical device industry. Litigation may be necessary to enforce patents issuedto us, to protect trade secrets or know-how owned by us, to defend us againstclaimed infringement of the rights of others or to determine the ownership,scope or validity of our proprietary rights or those of others. Any such claimsmay require us to incur substantial litigation expenses and to divertsubstantial time and effort of management personnel and could substantiallydecrease the amount of capital available for our operations. An adversedetermination in litigation involving the proprietary rights of others couldsubject us to significant liabilities to third parties, could require us toseek licenses from third parties, and could prevent us from manufacturing,selling or using our products. The occurrence of any such actual or threatenedlitigation or the effect on our business of such litigation may materiallyadversely affect our financial position, results of operations and cashflows.  Additionally, our assessmentthat a patent is no longer of value could result in a significant chargeagainst our earnings.

 

*10.**          We depend on singlesource suppliers for certain of the key components and sub-contractors toprovide much of our products used in the manufacturing of our products.  The loss of a supplier or limitation insupply from existing suppliers could have a material adverse effect on ourability to manufacture our products until a new source of supply is located.*Although we believe that there are alternative suppliers, any interruption inthe supply of key components could have a material adverse effect on us. Asudden increase in customer demand may create a backorder situation as leadtimes for some of our critical materials are in excess of 12 weeks.****Werely on subcontractors to provide products, either in the form of finishedgoods or sub-assemblies that we then assemble and test. While thesesub-contractors reduce our total cost of manufacturing, they may not be asresponsive to increased demand as we would be if we had our manufacturingcapacity entirely in-house, which may limit our growth strategy and revenues.

 

*11.**          The potentialfluctuation in future quarterly results may cause our stock price to fluctuate.*We expect that our operating results could fluctuate significantly from quarterto quarter in the future and will depend upon a number of factors, many ofwhich are outside our control. These factors include the extent to which ourAEM system and related accessories gain market acceptance; our investments inmarketing, sales, research and development and administrative personnelnecessary to support our anticipated growth; our ability to expand our marketshare; actions of competitors and general economic conditions. The market valueof our stock has dramatically fluctuated in the past and is likely to fluctuatein the future. Any deviation could have an immediate and significant negativeimpact on the market price of our stock.

 

*12.**          Our common stock is thinlytraded, the prices at which it trades are volatile and the buying or sellingactions of a few shareholders may adversely affect our stock price. *At March 31, 2003 we had a public floatof 2,457,358 shares or 43% of the outstanding common stock. The average numberof shares traded in any given day over the past year has been relatively smallcompared to the public float. Thus, the actions of a few shareholders eitherbuying or selling shares of our common stock may significantly affect the priceof the shares. Historically, the over-the-counter markets for securities suchas our common stock have experienced extreme price and volume fluctuations thatdo not necessarily relate to operating performance.

 

*13.**          Our insurance coveragefor product liability claims is up to $5,000,000.* We**face an inherent businessrisk of exposure to product liability claims in the event that the use of ourproducts is alleged to have resulted in adverse effects while in use. Wemaintain a general liability insurance policy up to the amount of $5,000,000that includes coverage for product liability claims. Liability claims may beexcluded from the policy, may exceed the coverage limits of the policy, or theinsurance may not continue to be available on commercially reasonable terms orat all. Consequently, a product liability claim or other claim with respect touninsured liabilities or in excess of insured liabilities could have a materialadverse effect on our financial position, results of operations and cash flows.

 

*14.**          We depend on revenuefrom some major customers*.  Wedepend on revenue that is generated from hospitals’ ongoing usage of the AEMsurgical instruments. In FY 2003, we generated revenue from over 300 hospitalsthat have converted to AEM products, but no hospital customer contributed morethan 3% to the total revenues.  In theU.S., we utilize one stocking distributor, which sells AEM products to multiplehospital customers.  During FY 2004, wehave generated revenue of $381,000 (7%) from this distributor.  While it is infrequent that a hospitalcustomer stops using AEM instruments after they convert, a loss of ongoingrevenue from a hospital customer could have a material adverse effect on ourrevenues and cash flows.

 

*15.**          We depend on certain keypersonnel.* We are highly dependent on a limited number of key managementpersonnel, particularly our President and Chief Executive Officer, James A.Bowman. Our loss of key personnel to death, disability or termination, or ourinability to hire and retain qualified personnel, could have a material adverseeffect on our financial position, results of operations and cash flows.

 

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**ITEM 3****– CONTROLSAND PROCEDURES**

 

(a) The Company hascarried out an evaluation under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andPrincipal Accounting Officer, of the effectiveness of the Company’s disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of theSecurities and Exchange Act of 1934 (the “Exchange Act”)). Based upon thatevaluation, the Chief Executive Officer and the Principal Accounting Officerconcluded as of December 31, 2003 that the Company’s disclosure controls andprocedures were effective in ensuring that information required to be disclosedby the Company under the Exchange Act was recorded, processed, summarized andreported within the time periods specified under the Exchange Act rules andforms.

 

(b) There were nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect the Company’s disclosure controls and proceduressubsequent to the date of the evaluation discussed above, nor any significantdeficiencies or material weaknesses in such disclosure controls, internalcontrols and procedures requiring corrective actions. As a result no correctiveactions were taken.

 

 

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**PART II****.**                **OTHERINFORMATION**

 

**ITEM 1****                   LEGALPROCEEDINGS**

 

The Company is not currentlyengaged in any legal proceedings except as described below.  The Company may become involved inlitigation in the future in the normal course of business.

 

The Company has notified oneof its distributors that it is in breach of its Distributor Agreement with theCompany in several respects, and that if the distributor does not cure thebreaches the Agreement may be terminated. The distributor has informed the Company that it believes the Company’sinterpretations of the Agreement are incorrect.  If the parties are not able to resolve the dispute or negotiate asettlement to the dispute, the Distributor Agreement provides for bindingarbitration in Boulder, Colorado.  Ifthe dispute is not resolved in a timely manner or is resolved in a manneradverse to the Company, it will likely affect sales activity in thedistributor’s territory.  While theCompany believes the existing on-going revenues from the installed baseof customers may not be affected, potential new sales to new hospitals in thatdistributor’s territory could be hindered. The distributor’s purchases have represented approximately 7% of theCompany’s revenue in FY2004 and 10% of the Company’s revenue in FY 2003.  The business entity is principally owned byan individual who is a shareholder of the Company.

 

**ITEM 2****                  **NotApplicable

 

**ITEM 3**                   **RECENT SALES OF UNREGISTERED SECURITIES**

 

On July 30, 2003 theCompany issued a total of 333,334 shares of its common stock to the WasatchMicro Cap Fund and the Wasatch Micro Cap Value Fund, for gross proceeds of$1,000,002.  Funds managed by WasatchAdvisors, Inc. held shares of the Company’s common stock, constituting lessthan 5% of the issued and outstanding shares of its common stock, prior to thattransaction.  These securities were soldin transactions exempt from registration under Section 4(2) of the SecuritiesAct of 1933 and Regulation D thereunder.

 

 

**ITEM 4 –**               Not Applicable

 

**ITEM 5 –**              Not Applicable

 

**ITEM****6**–               EXHIBITS AND REPORTSON FORM 8-K

 

(a)          Exhibits

 

 

31.1  Certification of Chief Executive Officer under Rule13a-14(a)

31.2  Certification of Principal Financial Officer under Rule13a-14(a)

32.1  Certification of Periodic Reports pursuant toSarbanes-Oxley Act of 2002

 

(b)         Reportson Form 8-K

 

NONE

 

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**SIGNATURE**

 

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,Encision has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 

 
| **Name**             |   | **Title**                       |   | **Date**          |
|----------------------|--------|---------------------------------|--------|-------------------|
|                 |   |                            |   |              |
|                 |   |                            |   |              |
| /s/ Marcia  McHaffie |   | Controller                      |   | February 13, 2004 |
| Marcia McHaffie      |   | (Principal Accounting  Officer) |   |              |

 

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