ENCISION INC 10-K/A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Certain statements contained in this section are not historical facts, including statements about our strategies and expectations about new and existing products, market demand, acceptance of new and existing products, technologies and opportunities, market and industry segment growth, and return on investments in products and markets. These statements are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve substantial risks and uncertainties that may cause actual results to differ materially from those indicated by the forward looking statements. All forward looking statements in this section are based on information available to us on the date of this document, and we assume no obligation to update such forward looking statements. Readers of this Form 10-K are strongly encouraged to review the section entitled “Risk Factors” . Outlook Installed Base of AEM Monitoring Equipment . We believe that we are gaining more awareness in medico-legal circles and publications and from presentations at medical meetings. We believe that improvement in the quality of sales representatives carrying our AEM products line, along with increased marketing efforts and the introduction of new products, may provide the basis for increased sales and continuing profitable operations. However, these measures, or any others that we may adopt, may not result in either increased sales or continuing profitable operations. Possibility of Operating Losses. We have an accumulated deficit of $21,853,264 at March 31, 2023. We have made significant strides toward improving our operating results. However, due to the ongoing need to develop new products, the need to develop, optimize and train our sales distribution network and the need to increase sustained sales to a level adequate to cover fixed and variable operating costs, we may operate at a net loss in future periods. Sales Growth . We expect to generate increased sales in the U.S. from sales to new hospital customers and to grow AEM instrumentation sales to existing accounts. In fiscal year 2024, we will focus on growing our AEM franchise through a campaign focused on the clinical, economic and safety benefits of AEM technology, a medico-legal initiative and our new AEM products. In addition, prior years’ efforts in vertical integration have given us three core competencies – electrosurgery, instrument design, and manufacturing – which we expect will allow us to increase sales from our strategic partnership initiatives. Our goal is to offer our customers an AEM disposable counterpart for each AEM reusable instrument. 16 Gross Margin. We believe that if our fiscal year 2024 revenues increase, then our fiscal year 2024 gross profit and gross margin, as a percentage of revenue, will increase due to a higher gross margin on product revenue as a result of an increase in product produced. Sales and Marketing Expenses. We continue our efforts to expand domestic and international distribution capability, and we believe that sales and marketing expenses will need to be maintained at a healthy level in order to expand our market visibility and optimize the field sales capability of converting new hospital customers to AEM technology . Sales and marketing expenses are expected to increase as we increase our marketing efforts to support our direct sales representatives. In fiscal year 2024, we expect to have six direct sales managers. Each direct sales manager also manages a separate territory. Manufacturing . We believe that we will be able to achieve cost reductions, and provide better control over quality and consistency, by producing products on our own. We manufacture our own disposable scissor inserts and are exploring other products that we may manufacture internally. Research and Development Expenses . Research and development expenses are expected to increase to support expansion to our AEM product line, which will further expand the instrument options for the surgeon. New refinements to AEM product lines are planned for introduction in fiscal year 2024. Results of Operations Net Product revenue. Net product revenue for the fiscal year ended March 31, 2023 (“FY 23”) was $6,885,158, and for the fiscal year ended March 31, 2022 (“FY 22”), net revenue was $6,914,678, or no percentage change. Product revenue for the fiscal year ended March 31, 2023 decreased primarily as a result of the decrease in non-essential surgical procedures performed during this period due to the COVID-19 pandemic. Net Service revenue . Net service revenue for FY 23 was $463,356, and for FY 22 net service revenue was $753,958. Net service revenue was for engineering services performed under a Master Services Agreement with Auris Health, Inc. (“Auris Health”). Auris Health is a part of the Johnson & Johnson family of companies. Under the agreement, we collaborated on the integration of AEM technology into monopolar instrumentation produced by Auris Health for advanced surgical applications. On August 23, 2021, we entered into a Supply Agreement with Auris Health, Inc. On May 5, 2022, the parties mutually agreed to terminate all of our agreements. Gross profit. Gross profit in FY 23 was $4,032,533, which represented an increase of $244,115, or 6%, from gross profit in FY 22 of $3,788,418. Gross profit margin was 52% of net product revenue for FY 22 and 49% of net product revenue for FY 21. Gross profit increased in FY 23 from FY 22 due principally to higher selling prices and high margin service revenue. Our product revenue from GPOs in FY 22 was approximately 79% of our total product revenue. In FY 23, we had increased product vendor costs that were not allowed to be passed on to our GPO customers for most of the fiscal year and resulted in a compressed gross profit margin. Sales and marketing expenses. Sales and marketing expenses were $2,032,415 in FY 23, a decrease of $51,695, or 2%, from $2,084,110 in FY 22. The decrease was the result of decreased advertising. General and administrative expenses. General and administrative expenses were $1,486,796 in FY 23, an increase of $105,709, or 8%, from $1,381,087 in FY 22. The increase was the result of decreased allocations. 17 Research and development expenses. Research and development expenses were $816,119 in FY 23, a decrease of $102,036 or 11%, from $918,155 in FY 22. The decrease was the result of decreased patent costs and test materials. Other (expense), net. Other (expense), net of $21,148 for FY 23 was primarily for interest expense of $19,529. Net (loss). Net (loss) in FY 23 of $323,945 represented a loss in crease of $258,351 compared to FY 22 net loss of $65,594. The net loss increase was principally the result of extinguishment of debt income of $533,118 in FY 22. Liquidity and Capital Resources To date, operating funds have been provided primarily by issuances of our common stock and warrants, the exercise of stock options to purchase our common stock, loans and, in some years, by operating profits. To date, common stock and additional paid in capital totaled $24,348,075 from our inception through March 31, 2023. Our operations used $861,485 and $444,432 of cash in FY 23 and FY 22, respectively, on net revenue of $7,348,514 and $7,668,636 in FY 23 and FY 22, respectively. Working capital was $1,993,777 at March 31, 2023 compared to $2,325,331 at March 31, 2022. The decrease in working capital was primarily caused by the FY 23 net loss. Current liabilities were $1,130,826 at March 31, 2023 compared to $1,276,391 at March 31, 2022. On February 8, 2021, we entered into a second unsecured promissory note under the PPP for a principal amount of $533,118. This was our second PPP loan. During the quarter that ended September 30, 2021, we achieved the requirements for forgiveness of the second note and recognized the forgiveness as extinguishment of debt income of $533,118. On November 15, 2022, we entered into a loan and security agreement with Pathward, N.A. (formerly Crestmark Bank). The loan is due on demand and has no financial covenants. Under the agreement, we were provided with a line of credit that is not to exceed the lesser of $1,000,000 or 85% of eligible accounts receivable. The interest rate is prime rate plus 0.5%, with a floor of 6.75%, plus a monthly maintenance fee of 0.4%, based on the average monthly loan balance. Interest is charged on a minimum loan balance of $300,000, a loan fee of 0.5% at closing and annually, and an exit fee of 3%, 2% and 1% during years one, two and three, respectively. We believe that the unique performance of AEM technology and our breadth of independent endorsements provide an opportunity for market share growth. We believe that the market awareness of AEM technology and its endorsements is continually improving and that this will benefit revenue efforts in FY 24. We believe that we enter FY 24 having achieved improvements in the clinical credibility of our technology. Our FY 24 operating plan is focused on growing revenue, increasing gross profits, increasing research and development costs while increasing profits and positive cash flows. We cannot predict with certainty the expected revenue, gross profit, net income or loss and usage of cash, cash equivalents and restricted cash for FY 24. We believe that cash resources and borrowing capacity will be sufficient to fund our operations for at least the next twelve months under our current operating plan. If we are unable to manage business operations in line with our budget expectations, it could have a material adverse effect on business viability, financial position, results of operations and cash flows. Further, if we are not successful in sustaining profitability and remaining at least cash flow break-even, additional capital may be required to maintain ongoing operations. 18 We have explored and are continuing to explore options to provide additional financing to fund future operations as well as other possible courses of action. Such actions include, but are not limited to, securing a larger credit facility, sales of debt or equity securities (which may result in dilution to existing shareholders), licensing of technology, strategic alliances and other similar actions. There can be no assurance that we will be able to obtain additional funding (if needed) through a sale of our common stock or loans from financial institutions or other third parties or through any of the actions discussed above on terms acceptable to us or at all. If we cannot sustain profitable operations and additional capital is unavailable, lack of liquidity could have a material adverse effect on our business viability, financial position, results of operations and cash flows. Income Taxes As of March 31, 2023, net operating loss carryforwards totaling approximately $7.3 million were available to reduce taxable income in the future. The net operating loss carryforwards expire, if not previously utilized, at various dates beginning in fiscal year 2023. We have not paid income taxes since our inception. The Tax Reform Act of 1986 and other income tax regulations contain provisions which may limit the net operating loss carryforwards available to be used in any given year if certain events occur, including changes in our ownership. We have established a valuation allowance for the entire amount of our deferred tax asset since inception due to our history of losses. Should we achieve sufficient, sustained income in the future, we may conclude that some or all of the valuation allowance should be reversed. Off-Balance Sheet Financing Arrangements We do not utilize variable interest entities or other off-balance sheet financial arrangements. Contractual Obligations Effective November 9, 2017, we extended our noncancelable lease agreement through July 31, 2024, and further extended it through October 31, 2024, for our facilities at 6797 Winchester Circle, Boulder, Colorado. Lease expense was $329,255 for the fiscal year ended March 31, 2023 and $357,644 for the fiscal year ended March 31, 2022. The minimum future lease payment, by fiscal year, as of March 31, 2023 is as follows: Fiscal Year Amount 2024 386,667 2025 232,139 Total $ 618,806 On August 4, 2020, we received $150,000 in loan funding from the U.S. Small Business Administration (“SBA”) under the Economic Injury Disaster Loan (“EIDL”) program administered by the SBA, which program was expanded pursuant to the CARES Act. The EIDL is evidenced by a promissory note, dated August 1, 2021 in the original principal amount of $150,000 with the SBA, the lender. Under the terms of the Note, interest accrues on the outstanding principal at the rate of 3.75% per annum. The term of the Note is thirty years, though it may be payable sooner upon an event of default under the Note. Under the Note, we will be obligated to make equal monthly payments of principal and interest of $731 beginning on August 1, 2022 through the maturity date of August 1, 2050. The Note may be prepaid in part or in full, at any time, without penalty. The minimum future EIDL payment, by fiscal year, as of March 31, 2023 is as follows: Fiscal Year Amount 2024 3,091 2025 3,208 2026 3,331 2027 3,457 Thereafter 148,744 Total $ 161,831 During January 2022, we entered into a note agreement with U.S. Bank for $92,000. The note is for five years at a 5% interest rate and the proceeds were used to purchase equipment. The note is secured by the equipment. 19 The minimum future U.S. Bank payment, by fiscal year, as of March 31, 2023 is as follows: Fiscal Year Amount 2024 18,400 2025 18,400 2026 16,867 Total $ 53,667 During September 2022, we entered into a note agreement with U.S. Bank for $115,004. The note is for five years at a 6% interest rate and the proceeds were used to purchase equipment. The note is secured by the equipment. The minimum future principal U.S. Bank payment, by fiscal year, as of December 31, 2022 is as follows: Fiscal Year Amount 2024 23,000 2025 23,000 2026 23,000 Thereafter 36,090 Total $ 105,090 Payment due by period Contractual obligations Totals Less than 1 year 1-3 years 3-5 years More than 5 years Lease obligations $ 618,806 $ 386,667 $ 232,139 $ — $ — EIDL note 161,831 3,091 6,539 6,788 145,413 U.S. Bank note 53,667 18,400 35,267 — — U.S. Bank note 105,090 23,000 46,000 36,090 — Totals $ 939,394 $ 431,158 $ 319,945 $ 42,878 $ 145,413 Aside from the operating lease, we do not have any material contractual commitments requiring settlement in the future. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States . The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, sales returns, warranty, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements. We record revenue at a single point in time, when control is transferred to the customer, which is consistent with past practice. We will continue to apply our current business processes, policies, systems and controls to support recognition and disclosure. Our shipping policy is FOB Shipping Point. We recognize revenue from sales to stocking distributors when there is no right of return, other than for normal warranty claims. We have no ongoing obligations related to product sales, except for normal warranty obligations. We evaluated the requirement to disaggregate product revenue, and concluded that substantially all of its revenue comes from multiple products within a line of medical devices. Our engineering service contracts are billed on a time and materials basis and revenue is recognized over time as the services are performed We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required, which would increase our expenses during the periods in which any such allowances were made. The amount recorded as a provision for bad debts in each period is based upon our assessment of the likelihood that we will be paid on our outstanding receivables, based on customer-specific as well as general considerations. To the extent that our estimates prove to be too high, and we ultimately collect a receivable previously determined to be impaired, we may record a reversal of the provision in the period of such determination. 20 We provide for the estimated cost of product warranties at the time sales are recognized. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, we have experienced some costs related to warranty. The warranty accrual is based upon historical experience and is adjusted based on current experience. Should actual warranty experience differ from our estimates, revisions to the estimated warranty liability would be required. We reduce inventory for estimated obsolete or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If a ctual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Any write-downs of inventory would reduce our reported net income during the period in which such write-downs were applied. We recognize deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets are then reduced, if deemed necessary, by a valuation allowance for the amount of any tax benefits which, more likely than not based on current circumstances, are not expected to be realized. Should we achieve sufficient, sustained income in the future, we may conclude that all or some of the valuation allowance should be reversed. Property and equipment are stated at cost, with depreciation computed over the estimated useful lives of the assets, generally three to seven years. We use the straight-line method of depreciation for property and equipment. Leasehold improvements are depreciated over the shorter of the remaining lease term or the estimated useful life of the asset. Maintenance and repairs are expensed as incurred and major additions, replacements and improvements are capitalized. We amortize our patent costs over their estimated useful lives, which is typically the remaining statutory life. From time to time, we may be required to adjust these lives based on advances in technology, competitor actions, and the like . We review the recorded amounts of patents at each period end to determine if their carrying amount is still recoverable based on our expectations regarding sales of related products. Such an assessment, in the future, may result in a conclusion that the assets are impaired, with a corresponding charge against earnings. Stock-based compensation is presented in accordance with the guidance of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, Compensation – Stock Compensation (“ASC 718 ”). Under the provisions of ASC 718, companies are required to estimate the fair value of share-based payment awards made to employees and directors including employee stock options based on estimated fair values on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statements of operations. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not required. 21