**U.S. Securities and Exchange CommissionWashington, D.C.  20549**

 

**Form 10-QSB**

 

| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|------------|------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30, 2003**

 

**For the transition period from           to           **

 

**Commission file number   0-28604**

 

| **ENCISION  INC.**                                                 |
|--------------------------------------------------------------------|
| (Exact name of small business issuer as  specified 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)                               |

 

**State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date:**

 

| **Common Stock, No par value** |   | **5,763,360 Shares**           |
|--------------------------------|--------|--------------------------------|
| Class                          |   | (outstanding at July 31, 2003) |

 

**Transitional SmallBusiness Disclosure Format**

 

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

 

 

----

 

**ENCISIONINC.**

 

**FORM10-QSB**

 

**Forthe Quarter Ended June 30, 2003**

 

**INDEX**

 
| **PART I.**  |          | **UNAUDITEDFINANCIAL  INFORMATION** |
|--------------|---------------|-------------------------------------|
|         |          |                                |   |
|         | **ITEM1**     | -                                   | Condensed  Interim Financial Statements: |
|         |          |                                |   |
|         |          | -                                   | Condensed Balance Sheets as of June 30,  2003 and March 31, 2003 |
|         |          |                                |   |
|         |          | -                                   | Condensed Statements of Operations for the  Three Months Ended June 30, 2003 and 2002 |
|         |          |                                |   |
|         |          | -                                   | Condensed Statements of Operations for the Three Months Ended June  30, 2003 and 2002 |
|         |          |                                |   |
|         |          | -                                   | Condensed Statements of Cash Flows for the  Three Months Ended June 30, 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

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**PART I****                  FINANCIAL INFORMATION**

 

**ITEM 1**** –  CONDENSED INTERIM FINANCIAL STATEMENTS**

 

ENCISION INC.

 

CONDENSEDBALANCE SHEETS

(Unaudited)

 
|                                                                                              |   | **June 30,  2003** |      | **March 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------|--------|--------------------|-----------|---------------------|------------|
|                                                                                              |   |               |      |                |       |
| ASSETS                                                                                            |   |               |      |                |       |
| CURRENT ASSETS:                                                                                   |   |               |      |                |       |
| Cash and cash equivalents                                                                         |   | $                  | 472,888   |                | $          | 585,552 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $19,000 and $25,000, respectively |   | 739,375            |      | 959,808             |       |
| Inventory, net of reserve for obsolescence  of $68,000 and $68,000, respectively                  |   | 1,084,730          |      | 931,323             |       |
| Prepaid expenses                                                                                  |   | 134,413            |      | 46,929              |       |
| Total current assets                                                                              |   | 2,431,406          |      | 2,523,612           |       |
|                                                                                              |   |               |      |                |       |
| EQUIPMENT, at cost:                                                                               |   |               |      |                |       |
| Furniture, fixtures and equipment                                                                 |   | 857,396            |      | 818,392             |       |
| Customer-site equipment                                                                           |   | 356,592            |      | 306,381             |       |
| Less - accumulated depreciation                                                                   |   | (893,775           | )         | (858,144            | )          |
| Equipment, net                                                                                    |   | 320,213            |      | 266,629             |       |
|                                                                                              |   |               |      |                |       |
| PATENTS, net of accumulated amortization of  $58,910 and $55,871, respectively                    |   | 126,877            |      | 129,916             |       |
| OTHER ASSETS                                                                                      |   | 12,972             |      | 12,972              |       |
| Total assets                                                                                      |   | $                  | 2,891,468 |                | $          | 2,933,129 |   |
|                                                                                              |   |               |      |                |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                         |   |               |      |                |       |
|                                                                                              |   |               |      |                |       |
| CURRENT LIABILITIES:                                                                              |   |               |      |                |       |
| Accounts payable                                                                                  |   | $                  | 483,373   |                | $          | 416,848 |   |
| Accrued compensation                                                                              |   | 70,386             |      | 150,607             |       |
| Other accrued liabilities                                                                         |   | 296,367            |      | 359,326             |       |
| Total current liabilities                                                                         |   | 850,126            |      | 926,781             |       |
|                                                                                              |   |               |      |                |       |
|                                                                                              |   |               |      |                |       |
| COMMITMENTS AND CONTINGENCIES                                                                     |   |               |      |                |       |
|                                                                                              |   |               |      |                |       |
| 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, 5,430,026 shares outstanding          |   | 17,267,684         |      | 17,267,684          |       |
| Accumulated deficit                                                                               |   | (15,226,342        | )         | (15,261,336         | )          |
| Total shareholders’ equity                                                                   |   | 2,041,342          |      | 2,006,348           |       |
| Total liabilities and shareholders’ equity                                                   |   | $                  | 2,891,468 |                | $          | 2,933,129 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

3

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ENCISION INC.

 

CONDENSEDSTATEMENTS OF OPERATIONS

(Unaudited)

 
|                                                                                  |   | **For the  Three Months  Ended June 30,** |      |
|---------------------------------------------------------------------------------------|--------|-------------------------------------------|-----------|
|                                                                                  |   | **2003**                                  |      | **2002** |   |
|                                                                                  |   |                                      |      |   |   |
| REVENUE, NET                                                                          |   | $                                         | 1,701,940 |   | $ | 1,342,392 |   |
|                                                                                  |   |                                      |      |   |   |
| COST OF SALES                                                                         |   | 732,007                                   |      | 513,060 |   |
| Gross profit                                                                          |   | 969,933                                   |      | 829,332 |   |
|                                                                                  |   |                                      |      |   |   |
| OPERATING EXPENSES:                                                                   |   |                                      |      |   |   |
| Sales and marketing                                                                   |   | 518,403                                   |      | 561,040 |   |
| General and administrative                                                            |   | 226,294                                   |      | 232,301 |   |
| Research and development                                                              |   | 188,574                                   |      | 124,778 |   |
| Total operating expenses                                                              |   | 933,271                                   |      | 918,119 |   |
|                                                                                  |   |                                      |      |   |   |
| INCOME (LOSS) FROM OPERATIONS                                                         |   | 36,662                                    |      | (88,787 | ) |
|                                                                                  |   |                                      |      |   |   |
| OTHER INCOME (EXPENSE):                                                               |   |                                      |      |   |   |
| Interest income                                                                       |   | 477                                       |      | 1,056 |   |
| Other income (expense), net                                                           |   | (2,145                                    | )         | (2,920 | ) |
| NET INCOME (LOSS)                                                                     |   | $                                         | 34,994    |   | $ | (90,651 | ) |
|                                                                                  |   |                                      |      |   |   |
| NET INCOME (LOSS) PER SHARE:                                                          |   |                                      |      |   |   |
| Basic and diluted net income (loss) per  common share                                 |   | $                                         | 0.01      |   | $ | (0.02 | ) |
|                                                                                  |   |                                      |      |   |   |
| Diluted net income (loss) per common share                                            |   | $                                         | 0.01      |   | $ | (0.02 | ) |
|                                                                                  |   |                                      |      |   |   |
| Weighted average shares used in computing  basic net income (loss) per common share   |   | 5,430,026                                 |      | 5,420,510 |   |
|                                                                                  |   |                                      |      |   |   |
| Weighted average shares used in computing  diluted net income (loss) per common share |   | 5,881,529                                 |      | 5,420,510 |   |

 

The accompanying notes are an integral part of these condensedfinancial statements.

 

4

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ENCISION INC.

 

CONDENSEDSTATEMENTS OF CASH FLOWS

(Unaudited)

 
|                                                                                                |   | **For the  Three Months  Ended June 30,** |    |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                                                                |   | **2003**                                  |    | **2002** |   |
|                                                                                                |   |                                      |    |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |   |                                      |    |   |   |
| Net income (loss)                                                                                   |   | $                                         | 34,994  |   | $ | (90,651 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities- |   |                                      |    |   |   |
| Depreciation and amortization                                                                       |   | 38,670                                    |    | 19,721 |   |
| Provision for bad debts                                                                             |   | (6,000                                    | )       | 3,000 |   |
| Inventory reserves                                                                                  |   | —                                    |    | — |   |
| Non-cash, stock-based, compensation charge                                                          |   | —                                    |    | 12,000 |   |
| Changes in operating assets and  liabilities-                                                       |   |                                      |    |   |   |
| Accounts receivable                                                                                 |   | 226,433                                   |    | 135,395 |   |
| Inventory                                                                                           |   | (153,407                                  | )       | 58,986 |   |
| Other assets                                                                                        |   | (87,484                                   | )       | (45,709 | ) |
| Accounts payable                                                                                    |   | 66,525                                    |    | 4,548 |   |
| Accrued compensation and other accrued  liabilities                                                 |   | (143,180                                  | )       | (34,403 | ) |
| Net cash provided by (used) in operating  activities                                                |   | (23,449                                   | )       | 62,887 |   |
|                                                                                                |   |                                      |    |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |   |                                      |    |   |   |
| Investment in equipment                                                                             |   | (89,215                                   | )       | (73,813 | ) |
| Patent costs                                                                                        |   | —                                    |    | (3,948 | ) |
| Net cash used in investing activities                                                               |   | (89,215                                   | )       | (77,761 | ) |
|                                                                                                |   |                                      |    |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |   |                                      |    |   |   |
| Proceeds from the exercise of stock options                                                         |   | —                                    |    | 3,950 |   |
| Net cash provided by financing activities                                                           |   | —                                    |    | 3,950 |   |
|                                                                                                |   |                                      |    |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                               |   | (112,664                                  | )       | (10,924 | ) |
|                                                                                                |   |                                      |    |   |   |
| CASH AND CASH EQUIVALENTS, beginning of  period                                                     |   | 585,552                                   |    | 500,988 |   |
| CASH AND CASH EQUIVALENTS, end of period                                                            |   | $                                         | 472,888 |   | $ | 490,064 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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ENCISION INC.

 

 

NOTES TO CONDENSED INTERIM FINANCIALSTATEMENTS

 

JUNE 30, 2003(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 well-documented risk inlaparoscopic surgery.  The Company’ssales to date have been made principally in the United States.

 

The Company achieved profitable operations in fiscal 2003 but prior tothat had incurred losses since its inception and has an accumulated deficit of$15,226,342 at March 31, 2003. Operations have been financed primarily throughissuance of common stock. The Company’s liquidity has substantially diminishedbecause of such continuing operating losses and the Company may be required toseek additional capital in the future.

 

During fiscal year 2003, the Company achieved annual net income andpositive cash flow for the first time in its history.  The Company’s strategic marketing and sales plan is designed toexpand the use of the Company’s products in surgically active hospitals in theUnited States.  Management expects theseefforts to result in continued revenue increases for fiscal 2004 which, combinedwith planned controlled operating expenses and consistent gross profit margins,are expected to maintain profitable operations and conserve the Company’s cashresources.

 

The Company believes that its cash and working capital resources willbe sufficient to fund its operations through March 31, 2004.  If the Company is not successful duringfiscal 2004 in sustaining profitability and positive cash flow, additionalcapital resources may be required.

 

(2)       SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

Use of Estimates in the Preparation of FinancialStatements

 

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 healthcare industry. The Company maintainsallowances for doubtful accounts for estimated losses resulting from theinability of its customers to make requiredpayments.

 

6

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A summary of the Company’s bad debt activity for the three months endedJune 30, 2003 is as follows:

 
| Balance, as of March 31, 2003 |   | $      | 25,000 |   |
|-------------------------------|--------|--------|--------|--------|
| Expense                       |   | (70    | )      |
| Write-offs                    |   | (5,930 | )      |
| Balance, as of June 30, 2003  |   | $      | 19,000 |   |

 

The net accounts receivable balance at June 30, 2003 of $739,375included $29,083, or approximately 4%, from one distributor. The net accountsreceivable balance at March 31, 2003 of $959,808 included $227,178, orapproximately 24%, from one distributor.

 

Warranty Accrual

 

The Company provides for the estimated costof product warranties at the time revenue is recognized. While the Companyengages in extensive product quality programs and processes, including activelymonitoring and evaluating the quality of its component suppliers, the Company’swarranty obligation is based upon historical experience and is also affected byproduct failure rates and material usage incurred in correcting a productfailure. Should actual product failure rates or material usage costs differfrom the Company’s estimates, revisions to the estimated warranty liabilitywould be required. A summary of the Company’s warranty claimsactivity for the three months ended June 30, 2003 is as follows:

 
| Balance, as of March 31, 2003 |   | $       | 152,500 |   |
|-------------------------------|--------|---------|---------|--------|
| Expense                       |   | 781     |    |
| Claims                        |   | (28,281 | )       |
| Balance, as of June 30, 2003  |   | $       | 125,000 |   |

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first-out basis)or market. The Company reduces 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. Inventory consisted of the following:

 
|                            |   | **June 30,  2003** |      | **March 31,  2003** |   |
|---------------------------------|--------|--------------------|-----------|---------------------|--------|
|                            |   |               |      |                |   |
| Raw materials                   |   | $                  | 769,105   |                | $      | 627,243 |   |
| Finished goods                  |   | 383,625            |      | 372,080             |   |
|                            |   | 1,213,988          |      | 999,323             |   |
| Less - Reserve for obsolescence |   | (68,000            | )         | (68,000             | )      |
|                            |   | $                  | 1,084,730 |                | $      | 931,323 |   |

 

A summary of the Company’s inventory reserve for obsolescence activityfor the three months ended June 30, 2003 is as follows:

 
| Balance, as of March 31, 2003 |   | $ | 68,000 |   |
|-------------------------------|--------|---|--------|--------|
| Expense                       |   | 0 |   |
| Write-offs                    |   | 0 |   |
| Balance, as of June 30, 2003  |   | $ | 68,000 |   |

 

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 areexpensed as incurred and major additions, replacements and improvements arecapitalized.

 

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, 

 

7

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undiscounted and without interest, are insufficient to recover thecarrying amount of the asset. If deemed impaired, the long-lived asset isreduced to its estimated fair value. Long-lived assets to be disposed of arereported at the lower of their carrying amount or estimated fair value lesscost 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 $125,000 related to warranty claims and $84,614related to sales commissions and has included these amounts in accruedliabilities in the accompanying balance sheets as of June 30, 2003.

 

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 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. SFAS No. 109 alsorequires recognition of deferred tax assets for the expected future tax effectsof all deductible 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. During FY03 the Company utilized net operating loss carryforwards to entirely offset itstax liability. As a result, no tax provision is reflected in the accompanyingstatements of operations.  Should theCompany achieve sufficient, sustained income in the future, the Company mayconclude that some or all of the valuation allowance should be reversed (Note5).

 

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 Company recognizes revenue from sales tostocking distributors when there is no right of return, other than for normalwarranty claims.  The Company has noongoing obligations 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 toEmployees” (“APB No. 25”), and related interpretations in accounting forstock options granted to employees.  Ifthe Company had accounted for its stock-based compensation plans in accordancewith SFAS 123, the Company’s net income or loss and pro forma net income orloss per basic and diluted common share for the three months ended June 30,2003 would have been reported as follows:

 
| Net Income (Loss)                                               |   |    |   |
|-----------------------------------------------------------------|--------|---------|--------|
| As Reported                                                     |   | $       | 34,994 |   |
| Stock-based compensation based upon  estimated fair values      |   | (35,605 | )      |
| Pro forma                                                       |   | $       | (611   | ) |
| Pro Forma Net Income (Loss) Per Basic and  Diluted Common Share |   |    |   |
| As Reported                                                     |   | $       | 0.01   |   |
| Pro Forma                                                       |   | $       | 0.00   |   |

 

Segment Reporting

 

The Company has concluded that it has one operating segment.

 

8

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Basic and Diluted Income and Loss per CommonShare

 

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 months ended June 30, 2002, allpotentially dilutive securities in the loss years would be anti-dilutive andwere excluded from the computation of diluted loss per share, and there are nodifferences between basic and diluted per share amounts for all prior yearspresented.

 

The following is a table that reconciles the numerators anddenominators of the basic and diluted earnings per share:

 
|                                                                       |   | **For the  Three Months Ended June 30, 2003** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                       |   | **Income  (Numerator)**                       |   | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
|                                                                       |   |                                          |   |   |   |   |   |
| Net income                                                                 |   |                                          |   |   |   |   |   |
| Basic EPS Income available to common  stockholders                         |   | $                                             | 34,994 |   | 5,430,026 |   | $ | 0.01 |   |
|                                                                       |   |                                          |   |   |   |   |   |
| Effect of Dilutive Securities Stock Options                                |   |                                          |   | 451,503 |   |   |   |
|                                                                       |   |                                          |   |   |   |   |   |
| Diluted EPS Income available to common  stockholders + dilutive securities |   | $                                             | 34,994 |   | 5,881,529 |   | $ | 0.01 |   |

 

Recently Issued Accounting 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, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”), which(i) amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to providealternative methods of transition for an entity that voluntarily changes to thefair value based method of accounting for stock-based compensation (ii) amendsthe disclosure provisions of SFAS No. 123 to require prominent disclosure aboutthe effects on reported net income of an entity’s accounting policy decisionswith respect to stock-based employee compensation and (iii) amends APB OpinionNo. 28, “Interim Financial Reporting,” to require disclosure about thoseeffects in interim financial information. Items (ii) and (iii) of the newrequirements in SFAS No. 148 are effective for financial statements for fiscalyears ending after December 15, 2002. We have included the requirements of item(ii) in Note 2 in the Notes to Financial Statements and will include therequirements of item (iii) beginning in our first quarter of 2004.

 

In November 2002, the FASB issued FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (“FIN 45”), which requires that,for guarantees within the scope of FIN 45 issued or amended after December 31,2002, a liability for the fair value of the obligation undertaken in issuingthe guarantee be recognized. FIN 45 does not apply to certain guaranteecontracts, such as for a lessee’s residual value guarantee embedded in acapital lease. FIN 45 also requires additional disclosures in financialstatements for periods ending after December 15, 2002, which we have adopted.However, as of June 30, 2003, we believe that, other than product warranty, wehave no material items subject to the new disclosure requirements.

 

9

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(3)       COMMITMENTS ANDCONTINGENCIES

 

The Company currently leases its facilities under noncancelable leaseagreements through October 31, 2004. The minimum future lease payments are$83,679 for fiscal year ended March 31, 2004 and $66,955 for fiscal year endedMarch 31, 2005.

 

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 of June30, 2003 the Company believes it was in substantial compliance with all knownregulations. The Company was last inspected in November 1998 and has not, atJune 30, 2003, been notified of any deficiencies from that inspection. FDAinspections are conducted approximately every two years or on a more frequentbasis at the discretion of the FDA.

 

The results of operations for the quarter ended June 30, 2003 shouldnot be taken as an indication of the results of operations for all or any partof the balance of the year.

 

The accounts receivable balance at June 30, 2003 of $739,375 included$35,802 (5%) 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 footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations, although the Company believes that the disclosures madeare adequate 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 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.

 

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**ITEM 2  –****             MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**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 the surgeons’ preference forusing electrosurgery devices in these procedures.  The product opportunity was created by surgeons’ continuedwidespread demand for using monopolar electrosurgery instruments which, whenused in laparoscopic surgery, are susceptible to causing inadvertent collateraltissue damage outside the surgeon’s field of view. The risk of unintendedelectrosurgical burn injury to the patient in laparoscopic surgery has beenwell documented. This risk poses a significant threat to patient safety andcreates liability exposure for surgeons and hospitals that do not adequatelyaddress 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, therebyhelping to prevent patient injury. With Encision’s “shielded and monitored”instruments, surgeons are able to perform electrosurgical procedures moresafely and efficaciously than is possible using conventional instruments. Inaddition, the AEM instruments are cost competitive with conventional“non-shielded, non-monitored” instruments. The result is advanced patient safety at comparable cost and with nochange in surgeon technique.

 

AEM technology has been recommended and endorsed by sources from all groupsinvolved in minimally-invasive surgery. Surgeons, nurses, biomedical engineers, the medicolegal community,malpractice insurance carriers and electrosurgical device manufacturersadvocate the use of AEM technology. The breadth of endorsements continues toexpand with the recognition of active electrode monitoring technology as an *AORNRecommended Practice* by the Association of periOperative RegisteredNurses and with insurance and medicolegal 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 wide choiceof instrument options and does not have to change surgical technique. Thiscoincides with the continued expansion of independent endorsements for AEMtechnology. New 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 technologyis the Company’s recent supplier agreements with Novation and Premier, two ofthe largest Group Purchasing Organizations (GPO) in the United States.Together, Novation and Premier represent over 3,000 hospitals and over 50% ofall surgery in the U.S. Management believes that the launch of these GPOsupplier agreements gives 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 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 AEMproducts once the hospital has converted. The replacement market of reusableand disposable AEM products in converted hospitals represents over 65% ofEncision’s revenue over the past twelve months and this revenue stream isexpected to grow as the base of newly converted hospitals continues to grow.

 

Until fiscal 2003, the Company has incurred annual losses since itsinception and has an accumulated deficit of $15,226,342 at June 30, 2003.  Operations have been financed primarilythrough issuance of equity. The Company’s liquidity has stabilized after ahistory of operating losses.  To furtherexpand it operations, or to support future operating losses, if any, theCompany may be required to seek additional capital to continue operations.

 

During the three months ended June 30, 2003, the Company used $23,449in cash from its operations, used $89,215 for investments in patents andequipment (primarily capital equipment owned by the Company at customerlocations). As of June 30, 2003, the

 

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Company had $472,888 in cash and cash equivalents available to fundfuture operations, a decrease of $112,664 from March 31, 2003.  The Company’s working capital is $1,581,280at June 30, 2003.

 

**HistoricalPerspective**

 

The Company was organized in 1991 and spentseveral years developing the AEM monitoring system and protective sheaths toadapt to conventional electrosurgical instruments. During this period, theCompany conducted product trials and applied for patents with the United StatesPatent Office and with the International patent agencies. Patents were issuedin 1994, 1997, 1998 and 2003.

 

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 AEMLaparoscopic Instruments was accomplished over the past two years. With the broad array of AEM instruments nowavailable, the surgeon has a wide choice of instrument options and does nothave to change surgical technique. Since conversion to AEM technology istransparent to the surgeon, hospitals cannow universally convert to AEM technology, thus providing all of theirlaparoscopic surgery patients a higher level of safety.  This coincides with the continuedexpansion of independent endorsements for AEM technology.  Recommendations from the malpracticeinsurance and medicolegal communities complement the broad clinicalendorsements AEM technology has garnered over the past few years.

 

**Outlook**

 

Certain statementscontained in this section on Outlook are not historical facts, includingstatements about the Company’s strategies and expectations about new andexisting products, market demand, acceptance of new and existing products,technologies and opportunities, market and industry segment growth, and returnon investments in products and markets. These statements are forward looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995 and involve substantialrisks and uncertainties that may cause actual results to differ materially fromthose indicated by the forward looking statements.  All forward looking statements in this section on Outlook arebased on information available to the Company on the date of this document, andthe Company assumes no obligation to update such forward lookingstatements.  Readers of this Form 10-KSBare strongly encouraged to review the section entitled *“Factors Which May Affect FuturePerformance and Financial Condition”*.

 

*Installed Base ofAEM Monitoring Equipment*:  The Company believes that the installed base of AEM monitors hasthe potential for increasing as the inherent risks associated with monopolarlaparoscopic electrosurgery become more widely acknowledged and as the networkof independent sales representatives becomes more adept at selling the AEMproducts to our customers. The Company expects that the replacement sales ofelectrosurgical instruments and accessories will increase as additionalhospitals are converted to AEM technology. The Company believes that themeasures taken to improve the quality of sales representatives carrying the AEMproduct line, along with increased marketing efforts and the introduction ofnew products, may provide the basis for increased revenue and continuingprofitable operations.  However these measures,or any others that the Company may adopt, may not result in either increasedrevenue or continuing profitable operations.

 

*Possibility ofContinued Operating Losses: *Untilfiscal 2003, the Company had incurred losses from operations since inceptionand has an accumulated deficit of $15,226,342 as of June 30, 2003. The Companyhas made significant strides toward improving its operating results and$442,315 of cash was provided by the Company’ operating activities in fiscal2003. However, due to the ongoing need to develop, optimize and train the salesdistribution network and the need to increase sustained revenues to a leveladequate to cover fixed and variable operating costs, the Company may operateat a net loss from time to time. The Company is evaluating various futurefunding options. However, management believes that its current cash on hand andworking capital will be sufficient to fund operations through at least March31, 2004.

 

*Revenue Growth*:  The Company expects to generate increased revenuein the U.S. from sales to new hospital customers as the network of independentsales representatives becomes more proficient and expands the number ofhospital conversions to AEM Laparoscopic Instruments. The Company believes thatthe visibility and credibility of the independent clinical endorsements for theAEM technology will contribute to new hospital conversions and increasedrevenues in fiscal 2004.  The Company also expects thatsupplier agreements with Novation and Premier, which together represent over3,000 U.S. hospitals, will expose more hospitals to the benefits of AEMtechnology and may stimulate new hospital conversions and increased revenues.The Company also expects to accelerate market share gains through promotionalprograms of placing Company-owned AEM monitors at no charge into hospitals thatcommit to standardize on AEM instruments.

 

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*Gross Profit andGross Margins*: Gross profit and gross margin can be expected to fluctuate from quarterto quarter, as a result of product sales mix and sales volume. Gross margins onproducts manufactured or assembled by the Company are expected to improve athigher levels of production and sales.

 

*Sales and MarketingExpenses*: We continue our efforts to expand domesticand international distribution capability andwe believe that sales and marketing expenses will decrease as a percentage ofnet revenue with increasing sales volume.

 

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

 

**Resultsof Operations**

 

*For the three monthsended June 30, 2003 compared to the three months ended June 30, 2002.*

 

*Net revenue*. Revenue for the quarter ended June 30, 2003, was $1,701,940, compared to$1,342,392 for the quarter ended June 30, 2002, an increase of 27%.  The increaseis attributable to our increasing visibility in the market which has resultedin the conversion of new hospitals utilizing AEM technology. The increasingnumber of hospitals using AEM technology is also attributed to improving salesand marketing efforts, the recent GPO supplier agreements with Novation andPremier, as well as our strategic plan to accelerate market share gains throughpromotional programs of placing Company-owned AEM Monitors at no-charge intohospitals that commit to standardize on AEM instruments. In addition, theCompany experienced a consistent level of replacement business from theinstalled base of users.  When ahospital converts to AEM technology the Company earns revenue from replacementinstrument purchases, which only the Company can provide.  The Company converted ten new hospitals toAEM technology in the three months ended June 30, 2003.

 

*Gross Profit*.  The gross profit for the quarter ended June30, 2003 of $969,933 increased by 17% from the quarter ended June 30, 2002gross profit of $829,332. Gross profit as a percentage of revenue (grossmargin) decreased from 62% for the quarter ended June 30, 2002 to 57% in thequarter ended June 30, 2003.  The decrease in gross margin was primarily theresult of increased depreciation expense for no-charge AEM monitors placed incustomer facilities, added headcount in operations department, a shift inrevenue mix in Q1 (increased sales for a lower margin product family), andunfavorable foreign exchange rates compared with one year ago.  For the three months ended June 30,2003, the Company provided $50,211 in AEM monitors to customers at no-charge tonewly converted hospitals as part of a sales incentive program.

 

*Sales and marketing expenses*.  Sales and marketing expenses of $518,403 forthe quarter ended June 30, 2003 decreased by 8% compared to $561,040 for thequarter ended June 30, 2002.  The decrease was a result of decreased sales commissions.  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.  The number of new conversions in the quarterwas below plan resulting in sales expenses being under budget.

 

*General and administrative expenses*.  General and administrative expenses of$226,294 for the quarter ended June 30, 2003 decreased by 3% compared to$232,301 for the quarter ended June 30, 2002. The decrease is the result of reduced investor relations costs and in line with thebudget plan.

 

*Research and development expenses*.  Research and development expenses of$188,574 for the quarter ended June 30, 2003 increased by 51% compared to$124,778 for the quarter ended June 30, 2002. The increase is a result of addedheadcount and the costs associated with initiatives to address design andmanufacturing improvements with two product lines.

 

**Liquidityand 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$17,267,684 through June 30, 2003, and, to a lesser degree, funds provided bysales of the Company’s products. The Company’s operations used $23,449 of cashin the three months ended June 30, 2003 on sales of $1,701,940 and generated$62,887 of cash in the three months ended June 30, 2002 on sales of $1,342,392.In previous years the use of cash in our operations resulted primarily from thefunding of the Company’s annual net losses. These amounts of cash generatedfrom and used in operations are not indicative of the expected cash to begenerated from or used in operations in FY 04. As of June 30, 2003, the Companyhad $472,888 in cash and cash equivalents available to fund future operations.Working capital was $1,581,280 at June 30, 2003 compared to $1,596,831 at March31, 2003. Current liabilities were $850,126 at June 30, 2003, compared to$926,781 at March 31, 2003.

 

Capital expenditures in the three months ended June 30, 2003 ($89,215)result primarily from the capitalization of AEM monitors placed in hospitalsunder various promotional programs. Placing Company-owned AEM monitors intohospitals at no charge to facilitate their use of AEM instruments is aninitiative to accelerate new hospital conversions to AEM instruments. Underthese 

 

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promotional programs the Company maintains ownership of the AEM monitorand the cost is capitalized and depreciated as cost of sales over the projectedfive year life of the asset.

 

Our fiscal year 2004 (“FY 04”) operating plan is focused on growingrevenue, increasing gross profits and conserving cash. We can not predict withcertainty the expected revenue, gross profit, net income or loss and usage ofcash and cash equivalents for FY 04. However, we believe that its cashresources will be sufficient to fund its operations for at least the nexttwelve months under its current operating plan.  If we are unable to manage the business operations in line withits budget expectations, it could have a material adverse effect on theCompany’s business viability, financial position, results of operations andcash flows. Further, if we are not successful in sustaining profitability andremaining at least cash flow break-even, additional capital will be required tomaintain ongoing operations.

 

We have explored and are continuing to explore options to provideadditional financing to fund future operations as well as other possiblecourses of action. Such actions include, but are not limited to, securing aline of credit, sales of debt or equity securities (which may result indilution to existing shareholders), licensing of technology, strategicalliances and other similar actions. There can be no assurance that the Companywill be able to obtain additional funding through a sale of its common stock orloans from financial institutions or other third parties or through any of theactions discussed above. If we cannot sustain profitable operations andadditional capital is unavailable, its lack of liquidity could have a materialadverse effect on our business viability, financial position, results ofoperations and cash flows.

 

We believe the unique performance of the AEM technology and its breadthof independent endorsements provides an opportunity for continued market sharegrowth. We believe that the market awareness of the AEM technology and itsendorsements is continually improving and that this will benefit the salesefforts in FY 04. We believe that the Company enters FY 04 having achievedimprovements in sales infrastructure, product line expansion and the clinicalcredibility of its technology. Our objective in FY 04 is to maintain expensecontrols while optimizing sales execution in the field, expand market awarenessof the AEM technology and maximize the number of additional hospitalconversions to AEM instruments.

 

**Income Taxes**

 

As of March 31, 2003, net operating loss carryforwards totalingapproximately $12,300,000 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 loss carryforwardsavailable to be used in any given year, if certain events occur, includingchanges in ownership interests. The Company has established a valuationallowance for the entire amount of its deferred tax asset since inception dueto its history of losses. Should the Company achieve sufficient, sustainedincome in the future, the Company may conclude that some or all of thevaluation allowance should be reversed.

 

## **Contractual Obligations**

 

At June 30, 2003, the Company’s commitments under these obligationswere as follows:

## ** **

|                      |   | **Operating Leases** |        |
|---------------------------|--------|----------------------|-------------|
| **Year  ended March 31,** |   |                 | ** **  |
| **2004**                  |   | **$**                | **83,679**  | ** ** |
| **2005**                  |   | **66,955**           | ** **  |
|                      |   | **$**                | **150,634** |   |

 

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

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of its financialcondition and results of operations are based upon our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenue and expenses, and related disclosure of contingentassets 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 on historical experienceand on various other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates under differentassumptions or conditions.  We believethe following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its financial statements.

 

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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 amountrecorded as a provision for bad debt in each period is based upon ourassessment of the likelihood that we will be paid on our outstandingreceivables, based on customer-specific as well as general considerations.  To the extent that our estimates prove to betoo high, and we ultimately collect a receivable previously determined to beimpaired, we may record a reversal of the provision in the period of suchdetermination.

 

We provide for the estimated cost of productwarranties at the time revenue is recognized. While we engage in extensiveproduct quality programs and processes, including actively monitoring andevaluating the quality of its component suppliers, we have experienced somecosts related to warranty.  The warrantyaccrual is based upon historical experience and is adjusted based on currentexperience. Should actual warranty experience differ from our estimates,revisions to the estimated warranty liability would be required.

 

We reduce inventory for estimated obsolete orunmarketable inventory equal to the difference between the cost of inventoryand the estimated market value based upon assumptions about future demand andmarket conditions. If actual market conditions are less favorable than thoseprojected by management, additional inventory write-downs may be required. Anywrite-downs of inventory would reduce our reported net income during the periodin which such write-downs were applied. To the extent that our estimates prove to be too high, and we ultimatelyutilize or sell inventory previously determined to be impaired, we may record areversal of the provision in the period of such determination.

 

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 theirestimated useful lives, which is typically the remaining statutory life.  From time to time, we may be required toadjust these lives based on advances in technology, competitor actions, and thelike.  We review the recorded amounts ofpatents at each period end to determine if their carrying amount is stillrecoverable based on our expectations regarding sales of related products.  Such an assessment, in the future, mayresult in a conclusion that the assets are impaired, with a correspondingcharge against earnings.

 

**FactorsWhich 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 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 riskfactors to reflect events or circumstances after the date of this report or toreflect the occurrence of unanticipated events.

 

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

 

*1.         Our products may not beaccepted by the market*.  The success of our products and our financial condition dependson the acceptance of AEM products by the medical community in commerciallyviable quantities during fiscal year 2004 and beyond. We cannot predict howquickly or how broadly AEM products will be accepted by the medical community.We need to continually 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.*             *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 organizations change their productlines and personnel. We may not be able to obtain full coverage of the U.S. byindependent sales representatives as quickly as anticipated. The independentsales representative network has inherent flaws and

 

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inefficiencies, which can include conflicts of interest and competingproducts. Optimizing the quality of the network and the performance ofindependent sales representatives in the U.S. is an ongoing challenge. We mayalso encounter difficulties in developing our international presence due toregulatory issues and our ability to successfully develop internationaldistribution options. Our inability to expand our network of independent salesrepresentatives and optimize their performance could adversely affect ourfinancial results.

* *

*3.         We may need additionalfunding 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 June30, 2003, we had $472,888 in cash available to fund future operations. Webelieve that we can maintain profitable operations in FY 2004 but there is noguarantee of our ability to do so.  Wemay also find ourselves at a competitive disadvantage due to our constrainedliquidity.

 

*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 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. 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 governmentregulations 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 productsin the United States and other countries is subject to extensive regulation bynumerous governmental authorities including, but not limited to, the Food andDrug Administration. Under the Federal Food, Drug and Cosmetic Act, medicaldevices must receive clearance from the Food and Drug Administration throughthe Section 510(k) pre-market notification process or through the more lengthypre-market approval process before they can be sold in the United States. Theprocess of obtaining required regulatory approvals is lengthy and has requiredthe expenditure of substantial resources. There can be no assurance that wewill be able to continue to obtain the necessary approvals. As part of ourstrategy, we also intend to pursue commercialization of our products ininternational markets. Our products are subject to regulations that vary fromcountry to country. The process of obtaining foreign regulatory approvals incertain countries can be lengthy and require the expenditure of substantialresources. We may not be able to obtain necessary regulatory approvals orclearances on a timely basis or at all, and delays in receipt of or failure toreceive such approvals or clearances, or failure to comply with existing orfuture regulatory requirements would have a material adverse effect on ourfinancial position, results of operations and cash 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.*The manufacturing of our products is subject to extensive regulatoryrequirements administered by the Food and Drug Administration and otherregulatory bodies. Inspection of our manufacturing facilities and processes canbe conducted at any time, without prior notice, by the agencies. In addition,future changes in regulations or interpretations made by the Food and DrugAdministration or other regulatory bodies, with possible retroactive effect,could adversely 

 

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affect us. Changes in existing regulations or adoption of newregulations or policies could prevent us from obtaining, or affect the timingof, future regulatory approvals or clearances. We may not be able to obtainnecessary regulatory approvals or clearances on a timely basis in the future,or at all. Delays in receipt of, failure to receive such approvals orclearances and/or failure to comply with existing or future regulatoryrequirements, would have a material adverse effect on our financial position,results of operations and cash flows.

 

*8.         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 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 assessmentthat a patent is no longer of value could result in a significant chargeagainst our earnings.

 

*9.         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.

 

*10.      The potential fluctuationin 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.

 

*11.      Our common stock isthinly traded, the prices at which it trades are volatile and the buying orselling actions of a few shareholders may adversely affect our stockprice.  *Wehave a public float of 2,457,358 shares or 45% of the outstanding common stock.The average number of shares traded in any given day over the past year hasbeen relatively small compared to the public float. Thus, the actions of a fewshareholders either buying or selling shares of our common stock may adverselyaffect the price of the shares. Historically, the over-the-counter markets forsecurities such as our common stock have experienced extreme price and volume fluctuationsthat do not necessarily relate to operating performance.

 

*12.      Our insurance coveragefor product liability claims is up to $5,000,000.* We**facean inherent business risk of exposure to product liability claims in the eventthat the use of our products is alleged to have resulted in adverse effects toa patient. We maintain a general liability insurance policy up to the amount of$5,000,000 that includes coverage for product liability claims. Liabilityclaims may be excluded from the policy, may exceed the coverage limits of thepolicy, or the insurance may not continue to be available on commerciallyreasonable terms or at all. Consequently, a product liability claim or otherclaim with respect to uninsured liabilities or in excess of insured liabilitiescould have a material adverse effect on our financial position, results ofoperations 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 2003, wegenerated revenue from over 300 hospitals that have converted to AEM products,but no hospital customer contributed more than 3% to the total revenues. Weutilize a small number of stocking distributors, which sell AEM products to multiplehospital customers.  In FY 2003, wegenerated revenue of $721,687 (11%) and $701,689 (10%) from two of thesedistributors.  While it is infrequentthat a hospital customer stops using AEM instruments after they convert, a lossof ongoing revenue from a hospital customer could have a material adverseeffect on our revenues and cash flows.

 

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*14.      We depend on certain keypersonnel.* We arehighly dependent on a limited number of key management personnel, particularlyour President & Chief Executive Officer, James A. Bowman. Our loss of keypersonnel to death, disability or termination, or our inability to hire andretain qualified personnel, could have a material adverse effect on our financialposition, results of operations and cash flows.

 

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**ITEM 3****   – CONTROLS AND PROCEDURES**

 

(a) Evaluation of disclosure controls and procedures. The Companycarried 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-14(c) and 15d-14c of the Securitiesand Exchange Act of 1934 (the “Exchange Act”)) as of a date within the 90 daysprior to the date of the filing of this report. Based upon that evaluation, theChief Executive Officer and the Principal Accounting Officer concluded that theCompany’s disclosure controls and procedures are effective in ensuring thatinformation required to be disclosed by the Company under the Exchange Act isrecorded, 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 Evaluation Date, nor anysignificant deficiencies or material weaknesses in such disclosure controls,internal controls and procedures requiring corrective actions. As a result nocorrective actions were taken.

 

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

** **
| **ITEM 1**    |                                            | Not Applicable                                                                                                      |
|---------------|-------------------------------------------------|---------------------------------------------------------------------------------------------------------------------|
|          |                                            |                                                                                                                |
| **ITEM 2**    |                                            | Not Applicable                                                                                                      |
|          |                                            |                                                                                                                |
| **ITEM 3**    |                                            | Not Applicable                                                                                                      |
|          |                                            |                                                                                                                |
| **ITEM 4**    | -                                               | Not Applicable                                                                                                      |
|          |                                            |                                                                                                                |
| **ITEM 5**    | -                                               | Not Applicable                                                                                                      |
|          |                                            |                                                                                                                |
| **ITEM****6** | -                                               | EXHIBITS AND REPORTS ON FORM 8-K                                                                                    |
|          |                                            |
|          | (a)      Exhibits |
|          |                                            |
|          | 31.1                                            | Certification of President and Chief  Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002       |
|          |                                            |
|          | 31.2                                            | Certification of Controller and Principal  Accounting Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002 |
|          |                                            |
|          | 32                                              | Certification of Periodic Reports pursuant  to Sarbanes-Oxley Act of 2002                                           |
|               |                                                 |                                                                                                                     |  |  |

 

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**SIGNATURE**

 

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, Encision has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 

 
| **Name**            |                           | **Title**  |            | **Date** |
|---------------------|--------------------------------|------------|-----------------|----------|
|                |                           |       |
|                |                           |       |
| /s/ Marcia McHaffie |                           | Controller | August 14, 2003 |
| Marcia McHaffie     | (Principal Accounting Officer) |       |
|                     |                                |            |                 |          |  |

 

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