**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 ended June 30,2004**

 

**For the transition period from             to            **

 

**Commission file number     0-28604**

 

**ENCISION INC.**

(Exact name of small business issuer asspecified in its 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 bySection 13 of 15(d) of the Exchange Act during the past 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.**

 

**Yes****                           ****ý****                                  ****No****                                ****o**

 

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

 

| **Common Stock, No par****value** | ** ** | **6,234,309 Shares**                |
|-----------------------------------|------------|-------------------------------------|
| Class                             |       | (outstanding at July 31, 2004) |

 

**Transitional Small Business Disclosure Format**

 

**Yes****                           ****o****                                  ****No****                                ****ý**

 

 

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**ENCISION INC.**

 

**FORM 10-QSB**

 

**For the Quarter Ended June 30, 2004**

 

**INDEX**

 
| **PART I.**   | **UNAUDITED  FINANCIAL INFORMATION** |   |
|---------------|-------------------------------------------|--------|
|          |                                      |   |
|          | **ITEM 1**                                | – | Condensed  Interim Financial Statements: |   |
|          |                                      | -      | Condensed Balance Sheets as of  June 30, 2004 and March 31, 2004 |   |
|          |                                      | -      | Condensed Statements of Operations for the  Three Months Ended June 30, 2004 and 2003 |   |
|          |                                      | -      | Condensed Statements of Cash Flows for the  Three Months Ended June 30, 2004 and 2003 |   |
|          |                                      | -      | 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

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**PART I****                                                       FINANCIALINFORMATION**

 

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

 

ENCISION INC.

 

CONDENSED BALANCE SHEETS

(Unaudited)

 
|                                                                                                                                               |   | **June 30,  2004** | ** ** | **March 31,  2004** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|--------------------------|--------|
| ASSETS                                                                                                                                             |   |                    |       |                     |   |
| CURRENT ASSETS:                                                                                                                                    |   |                    |       |                     |   |
| Cash and cash equivalents                                                                                                                          |   | $                       | 1,409,389  |                     | $      | 1,356,607 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $65,000 and $62,000, respectively                                                  |   | 840,636                 |       | 947,692                  |   |
| Inventory, net of reserve for obsolescence  of $95,000 and $90,000, respectively                                                                   |   | 1,128,665               |       | 1,060,251                |   |
| Prepaid expenses                                                                                                                                   |   | 152,223                 |       | 67,120                   |   |
| Total current assets                                                                                                                               |   | 3,530,913               |       | 3,431,670                |   |
| EQUIPMENT, at cost:                                                                                                                                |   |                    |       |                     |   |
| Furniture, fixtures and equipment                                                                                                                  |   | 798,106                 |       | 771,916                  |   |
| Customer-site equipment                                                                                                                            |   | 450,538                 |       | 436,550                  |   |
| Less - accumulated depreciation                                                                                                                    |   | (927,843                | )          | (886,674                 | )      |
| Equipment, net                                                                                                                                     |   | 320,801                 |       | 321,792                  |   |
| PATENTS, net of accumulated amortization of  $71,066 and $68,027, respectively                                                                     |   | 114,721                 |       | 117,760                  |   |
| OTHER ASSETS                                                                                                                                       |   | 12,972                  |       | 12,972                   |   |
| Total assets                                                                                                                                       |   | $                       | 3,979,407  |                     | $      | 3,884,194 |   |
|                                                                                                                                               |   |                    |       |                     |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                          |   |                    |       |                     |   |
|                                                                                                                                               |   |                    |       |                     |   |
| CURRENT LIABILITIES:                                                                                                                               |   |                    |       |                     |   |
| Accounts payable                                                                                                                                   |   | $                       | 448,201    |                     | $      | 430,600 |   |
| Accrued compensation                                                                                                                               |   | 153,733                 |       | 107,266                  |   |
| Other accrued liabilities                                                                                                                          |   | 527,093                 |       | 285,232                  |   |
| Capitalized lease obligation                                                                                                                       |   | 15,690                  |       | 15,690                   |   |
| Total current liabilities                                                                                                                          |   | 1,144,717               |       | 838,788                  |   |
|                                                                                                                                               |   |                    |       |                     |   |
| LONG-TERM LIABILITIES:                                                                                                                             |   |                    |       |                     |   |
| Capitalized lease obligation                                                                                                                       |   | 11,767                  |       | 15,690                   |   |
|                                                                                                                                               |   |                    |       |                     |   |
| 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, 5,901,059 (June 30, 2004) and 5,845,526  (March 31, 2004) shares outstanding |   | 18,370,133              |       | 18,285,991               |   |
| Accumulated deficit                                                                                                                                |   | (15,547,210             | )          | (15,256,275              | )      |
| Total shareholders’ equity                                                                                                                    |   | 2,822,923               |       | 3,029,716                |   |
| Total liabilities and shareholders’ equity                                                                                                    |   | $                       | 3,979,407  |                     | $      | 3,884,194 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

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ENCISION INC.

 

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 
| ** **                                                                            | ** ** | **For the Three Months  Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
|                                                                                  |       | **2004**                                      | ** ** | **2003** |   |
|                                                                                  |       |                                          |       |   |   |
| REVENUE, NET                                                                          |       | $                                             | 1,763,264  |   | $ | 1,701,940 |   |
|                                                                                  |       |                                          |       |   |   |
| COST OF SALES                                                                         |       | 747,300                                       |       | 732,007 |   |
| Gross profit                                                                          |       | 1,015,964                                     |       | 969,933 |   |
| OPERATING EXPENSES:                                                                   |       |                                          |       |   |   |
| Sales and marketing                                                                   |       | 760,382                                       |       | 518,403 |   |
| General and administrative                                                            |       | 352,845                                       |       | 226,294 |   |
| Research and development                                                              |       | 193,857                                       |       | 188,574 |   |
| Total operating expenses                                                              |       | 1,307,084                                     |       | 933,271 |   |
| (LOSS) INCOME  FROM OPERATIONS                                                   |       | (291,120                                      | )          | 36,662 |   |
|                                                                                  |       |                                          |       |   |   |
| OTHER INCOME (EXPENSE):                                                               |       |                                          |       |   |   |
| Interest income                                                                       |       | 1,667                                         |       | 477 |   |
| Other (expense), net                                                                  |       | (1,482                                        | )          | (2,145 | ) |
| NET (LOSS) INCOME                                                                     |       | $                                             | (290,935   | ) | $ | 34,994 |   |
|                                                                                  |       |                                          |       |   |   |
| NET (LOSS) INCOME PER SHARE:                                                          |       |                                          |       |   |   |
| Basic and diluted net (loss) income per  common share                                 |       | $                                             | (0.05      | ) | $ | 0.01 |   |
|                                                                                  |       |                                          |       |   |   |
| Weighted average shares used in computing  basic net (loss) income per common share   |       | 5,853,845                                     |       | 5,430,026 |   |
|                                                                                  |       |                                          |       |   |   |
| Weighted average shares used in computing  diluted net (loss) income per common share |       | 5,853,845                                     |       | 5,881,529 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

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ENCISION INC.

 

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 
| ** **                                                                                          | ** ** | **For the Three Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
|                                                                                                |       | **2004**                                      | ** ** | **2003** |   |
|                                                                                                |       |                                          |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |                                          |       |   |   |
| Net (loss) income                                                                                   |       | $                                             | (290,935   | ) | $ | 34,994 |   |
| Adjustments to reconcile net (loss) income  to net cash provided by (used in) operating activities- |       |                                          |       |   |   |
| Depreciation and amortization                                                                       |       | 44,208                                        |       | 38,670 |   |
| Provision for bad debts                                                                             |       | 3,000                                         |       | (6,000 | ) |
| Inventory reserves                                                                                  |       | 5,000                                         |       | — |   |
| Changes in operating assets and  liabilities-                                                       |       |                                          |       |   |   |
| Accounts receivable                                                                                 |       | 104,056                                       |       | 226,433 |   |
| Inventory                                                                                           |       | (73,414                                       | )          | (153,407 | ) |
| Other assets                                                                                        |       | (85,103                                       | )          | (87,484 | ) |
| Accounts payable                                                                                    |       | 17,601                                        |       | 66,525 |   |
| Accrued compensation and other accrued  liabilities                                                 |       | 284,405                                       |       | (143,180 | ) |
| Net cash provided by (used) in operating  activities                                                |       | 8,818                                         |       | (23,449 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |                                          |       |   |   |
| Investment in equipment                                                                             |       | (40,178                                       | )          | (89,215 | ) |
| Net cash used in investing activities                                                               |       | (40,178                                       | )          | (89,215 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |                                          |       |   |   |
| Proceeds from the exercise of stock options                                                         |       | 84,142                                        |       | — |   |
| Net cash provided by financing activities                                                           |       | 84,142                                        |       | — |   |
|                                                                                                |       |                                          |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                               |       | 52,782                                        |       | (112,664 | ) |
|                                                                                                |       |                                          |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of  period                                                     |       | 1,356,607                                     |       | 585,552 |   |
| CASH AND CASH EQUIVALENTS, end of period                                                            |       | $                                             | 1,409,389  |   | $ | 472,888 |   |

 

The accompanying notes are an integral partof these financial statements.

 

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ENCISION INC.

 

NOTES TO CONDENSED INTERIM FINANCIALSTATEMENTS

 

JUNE 30, 2004

(Unaudited)

 

(1)                                  ORGANIZATION AND NATURE OF BUSINESS

 

Encision Inc. (the “Company”) is a medical device company that designs,develops, manufactures and markets patented surgical instruments that providegreater safety to patients undergoing minimally-invasive surgery.  The Company believes its patented AEM®surgical instrument technology is changing the marketplace for electrosurgicaldevices and instruments by providing a solution to a patient safety risk inlaparoscopic surgery. The Company’s sales to date have been made principally inthe United States.

 

On June 28, 2004, the Company announced that James A. Bowmanresigned as President and CEO of the Company. Mr. Bowman also stepped down fromhis post on the Company’s Board of Directors. On July 6, 2004, Mr. John R.Serino became President and CEO of the Company.

 

The Company achieved profitable operations in fiscal 2004 and 2003, butprior to that had incurred losses since its inception and has an accumulateddeficit of $15,547,210 at June 30, 2004. Operations have been financedprimarily through issuance of common stock.

 

During fiscal years 2004 and 2003, the Company achieved annual netincome for the first time in its history. The Company’s strategic marketing andsales plan is designed to expand the use of the Company’s products insurgically active hospitals in the United States. Management expects theseefforts to result in continued revenue increases for fiscal 2005 which,combined with planned controlled operating expenses and consistent gross profitmargins, are expected to maintain profitable operations and conserve theCompany’s cash resources.

 

On July 30, 2003 the Company issued a total of 333,334 shares ofits common 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.

 

(2)                                  SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions.  Suchestimates and assumptions affect the reported amounts of assets and liabilitiesas well as disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expense during thereporting period.  Actual results coulddiffer from those estimates.

 

Cash and Cash Equivalents

 

For purposes of reporting cash flows, the Company considers all cashand highly liquid investments with an original maturity of three months or lessto be cash equivalents.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments consist of cash and cashequivalents and short-term trade receivables and payables.  The carrying values of cash and cashequivalents and short-term receivables and payables approximate their fairvalue due to their short maturities.

 

Concentration of Credit Risk

 

The Company has no significant off-balance sheet concentrations ofcredit risk such as foreign exchange contracts, options contracts or otherforeign hedging arrangements. The Company maintains the majority of its cashbalances with two financial institutions in the form of demand deposits andmoney market funds.

 

Accounts receivables are typically unsecured and are derived fromtransactions with and from entities in the healthcare industry primarilylocated in the United States. Accordingly, the Company may be exposed to creditrisk generally associated with the 

 

6

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healthcare industry. The Company maintains allowances for doubtfulaccounts for estimated losses resulting from the inability of its customers tomake required payments.

 

The net accounts receivable balance at June 30, 2004 of $840,636included $67,633, or approximately 8%, from one distributor. The net accountsreceivable balance at March 31, 2004 of $947,692 included $48,212, orapproximately 5%, from one distributor.

 

Warranty Accrual

 

The Company provides for the estimated cost of product warranties atthe time revenue is recognized. While the Company engages in extensive productquality programs and processes, including actively monitoring and evaluatingthe quality of its component suppliers, the Company’s warranty obligation isbased upon historical experience and is also affected by product failure ratesand material usage incurred in correcting a product failure. Should actualproduct failure rates or material usage costs differ from the Company’s estimates,revisions to the estimated warranty liability would be required.

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first-out basis)or market. The Company reduces inventory for estimated obsolete or unmarketableinventory equal to the difference between the cost of inventory and theestimated market value based upon assumptions about future demand and marketconditions. If actual market conditions are less favorable than those projectedby management, additional inventory write-downs may be required. Inventoryconsisted of the following:

 
| ** **                      | ** ** | **June 30,  2004** | ** ** | **March 31,  2004** | ** ** |
|---------------------------------|------------|-------------------------|------------|--------------------------|------------|
|                            |       |                    |       |                     |       |
| Raw materials                   |       | $                       | 914,016    |                     | $          | 724,553 |   |
| Finished goods                  |       | 309,649                 |       | 425,698                  |       |
|                            |       | 1,223,665               |       | 1,150,251                |       |
| Less - Reserve for obsolescence |       | (95,000                 | )          | (90,000                  | )          |
|                            |       | $                       | 1,128,665  |                     | $          | 1,060,251 |   |

 

Property and Equipment

 

Property and equipment are stated at cost, with depreciation computedprimarily on a double-declining basis over the estimated useful life of theasset, generally three to five years. Company-owned AEM Monitors at customersites are depreciated on a double-declining basis for a period of 5 years.Leasehold improvements are depreciated over the shorter of the remaining leaseterm or the estimated useful life of the asset. Maintenance and repairs are expensedas incurred and major additions, replacements and improvements are capitalized.

 

Long-Lived Assets 

 

Long-lived assets are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. A long-lived asset is considered impaired when estimated futurecash flows related to the asset, undiscounted and without interest, areinsufficient to recover the carrying amount of the asset. If deemed impaired,the long-lived asset is reduced to its estimated fair value. Long-lived assetsto be disposed of are reported at the lower of their carrying amount orestimated fair value less cost to sell.

 

Patents

 

The costs of applying for patents are capitalized and amortized on astraight-line basis over the lesser of the patent’s economic or legal life (17years in the United States). Capitalized costs are expensed if patents are notgranted. The Company reviews the carrying value of its patents periodically todetermine whether the patents have continuing value and such reviews couldresult in the conclusion that the recorded amounts have been impaired.

 

Accrued Liabilities

 

The Company has accrued $116,000 related to warranty claims and $58,701related to sales commissions and has included these amounts in accruedliabilities in the accompanying balance sheets as of June 30, 2004.

 

7

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Income Taxes 

 

The Company accounts for income taxes under the provisions of Statementof Financial Accounting Standards (“SFAS”) No. 109, “Accounting for IncomeTaxes” (“SFAS No. 109”). SFAS No. 109 requires recognition of deferred incometax assets and liabilities for the expected future income tax consequences,based on enacted tax laws, of temporary differences between the financialreporting and tax bases of assets and liabilities. SFAS No. 109 also requiresrecognition of deferred tax assets for the expected future tax effects of alldeductible temporary differences, loss carryforwards and tax creditcarryforwards. Deferred tax assets are then reduced, if deemed necessary, by avaluation allowance for the amount of any tax benefits which, more likely thannot based on current circumstances, are not expected to be realized. Should theCompany achieve sufficient, sustained income in the future, the Company mayconclude that some or all of the valuation allowance should be reversed.

 

Revenue Recognition

 

Revenue from product sales is recorded when the Company ships theproduct and title has passed to the customer, provided that the Company hasevidence of a customer arrangement and can conclude that collection isprobable. The Company’s shipping policy is FOB 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 ongoingobligations related to product sales, except for normal warranty.

 

Research and Development Expenses

 

The Company expenses research and development costs for products andprocesses as incurred.

 

Stock-Based Compensation  

 

The Company has adopted the disclosure-only provisions of SFAS No. 123,“Accounting for Stock-Based Compensation” (“SFAS No. 123”), and appliesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB No. 25”), and related interpretations in accounting for stockoptions granted to employees.  If theCompany had accounted for its stock-based compensation plans in accordance withSFAS 123, the Company’s net income or loss and pro forma net income or loss perbasic and diluted common share for the three months ended June 30, 2004would have been reported as follows:

 
| Three months ended June 30, 2004                           |   |    |     |
|-----------------------------------------------------------------|--------|---------|----------|
| Net (Loss)                                                      |   |    |     |
| As Reported                                                     |   | $       | (290,935 | ) |
| Stock-based compensation based upon  estimated fair values      |   | (41,647 | )        |
| Pro forma                                                       |   | $       | (332,582 | ) |
| Pro Forma Net Income (Loss) Per Basic and  Diluted Common Share |   |    |     |
| As Reported                                                     |   | $       | (0.05    | ) |
| Pro Forma                                                       |   | $       | (0.06    | ) |

 

Segment Reporting

 

The Company has concluded that it has one operating segment.

 

Basic and Diluted Income and Loss per Common Share

 

Net income or loss per share is calculated in accordance with SFAS No.128, “Earnings Per Share” (“SFAS No. 128”). Under the provisions of SFAS No.128, basic net income or loss per common share is computed by dividing netincome or loss for the period by the weighted average number of common sharesoutstanding for the period. Diluted net income or loss per common share iscomputed by dividing the net income or loss for the period by the weightedaverage number of common and potential common shares outstanding during theperiod if the effect of the potential common shares is dilutive. As a result ofthe Company’s net loss for the three month period ended June 30, 2004, allpotentially dilutive securities would be anti-dilutive and thus, are excludedfrom diluted earnings per share.

 

For the three month period ended June 30, 2004, the Company hadfinancial instruments that could create future dilution to the Company’s commonshareholders and are not currently classified as outstanding common shares ofthe Company. The common stock number is based on specific conversion orissuance assumptions pursuant to the corresponding terms of each instrument.Potential stock issuance excluded from earnings per share because their effectwas anti-dilutive are 775,286 for the three months ended June 30, 2004.

 

8

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(3)                                  COMMITMENTSAND CONTINGENCIES

 

The Company currently leases its facilities under noncancelable leaseagreements through October 31, 2004. The minimum future lease payments are$38,260 for the fiscal year ended March 31, 2005. The Company has entereda new lease for its facilities under noncancelable lease agreements throughAugust 14, 2009 at 6797 Winchester Circle, Boulder, Colorado. The minimumfuture lease payments are as follows:

 
| Year ended March 31, |   |    |    |
|---------------------------|--------|---------|---------|
| 2005                      |   | —  |    |
| 2006                      |   | 86,826  |    |
| 2007                      |   | 154,179 |    |
| 2008                      |   | 166,930 |    |
| 2009                      |   | 172,685 |    |
| 2010                      |   | 65,566  |    |
|                      |   | $       | 646,186 |   |
|                           |        |         |         |  |

 

The Company had notified one of its distributors that it was in breachof its Distributor Agreement with the Company in several respects, and that ifthe distributor did not cure the breaches the Agreement may be terminated. Thedistributor had informed the Company that it believed the Company’sinterpretations of the Agreement were incorrect. The distributor disputed theCompany’s position and asserted that the Company had breached the Agreement.The dispute was proceeding in arbitration pursuant to the terms of theAgreement. On July 23, 2004, the dispute was resolved. During the firstquarter ended June 30, 2004, the Company had expensed approximately$201,000, and as of June 30, 2004, the balance in other accruedliabilities was $185,000 (including legal and arbitrator fees) for thisdispute.

 

The Company is subject to regulation by the United States Food and DrugAdministration (“FDA”). The FDA provides regulations governing the manufactureand sale of the Company’s products and regularly inspects the Company and othermanufacturers to determine their compliance with these regulations. As ofJune 30, 2004 the Company believes it was in substantial compliance withall known regulations. The Company was last inspected in November 1998 andhas not been notified of any deficiencies from that inspection. FDA inspectionsare conducted periodically at the discretion of the FDA.

 

The results of operations for the quarter ended June 30, 2004should not be taken as an indication of the results of operations for all orany part of the balance of the year.

 

The accounts receivable balance at June 30, 2004 of $840,636included $27,960 (3%) from international customers.

 

(4)                                  MANAGEMENT’SREPRESENTATIONS

 

The condensed interim financial statements included herein have beenprepared by the Company, without audit, pursuant to the rules and regulationsof the Securities and Exchange Commission. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omittedpursuant to such rules and regulations, although the Company believes that thedisclosures made are adequate to make the information presented not misleading.The condensed interim financial statements and notes thereto should be read inconjunction with the financial statements and the notes thereto, included inthe Company’s Annual Report to the Securities and Exchange Commission for thefiscal year ended March 31, 2004, filed on Form 10-KSB on June 29,2004.

 

The accompanying condensed interim financial statements have beenprepared, in all material respects, in conformity with the standards ofaccounting measurements set forth in Accounting Principles Board Opinion No. 28and reflect, in the opinion of management, all adjustments necessary tosummarize fairly the financial position and results of operations for suchperiods in accordance with accounting principles generally accepted in theUnited States of America.  Alladjustments are of a normal recurring nature. The results of operations for themost recent interim period are not necessarily indicative of the results to beexpected for the full year.

 

9

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**ITEM 2**** ****-  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. Thesestatements are forward looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995 and involve substantial risks anduncertainties that may cause actual results to differ materially from thoseindicated by the forward looking statements. All forward looking statements inthis section on Management’s Discussion and Analysis are based on informationavailable to the Company on the date of this document, and the Company assumesno obligation to update such forward looking statements. Readers of this Form10-QSB are strongly encouraged to review the section entitled *“Factors Which May Affect Future Performance and Financial Condition.”*

 

**General**

 

Encision Inc. (“Encision” or “the Company”), a medical device companybased in Boulder, Colorado, has developed and launched innovative technologythat is emerging as a standard of care in minimally-invasive surgery. TheCompany believes its patented AEM® Surgical Instruments are changingthe marketplace for electrosurgical devices and laparoscopic instruments byproviding a solution to a well documented patient safety risk in laparoscopicsurgery.

 

Encision was founded to address market opportunities created by theincrease in minimally-invasive surgery (“MIS”) and surgeons’ preference forusing electrosurgery devices in these procedures. The product opportunity wascreated by surgeons’ continued widespread demand for using monopolarelectrosurgery instruments which, when used in laparoscopic surgery, aresusceptible 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 AEM technology provides surgeons with the desiredtissue effects, while preventing stray electrosurgical energy that can causeunintended and unseen tissue injury. AEM Laparoscopic Instruments areequivalent to conventional instruments in size, shape, ergonomics andfunctionality but they incorporate “active electrode monitoring” technology todynamically and continuously monitor the flow of electrosurgical current,thereby helping to prevent patient injury. With Encision’s “shielded andmonitored” instruments, surgeons are able to perform electrosurgical proceduresmore safely and effectively than is possible using conventional instruments. Inaddition, the AEM instruments are cost competitive with conventional“non-shielded, non-monitored” instruments. The result is advanced patientsafety at comparable cost and with no change in surgeon technique.

 

AEM technology has been recommended and endorsed by sources from allgroups involved in minimally-invasive surgery. Surgeons, nurses, biomedicalengineers, the medicolegal community, malpractice insurance carriers andelectrosurgical device manufacturers advocate the use of AEM technology. Thebreadth of endorsements continues to expand with the recognition of activeelectrode monitoring technology as an *AORN Recommended Practice*by the Association of periOperative Registered Nurses and with insurance andmedicolegal endorsements.

 

The Company has focused its marketing strategies on expanding themarket awareness of the AEM technology and its broad independent endorsements,and has continued efforts to expand the AEM product line. With the broad arrayof AEM instruments now available from the Company, the surgeon has a widechoice of instrument options and does not have to change surgical technique.This coincides with the continued expansion of independent endorsements for AEMtechnology. Recommendations from the malpractice insurance and medicolegalcommunities complement the broad clinical endorsements AEM technology hasgarnered over the past few years.

 

Adding further credibility to the benefits of Encision’s AEM technologyare the Company’s supplier agreements with Novation and Premier, two of thelargest Group Purchasing Organizations (GPO) in the United States. Together,Novation and Premier represent over 3,000 hospitals and over 50% of all surgeryin the U.S. Management believes that these GPO supplier agreements give furtherindication that AEM technology is gaining broader acceptance in the market.Management believes that having the nation’s leading medical purchasing groupsrecognize the value of the Company’s technology reflects the potential impactthat AEM instruments products can have in the market and in advancing patientsafety in surgery nationwide. These agreements do not involve purchasecommitments but the Company expects these relationships to expand the marketvisibility of AEM technology and smooth the procurement and conversion processfor new hospital customers.

 

When a hospital converts to AEM technology it provides recurringrevenue to the Company from sales of replacement instruments. There is a strongretention rate of customers who have converted to AEM technology. Managementbelieves this indicates strong customer satisfaction and is further supportedby the fact that there is no directly competing technology to supplant AEM productsonce the hospital has converted. The replacement market of reusable anddisposable AEM products in converted hospitals represents 

 

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over 90% of Encision’s revenue over the past three months and thisrevenue stream is expected to grow as the base of newly converted hospitalscontinues to grow.

 

Until fiscal 2003, the Company incurred annual losses since itsinception, and has an accumulated deficit of $15,547,210 at June 30, 2004.Operations have been financed primarily through issuance of equity. TheCompany’s liquidity has stabilized after a history of operating losses. OnJuly 30, 2003 the Company issued 333,334 shares of its common stock to theWasatch Micro Cap Fund and the Wasatch Micro Cap Value Fund, for gross proceedsof $1,000,002. Funds managed by Wasatch Advisors, Inc. held shares of theCompany’s common stock, constituting less than 5% of the issued and outstandingshares of its common stock, prior to that transaction.

 

During the three months ended June 30, 2004, the Company generated$8,818 of cash from operations and used $40,178 for investments in equipment(primarily capital equipment owned by the Company at customer locations). As ofJune 30, 2004, the Company had $1,409,389 in cash and cash equivalentsavailable to fund future operations, an increase of $52,782 from March 31,2004. The Company’s working capital is $2,386,196 at June 30, 2004.

 

**Historical Perspective**

 

The Company was organized in 1991 and spent several years developingthe AEM monitoring system and protective sheaths to adapt to conventionalelectrosurgical instruments. During this period, the Company conducted producttrials and applied for patents with the United States Patent Office and withthe 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 ‘activeelectrode monitoring’ technology needed to be integrated into the standardlaparoscopic instrument design. As the development program proceeded, it alsobecame apparent that the merging of electrical and mechanical engineeringskills in the instrument development process for the Company’s patented,integrated electrosurgical instruments was a complex and difficult task. As aresult, instruments with integrated AEM technology were not completed forseveral years. Prior to offering a full range of laparoscopic electrosurgicalinstrumentation, it was difficult for hospitals to commit to the AEM solution,as the Company did not have adequate comparable surgical instrument options tomatch what the surgeon demanded. As of fiscal 2001, a sufficiently broadproduct line was available to provide hospital operating rooms with AEMInstruments in most of the designs common for laparoscopic surgery.

 

The launch of an expanded line of AEM Laparoscopic Instruments wasaccomplished over the past two years. With the broad array of AEM instrumentsnow available, the surgeon has a wide choice of instrument options and does nothave to change surgical technique. Because conversion to AEM technology istransparent to the surgeon, hospitals can now universally convert to AEMtechnology, thus providing their laparoscopic surgery patients a higher levelof safety. This coincides with the continued expansion of independentendorsements for AEM technology. Recommendations from the malpractice insuranceand medicolegal communities complement the broad clinical endorsements AEMtechnology 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. During thequarter ended June 30, 2004, the Company hired three direct territoryrepresentatives. The Company believes that the efforts to improve the qualityof sales representatives carrying the AEM product line, along with increasedmarketing efforts and the introduction of new products, may provide the basisfor increased revenue and continuing profitable operations. However thesemeasures, or any others that the Company may adopt, may not result in eitherincreased revenue or continuing profitable operations.

 

*Possibility of Continued Operating Losses: *Until fiscal 2003,the Company had incurred losses from operations since inception and has anaccumulated deficit of $15,547,210 as of June 30, 2004. The Company hasmade significant strides toward improving its operating results. Approximately$247,000 of cash was used in the Company’s activities in fiscal 2004. Due tothe ongoing need to develop, optimize and train the independent sales repnetwork and the need to increase sustained revenues to a level adequate tocover fixed and variable operating costs, the Company may operate at a net lossfrom time to time. On July 30, 2003 the Company issued a total of 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 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 increasedrevenue in the U.S. from sales to new hospital customers as the network ofindependent sales representatives becomes more proficient and expands thenumber of hospital conversions to AEM Surgical Instruments. The Companybelieves that the visibility and credibility of the independent clinicalendorsements for AEM technology will contribute to new hospital conversions andincreased revenues in fiscal 2005. The Company also expects that supplieragreements with Novation and Premier, which together represent over 3,000 U.S.hospitals, will expose more hospitals to the benefits 

 

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of AEM technology and may stimulate new hospital conversions andincreased revenues. The Company also expects to increase market share gainsthrough promotional programs of placing Company-owned AEM monitors at no chargeinto hospitals that commit to standardize on AEM instruments. However theCompany’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. During the quarter endedJune 30, 2004, the Company hired three direct territory representatives.

 

*Gross Profit and Gross Margins*:  Gross profit and gross margin can be expectedto fluctuate from quarter to quarter, as a result of product sales mix andsales 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*: The Companycontinues its efforts to expand domestic and international distributioncapability and it believes that sales and marketing expenses will decrease as apercentage of net revenue with increasing sales volume.

 

*Research and Development Expenses*: Researchand 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 2005.

 

**Results of Operations**

 

*For the three months ended June 30, 2004 compared to the threemonths ended June 30, 2003.*

 

*Net revenue*.  Revenue for the quarter ended June 30,2004, was $1,763,264, compared to $1,701,940 for the quarter endedJune 30, 2003, an increase of 4%. Theincrease is attributable to the conversion of new hospitals using our AEMtechnology. The Company converted seven new hospitals to AEM technology in thethree months ended June 30, 2004 versus ten new hospitals that convertedto AEM technology in the three months ended June 30, 2003. New hospital prospects remains strong; however,progress has slowed and we have seen a lower rate of new hospital conversionsduring the past three months. This is due to the Company having encountered ahigher turnover in its direct and independent sales representatives and theresulting time needed to train their replacements. While it will take a number of months before new independent salesrepresentatives generate new hospital conversions, the combination of the newrepresentative 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 June 30, 2004 of $1,015,964increased by 5% from the quarter ended June 30, 2003 gross profit of$969,933. Gross profit as a percentage of revenue (gross margin) increased from57% for the quarter ended June 30, 2003 to 58% in the quarter endedJune 30, 2004. The increase in gross margin was primarily the result ofpurchasing efficiencies compared with one year ago. For the three months endedJune 30, 2004, the Company provided $13,988 in AEM monitors to customers atno-charge to newly converted hospitals as part of a sales incentive program.

 

*Sales and marketing expenses*.  Sales and marketing expenses of $760,382 forthe quarter ended June 30, 2004 increased by 47% compared to $518,403 forthe quarter ended June 30, 2003. The increase was a result of compensationfor increased sales employees and resolution of an arbitration dispute. TheCompany had notified one of its distributors that it was in breach of itsDistributor Agreement with the Company in several respects, and that if thedistributor did not cure the breaches the Agreement may be terminated. Thedistributor had informed the Company that it believed the Company’sinterpretations of the Agreement were incorrect. The distributor disputed theCompany’s position and asserted that the Company had breached the Agreement.The dispute was proceeding in arbitration pursuant to the terms of theAgreement. On July 23, 2004, the dispute was resolved. During the firstquarter ended June 30, 2004, the Company had expensed approximately$201,000.

 

*General and administrative expenses*.  General and administrative expenses of$352,845 for the quarter ended June 30, 2004 increased by 56% compared to$226,294 for the quarter ended June 30, 2003. The increase is the resultof increases in compensation, legal fees and usetaxes compared with one year ago.

 

*Research and development expenses*.  Research and development expenses of $193,857for the quarter ended June 30, 2004 increased by 3% compared to $188,574for the quarter ended June 30, 2003. The increase is a result of increasesin compensation.

 

**Liquidity and Capital Resources**

 

To date, operating funds have been provided primarily by sales ofcommon stock and warrants to purchase the Company’s common stock, which totaled$18,370,133 through June 30, 2004, and, to a lesser degree, funds providedby sales of the Company’s products. On July 30, 2003 the Company issued atotal of 333,334 shares of its common stock to the Wasatch Micro Cap Fund andthe Wasatch Micro Cap Value Fund, for gross proceeds of $1,000,002. Fundsmanaged by Wasatch Advisors, Inc. held shares of the Company’s common stock,constituting less than 5% of the issued and outstanding shares of its commonstock, prior to that transaction.

 

The Company’s operations generated $8,818 of cash in the three monthsended June 30, 2004 on sales of $1,763,264 and used $23,449 of cash in thethree months ended June 30, 2003 on sales of $1,701,940. Prior to fiscal2003, the use of cash in our 

 

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operations resulted primarily from the funding of the Company’s annualnet losses. 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 05. As of June 30, 2004, the Company had $1,409,389 in cash and cashequivalents available to fund future operations. Working capital was $2,386,196at June 30, 2004 compared to $2,592,882 at March 31, 2004. Currentliabilities were $1,144,717 at June 30, 2004, compared to $838,788 atMarch 31, 2004.

 

The Company has entered a new lease for its facilities undernoncancelable lease agreements through August 14, 2009 at 6797 WinchesterCircle, Boulder, Colorado. The minimum future lease payments are as follows:

 
| Year ended March 31, |   |    |    |
|---------------------------|--------|---------|---------|
| 2011                      |   | —  |    |
| 2012                      |   | 86,826  |    |
| 2013                      |   | 154,179 |    |
| 2014                      |   | 166,930 |    |
| 2015                      |   | 172,685 |    |
| 2016                      |   | 65,566  |    |
|                      |   | $       | 646,186 |   |
|                           |        |         |         |  |

 

Capital expenditures in the three months ended June 30, 2004($40,178) result primarily from the capitalization of AEM monitors placed inhospitals under various promotional programs. Placing Company-owned AEMmonitors into hospitals at no charge to facilitate their use of AEM instrumentsis an initiative to accelerate new hospital conversions to AEM instruments.Under these promotional programs the Company maintains ownership of the AEMmonitor and the cost is capitalized and depreciated as cost of sales over theprojected five year life of the asset.

 

The Company’s fiscal year 2005 (“FY 05”) operating plan is focused onincreasing hospital conversions to AEM products, growing revenue, increasinggross profits and conserving cash. The Company can not predict with certaintythe expected revenue, gross profit, net income or loss and usage of cash andcash equivalents for FY 05. However, management believes that its cashresources will be sufficient to fund its operations for at least the nexttwelve months under its current operating plan. If management is unable tomanage the Company’s business operations in line with budget expectations, itcould have a material adverse effect on the Company’s business viability,financial position, results of operations and cash flows. Further, if theCompany is not successful in sustaining profitability and remaining at leastcash flow break-even, additional capital may be required to maintain ongoingoperations.

 

The Company believes the unique performance of the AEM technology andits breadth of independent endorsements provides an opportunity for continuedmarket share growth. The Company believes that the market awareness of the AEMtechnology and its endorsements is continually improving and that this willbenefit the sales efforts in FY 04. The Company believes that the Companyentered FY 04 having achieved improvements in the clinical credibility of itstechnology. The Company’s objective in FY 04 is to maintain expense controlswhile optimizing sales execution in the field, expand market awareness of theAEM technology and maximize the number of additional hospital conversions toAEM instruments.

 

**Income Taxes**

 

As of March 31, 2004, net operating loss carryforwards totalingapproximately $15,300,000 are available to reduce taxable income in the future.The net operating loss carryforwards expire, if not previously utilized, atvarious dates beginning in the year 2006. The Company has not paid income taxessince its inception. The Tax Reform Act of 1986 and other income taxregulations contain provisions which may limit the net operating losscarryforwards available to be used in any given year, if certain events occur,including changes in ownership interests. The Company has established avaluation allowance for the entire amount of its deferred tax asset sinceinception due to its history of losses. Should the Company achieve sufficient,sustained income in the future, the Company may conclude that some or all ofthe valuation allowance should be reversed.

 

## **ContractualObligations**

 

Aside from the operating lease commitments, the Company does not haveany material contractual commitments requiring settlement in the future.

 

## **At June 30, 2004, theCompany’s commitments under these obligations were as follows:**

 

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| ** **                | ** ** | **Operating Leases** | ** ** |
|---------------------------|------------|----------------------|------------|
| Year ended March 31, |       |                 |       |
| 2005                      |       | 38,260               |       |
| 2006                      |       | 86,826               |       |
| 2007                      |       | 154,179              |       |
| 2008                      |       | 166,930              |       |
| 2009                      |       | 172,685              |       |
| 2010                      |       | 65,566               |       |
|                      |       | $                    | 684,446    |   |
|                           |            |                      |            |  |

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenue and expenses,and related disclosure of contingent assets and liabilities. On an on-goingbasis, we evaluate our estimates, including those related to bad debts,inventories, sales returns, warranty, contingencies and litigation. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions. Webelieve the following critical accounting policies affect our more significantjudgments and estimates used in the preparation of our financial statements.

 

The Company maintains allowances for doubtful accounts for estimatedlosses resulting from the inability of its customers to make required payments.If the financial condition of our customers were to deteriorate, resulting inan impairment of their ability to make payments, additional allowances may berequired, which would increase our expenses during the periods in which anysuch allowances were made. The amount recorded as a provision for bad debt ineach period is based upon our assessment of the likelihood that we will be paidon our outstanding receivables, based on customer-specific as well as generalconsiderations. To the extent that our estimates prove to be too high, and weultimately collect a receivable previously determined to be impaired, we mayrecord a reversal of the provision in the period of such determination.

 

We provide for the estimated cost of product warranties at the timerevenue is recognized. While we engage in extensive product quality programsand processes, including actively monitoring and evaluating the quality of itscomponent suppliers, we have experienced some costs related to warranty. Thewarranty accrual is based upon historical experience and is adjusted based oncurrent experience. Should actual warranty experience differ from ourestimates, revisions to the estimated warranty liability would be required.

 

We reduce inventory for estimated obsolete or unmarketable inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon assumptions about future demand and market conditions. Ifactual market conditions are less favorable than those projected by management,additional inventory write-downs may be required. Any write-downs of inventorywould reduce our reported net income during the period in which suchwrite-downs were applied. To the extent that our estimates prove to be toohigh, and we ultimately utilize or sell inventory previously determined to beimpaired, we may record a reversal of the provision in the period of suchdetermination.

 

We recognize deferred income tax assets and liabilities for theexpected future income tax consequences, based on enacted tax laws, oftemporary differences between the financial reporting and tax bases of assetsand liabilities. Deferred tax assets are then reduced, if deemed necessary, bya valuation allowance for the amount of any tax benefits which, more likelythan not based on current circumstances, are not expected to be realized.Should we achieve sufficient, sustained income in the future, we may concludethat all or some of the valuation allowance should be reversed

 

We depreciate our property and equipment primarily on adouble-declining basis over the estimated useful life of the asset, generallythree to five years. The Company-owned, consignment AEM Monitors aredepreciated on a double-declining basis for a period of 5 years. Leaseholdimprovements are depreciated over the shorter of the remaining lease term orthe estimated useful life of the asset. Maintenance and repairs are expensed asincurred and major additions, replacements and improvements are capitalized.

 

We amortize our patent costs over their estimated useful lives, whichis typically the remaining statutory life. From time to time, we may berequired to adjust these lives based on advances in technology, competitoractions, and the like. We review the recorded amounts of patents at each periodend to determine if their carrying amount is still recoverable based on ourexpectations regarding sales of related products. Such an assessment, in thefuture, may result in a conclusion that the assets are impaired, with acorresponding charge against earnings.

 

**Factors Which May Affect Future Performance and Financial Condition**:

 

You should carefully consider the risk factors described below. If anyof the following risk factors actually occur, the Company’s business,prospects, financial condition or results of operations would likely suffer. Insuch case, the trading price of the Company’s common stock could fall resultingin the loss of all or part of your investment. You should look at all theserisk factors in total. Some risk factors may stand on their own. Some riskfactors may affect (or be affected by) other risk factors. You should notassume the 

 

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Company has identified these connections. You should not assume thatthe Company will always update these and future risk factors in a timelymanner. The Company is not undertaking any obligation to update these risk factorsto reflect events or circumstances after the date of this report or to reflectthe occurrence of unanticipated events.

 

Among the factors that could cause future results and financialcondition to be materially different from expectations are:

 

*1.**                                      Ourproducts may not be accepted by the market*. The success of our products and our financial condition depends on theacceptance of AEM products by the medical community in commercially viablequantities during fiscal year 2005 and beyond. We cannot predict how quickly orhow broadly AEM products will be accepted by the medical community. We need tocontinually educate the marketplace about the**potentialhazards involved in the use of conventional electrosurgical products duringminimally-invasive surgical procedures and the expected benefits associatedwith the use of AEM products. If we are unsuccessful in educating themarketplace about our technology and the hazards of conventional instruments,we will not create sufficient demand by hospitals and surgeons for AEM productsand our financial condition, results of operations and cash flows could beadversely affected.

 

*2.**                                      Weneed to continually develop and train our network of independent salesrepresentatives and expand our distribution efforts in order to be successful.*Our attempts to develop and train a network of independent salesrepresentatives in the U.S. and to expand our international distributionefforts may take longer than expected and may result in considerable amounts ofretraining effort as the independent sales reps change their product lines,product focus and personnel. We may not be able to obtain full coverage of theU.S. by independent sales representatives as quickly as anticipated. Theindependent sales representative network has inherent flaws and inefficiencies,which can include conflicts of interest 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.**                                      Wemay need additional funding to support our operations.* We were**formed in 1991 and have incurred losses of over $15 millionsince that date. We have primarily financed research, development, andoperational activities with sales of our common stock. At June 30, 2004,we had $1,409,389 in cash available to fund future operations. During FY 2004,we issued a total of 333,334 shares of our common stock to the Wasatch MicroCap Fund and the Wasatch Micro Cap Value Fund, for gross proceeds of$1,000,002. Funds managed by Wasatch Advisors, Inc. held shares of our commonstock, constituting less than 5% of the issued and outstanding shares of commonstock, prior to that transaction. We may have profitable operations in FY 2005but there is no guarantee we will do so. We may find that investment in salesand marketing initiatives, merited by market opportunity, may result in theCompany operating at a net loss from quarter to quarter.  We may also find ourselves at a competitivedisadvantage due to our constrained liquidity.

 

*4.**                                      Wemay not be able to compete successfully against current manufacturers ofconventional (“unshielded, unmonitored”) electrosurgical instruments or againstcompetitors who manufacture products that are based on surgical technologiesthat are alternatives to monopolar electrosurgery. *The electrosurgical products market isintensely competitive. We expect that manufacturers of “unshielded,unmonitored” electrosurgical instruments will resist any loss of market sharethat might result from the presence of our “shielded and monitored” instrumentsin the marketplace. We also believe that manufacturers of products that arebased upon surgical technologies that are alternatives to monopolar electrosurgeryare our competitors. These technologies include bipolar 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 than we do. Mostof our competitors also currently have substantial installed customer bases inthe medical products market and have significantly greater market recognition.As a result of these factors, our competitors may be able to respond morequickly to new or emerging technologies and changes in customer requirements orto devote greater resources to the development, promotion and sale of theirproducts. It is possible that new competitors or new alliances amongcompetitors may emerge and rapidly acquire significant market share. Thecompetitive pressures we face may materially adversely affect our financialposition, results of operations and cash flows, and this may hinder our abilityto respond to competitive threats.

 

*5.**                                      Ifwe do not continually enhance our products and keep pace with rapidtechnological changes, we may not be able to attract and retain customers.*****Our future success and financial performance will depend inpart on our ability to meet the increasingly sophisticated needs of customersthrough the timely development and successful introduction of product upgrades,enhancements and new products. These upgrades, enhancements and new productsare subject to significant technical risks. The medical device market issubject to rapid technological change, resulting in frequent new productintroductions and enhancements of existing products, as well as the risk ofproduct obsolescence. While we are currently developing new products andenhancing our existing product lines, we may not be successful in completingthe development of the new products or enhancements. In addition, we mustrespond effectively to technological changes by continuing to enhance ourexisting products to incorporate emerging or evolving standards. We may not besuccessful in developing and marketing product enhancements or new productsthat respond to technological changes or evolving industry standards. We mayexperience difficulties 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 

 

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acceptance, or if new products make our existing products obsolete, ourfinancial position, results of operations and cash flows would be materiallyadversely affected.

 

*6.**                                      Ifgovernment regulations change or if we fail to comply with existing and/or newregulations, we might miss market opportunities and experience increased costsand limited growth.*  The research,manufacturing, marketing and distribution of our products in the United Statesand other countries are subject to extensive regulation by numerousgovernmental authorities including, but not limited to, the U. S. Food and DrugAdministration. Under the Federal Food, Drug and Cosmetic Act, medical devicesmust receive clearance from the U. S. Food and Drug Administration through the Section 510(k) pre-marketnotification process or through the more lengthy pre-market approval processbefore they can be sold in the United States. The process of obtaining requiredregulatory approvals is lengthy and has required the expenditure of substantialresources. There can be no assurance that we will be able to continue to obtainthe necessary approvals. As part of our strategy, we also intend to pursuecommercialization of our products in international markets. Our products aresubject to regulations that vary from country to country. The process ofobtaining foreign regulatory approvals in certain countries can be lengthy andrequire the expenditure of substantial resources. We may not be able to obtainnecessary regulatory approvals or clearances on a timely basis or at all, anddelays in receipt of or failure to receive such approvals or clearances, orfailure to comply with existing or future regulatory requirements would have amaterial adverse effect on our financial position, results of operations andcash flows.

 

*7.**                                      Ifwe fail to comply with the extensive regulatory requirements governing themanufacturing of our products, we could be subject to fines, suspensions orwithdrawals of regulatory approvals, product recalls, suspension ofmanufacturing, operating restrictions and/or criminal prosecution.* Themanufacturing of our products is subject to extensive regulatory requirementsadministered by the Food and Drug Administration and other regulatory bodies.Inspection of our manufacturing facilities and processes can be conducted atany time, without prior notice, by the agencies. In addition, future changes inregulations or interpretations made by the Food and Drug Administration orother regulatory bodies, with possible retroactive effect, could adverselyaffect us. Changes in existing regulations or adoption of new regulations orpolicies could prevent us from obtaining, or affect the timing of, futureregulatory approvals or clearances. We may not be able to obtain necessaryregulatory approvals or clearances on a timely basis in the future, or at all.Delays in receipt of, failure to receive such approvals or clearances and/orfailure to comply with existing or future regulatory requirements would have amaterial adverse effect on our financial position, results of operations andcash flows.

 

*8.**                                      Ourcurrent patents, trade secrets and know-how may not provide a competitiveadvantage, the pending applications may not result in patents being issued, andour competitors may design around any patents issued to us.* Our successwill continue to depend in part on our ability to maintain patent protectionfor our products and processes, to preserve our trade secrets and to operatewithout infringing the proprietary rights of third parties. We have four issuedU.S. patents on several technologies embodied in our AEM Monitoring System, AEMInstruments and related accessories and we have applied for additional U.S.patents. In addition, we have four issued foreign patents. The validity andbreadth of claims coverage in medical technology patents involve complex legaland factual questions and may be highly uncertain. Also, patents may notprotect our proprietary information and know-how or provide adequate remediesfor us in the event of unauthorized use or disclosure of such information, andothers may be able to develop, independently, such information. There has beensubstantial litigation regarding patent and other intellectual property rightsin the medical device industry. Litigation may be necessary to enforce patentsissued to us, to protect trade secrets or know-how owned by us, to defend usagainst claimed infringement of the rights of others or to determine theownership, scope or validity of our proprietary rights or those of others. Anysuch claims may require us to incur substantial litigation expenses and todivert substantial time and effort of management personnel and couldsubstantially decrease the amount of capital available for our operations. Anadverse determination in litigation involving the proprietary rights of otherscould subject us to significant liabilities to third parties, could require usto seek 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 assessment thata patent is no longer of value could result in a significant charge against ourearnings.

 

*9.**                                      Wedepend on single source suppliers for certain of the key components andsub-contractors to provide much of our products used in the manufacturing ofour products.  The loss of a supplier or limitationin supply 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.****We rely on subcontractors to provide products, either inthe form of finished goods or sub-assemblies that we then assemble and test.While these sub-contractors reduce our total cost of manufacturing, they maynot be as responsive to increased demand as we would be if we had ourmanufacturing capacity entirely in-house, which may limit our growth strategyand revenues.

 

*10.**                               Thepotential fluctuation in future quarterly results may cause our stock price tofluctuate.*  We expect that ouroperating results could fluctuate significantly from quarter to quarter in thefuture and will depend upon a number of factors, many of which are outside ourcontrol. These factors include the extent to which our AEM technology andrelated accessories gain market acceptance; our investments in marketing,sales, research and development and administrative personnel necessary tosupport growth; our ability to expand our market share; actions of competitorsand general economic conditions. The market value of our common stock has 

 

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dramatically fluctuated in the past and is likely to fluctuate in thefuture. Any deviation could have an immediate and significant negative impacton the market price of our stock.

 

*11.**                               Ourcommon stock is thinly traded, the prices at which it trades are volatile andthe buying or selling actions of a few shareholders may adversely affect ourstock price. *At March 31, 2004,we had a public float of 2,714,083 shares or 46% of the outstanding commonstock. The average number of shares traded in any given day over the past yearhas been relatively small compared to the public float. Thus, the actions of afew shareholders either buying or selling shares of our common stock mayadversely affect the price of the shares. Historically, thinly traded securitiessuch as our common stock have experienced extreme price and volume fluctuationsthat do not necessarily relate to operating performance.

 

*12.**                               Ourinsurance coverage for product liability claims is up to $5,000,000.* We**face an inherent business risk of exposure to productliability claims in the event that the use of our products is alleged to haveresulted in adverse effects to a patient. We maintain a general liabilityinsurance policy up to the amount of $5,000,000 that includes coverage forproduct liability claims. Liability claims may be excluded from the policy, mayexceed the coverage limits of the policy, or the insurance may not continue tobe available on commercially reasonable terms or at all. Consequently, aproduct liability claim or other claim with respect to uninsured liabilities orin excess of insured liabilities could have a material adverse effect on ourfinancial position, results of operations and cash flows.

 

*13.**                               Wedepend on revenue from some major customers*.  We depend on revenue that is generated fromhospitals’ ongoing usage of the AEM surgical instruments. In FY 2004, wegenerated revenue from over 350 hospitals that have converted to AEM products,but no hospital customer contributed more than 2% to the total revenues. We utilizea small number of stocking distributors, which sell AEM products to multiplehospital customers. In FY 2004, we generated revenue of $437,307 (6%) from oneof these distributors.  While it isinfrequent that a hospital customer stops using AEM instruments after theyconvert, a loss of ongoing revenue from a hospital customer could have amaterial adverse effect on our revenues and cash flows.

 

*14.**                               Wedepend on certain key personnel.* We are highly dependent on a limitednumber of key management personnel, particularly our CEO and President, John R.Serino, and our Chairman of the Board and Vice President of BusinessDevelopment, Roger C. Odell. Our loss of key personnel to death, disability ortermination, or our inability to hire and retain qualified personnel, couldhave a material adverse effect on our financial position, results of operationsand cash flow.

 

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**ITEM 3**** ****-  CONTROLS AND PROCEDURES**

 

(a) The Company has carried out an evaluation under the supervision andwith the participation of the Company’s management, including the Company’sChief Executive Officer and Principal Accounting Officer, of the effectivenessof the Company’s disclosure controls and procedures (as defined in Rules13a-14(c) and 15d-14c of the Securities and Exchange Act of 1934 (the “ExchangeAct”)). Based upon that evaluation, the Chief Executive Officer and thePrincipal Accounting Officer concluded as of June 30, 2004 that theCompany’s disclosure controls and procedures were effective in ensuring thatinformation required to be disclosed by the Company under the Exchange Act wasrecorded, processed, summarized and reported within the time periods specifiedunder the Exchange Act rules and forms.

 

(b) There were no significant changes in the Company’s internalcontrols or in other factors that could significantly affect the Company’sdisclosure controls and procedures subsequent to the date of the evaluationdiscussed above, nor any significant deficiencies or material weaknesses insuch disclosure controls, internal controls and procedures requiring correctiveactions. As a result no corrective actions were taken.

 

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**PART II.**                                                **OTHER INFORMATION**

 

**ITEM 1****                                                        LEGALPROCEEDINGS**

 

The Company was involved in one legal proceeding (described below). TheCompany may become involved in litigation in the future in the normal course ofbusiness.

 

The Company had notified one of its distributors that it was in breachof its Distributor Agreement with the Company in several respects, and that ifthe distributor did not cure the breaches the Agreement may be terminated. Thedistributor had informed the Company that it believed the Company’sinterpretations of the Agreement were incorrect. The distributor disputed theCompany’s position and asserted that the Company had breached the Agreement.The dispute was proceeding in arbitration pursuant to the terms of theAgreement. On July 23, 2004, this dispute was resolved for approximately$201,000, including legal and arbitrator fees. The distributor’s purchasesrepresented approximately 6% of the Company’s revenue in FY2004 and 10% of theCompany’s revenue in FY2003. During the first quarter ended June 30, 2004,the Company had expensed approximately $201,000, and as of June 30, 2004,the balance in other accrued liabilities was $185,000 (including legal andarbitrator fees) for this dispute.

 

**ITEM 2****                                                       **Not Applicable

 

**ITEM 3****                                                       **Not Applicable

 

**ITEM 4**  -**                                          **Not Applicable

 

**ITEM 5**  -**                                          **Not Applicable

 

**ITEM****6**** **-                                           EXHIBITSAND REPORTS ON FORM 8-K

 

(a)          Exhibits

 
| 10.4 |   | Lease Agreement Dated June 3, 2004 between Encision Inc. and DaPuzzo Investment  Group, LLC |
|------|--------|---------------------------------------------------------------------------------------------|
| 31.1 |   | Certification of Chief Executive Officer under Rule 13a-14(a)                               |
| 31.2 |   | Certification of Principal Financial Officer under Rule 13a-14(a)                           |
| 32.1 |   | Certification of Periodic Reports pursuant to Sarbanes-Oxley Act of  2002                   |

                                                

 

(b)         Reports on Form 8-K

 

On April 8, 2004, the Company filed acurrent report on Form 8-K reporting the Company’s change of auditors, underItem 4. The Company also filed an amendment on Form 8-K/A on April 27,2004 to provide the outgoing auditors’ statement of agreement with theCompany’s disclosures in the Form 8-K filed on April 8.

 

On April 13, 2004, the Company furnisheda press release under Item 9 of Form 8-K.

 

On May 19, 2004, the Company furnished apress release under Item 12 of Form 8-K.

 

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**SIGNATURE**

 

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, Encision has duly caused this report to besigned on its behalf by the undersigned thereunto duly authorized.

 

 
| **Name**            | ** ** | **Title** | ** **                     | **Date** |
|---------------------|------------|-----------|--------------------------------|----------|
|                |       |      |                           |     |
| /s/ Marcia McHaffie |       |      | Controller                     |     | August 12, 2004 |
| Marcia McHaffie     |       |      | (Principal Accounting Officer) |     |   |

 

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