ECIA Encision Inc (PK)

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements contained in this section on Management’s Discussion and Analysis are not historical facts, including statements about our strategies and expectations with respect to new and existing products, market demand, acceptance of new and existing products, marketing efforts, 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 on Management’s Discussion and Analysis 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-Q are strongly encouraged to review the section entitled “Risk Factors” in our Form 10-K for the fiscal year ended March 31, 2022.

General

Encision Inc., a medical device company based in Boulder, Colorado, has developed and markets innovative technology that provides unprecedented outcomes and patient safety in minimally-invasive surgery. We believe that our patented Active Electrode Monitoring (“AEM®”) AEM EndoShield™ Burn Protection System is changing the marketplace for electrosurgical devices and laparoscopic instruments by providing a solution to a well-documented hazard unique to laparoscopic surgery. The Center for Medicare and Medicaid Services has published its Hospital-Acquired Condition Reduction Program. The program has begun to levy as much as a 1% penalty on Medicare reimbursements to hospitals in the lower quadrant of performance for selected quality indicators, including accidental puncture and laceration (“APL”). Examples of APL include the use of a cautery device (electrosurgery) or scissors to dissect a tissue plane that errantly causes an injury to underlying bowels. A Safety Communication was released by the FDA on May 29, 2018. It is on the FDA's website at: https://www.fda.gov/MedicalDevices/Safety/AlertsandNotices/ucm608637.htm. The Safety Communication states that, "In addition to serving as an ignition source, monopolar energy use can directly result in unintended patient burns from capacitive coupling and intra-operative insulation failure. If a monopolar electrosurgical unit (“ESU”) is used: Do not activate when near or in contact with other instruments.”

We address market opportunities created by the increase in minimally-invasive surgery (“MIS”) and surgeons’ use of electrosurgery devices in these procedures. The product opportunity exists in that monopolar electrosurgery instruments used in laparoscopic procedures provide excellent clinical results, but are also susceptible to causing inadvertent collateral tissue damage outside the surgeon’s field of view due to insulation failure and capacitive coupling. The risk of unintended electrosurgical burn injury to the patient in laparoscopic surgery has been well documented. This risk poses a threat to patient safety, including the risk of death, and creates liability exposure for surgeons and hospitals, as well as increased and preventable readmissions.

Our patented AEM technology provides surgeons with the desired tissue effects, while capturing stray electrosurgical energy that can cause unintended and unseen tissue injury that may result in death. AEM Surgical Instruments are equivalent to conventional instruments in size, shape, ergonomics, functionality and competitive pricing, but they incorporate “Active Electrode Monitoring” technology to dynamically and continuously monitor the flow of electrosurgical current, thereby helping to prevent patient injury. With our “shielded and monitored” instruments, surgeons are able to perform electrosurgical procedures more safely, effectively and economically than is possible using conventional instruments or alternative energy sources.

AEM technology has been recommended and endorsed by many groups involved in MIS. Surgeons, nurses, biomedical engineers, the medicolegal community, malpractice insurance carriers and electrosurgical device manufacturers advocate the use of AEM technology. We have focused our marketing strategies to date on expanding the market awareness of the AEM technology and our broad independent endorsements and have continued efforts to improve and expand the AEM technology penetration.

When a hospital or surgery center changes to AEM technology, we receive recurring revenue from sales of replacement instruments. We believe that there is no directly competing technology to supplant AEM products. The replacement market of reusable and disposable AEM products in hospitals and surgery centers that use our AEM technology represented over 90% of our product revenue during the three and six months ended September 30, 2022. This revenue stream is expected to grow as the base of accounts using AEM technology expands. In addition, we intend to further develop disposable versions of more of our AEM products in order to meet market demands and expand our sales opportunities.

We have an accumulated deficit of $21,544,039 at September 30, 2022. A significant portion of our operating funds have been provided by issuances of our common stock and warrants and the exercise of stock options to purchase our common stock. Should our liquidity be diminished in the future because of operating losses, we may be required to seek additional capital.

During the six months ended September 30, 2022, we used $412,806 of cash in our operating activities and used $201,330 for investments in property and equipment. At September 30, 2022, we had $536,839 and at March 31, 2022 we had $949,645 in cash available to fund future operations, a decrease of $412,806 from March 31, 2022. The decrease to cash was principally the result of an increase to inventories. Our working capital was $2,242,309 at September 30, 2022 compared to $2,325,331 at March 31, 2022.

Historical Perspective

We were organized in 1991 and spent several years developing the AEM monitoring system and protective sheaths to adapt to conventional electrosurgical instruments. We have invested heavily in an effort to protect our valuable technology, and, as a result of this effort, we have been issued 16 unexpired relevant patents that together form a significant intellectual property position. Our patents relate to the basic shielding and monitoring technologies that we incorporate into our AEM products.

Our AEM Surgical Instruments have been engineered to provide a seamless transition for surgeons switching from conventional laparoscopic instruments. AEM technology has been integrated into instruments that have the same look, feel and functionality as conventional instruments that surgeons have been using for years. The AEM product line encompasses the full range of instrument sizes, types and styles favored by surgeons. Additionally, we continue to improve quality and add to the product line. These additions include more disposable versions, the introduction of hand-activated instruments, our enhanced scissors, our eEdge™ scissors, our EM3 AEM Monitor, our AEM EndoShield Burn Protection System and the recent introduction of our AEM 2X enTouch® Scissors. Hospitals can make a complete and smooth conversion to our product line, thereby advancing patient safety in MIS with optimal convenience.

Outlook

Installed Base of AEM Monitoring Equipment: We believe that sales of our installed base of AEM products will increase as the inherent risks associated with monopolar laparoscopic electrosurgery become more widely acknowledged and as we focus on increasing our sales efficiency and continue to enhance our product line. We expect that the replacement sales of electrosurgical instruments and accessories will also increase as additional facilities adopt AEM technology. We anticipate that the efforts to improve the productivity of sales representatives carrying the AEM product line, along with the introduction of next generation products, may provide the basis for increased sales and profitable operations. However, these measures, or any others that we may adopt, may not result in either increased sales or profitable operations.

We believe that the unique performance of the AEM technology and our breadth of independent endorsements provide an opportunity for continued market share growth. In our view, market awareness and awareness of the clinical credibility of the AEM technology, as well as awareness of our endorsements, are improving, and we expect this awareness to benefit our sales efforts for the remainder of fiscal year 2023. Our objectives for the remainder of fiscal year 2023 are to optimize sales execution, to expand market awareness of the AEM technology and to maximize the number of additional hospital and surgery center accounts switching to AEM instruments while retaining existing customers. In addition, acceptance of AEM products depends on surgeons’ preference for our instruments, which depends on factors such as ergonomics, quality and ease of use in addition to the technological and safety advantages of AEM products. If surgeons prefer other instruments to our instruments, our business results will suffer.

We have been actively monitoring the COVID situation and its impact. Our primary objectives have remained the same throughout the pandemic: to support the safety of our team members and their families and continue to support patients. Our production facility continued to operate during the year as it had prior to the COVID pandemic with very little change, other than for enhanced safety measures intended to prevent the spread of the virus. Our capital and financial resources, including overall liquidity, remain strong. The remote working arrangements and travel restrictions imposed by various governments had limited impact on our ability to maintain operations during the year, as our manufacturing operation has generally been exempted from stay-at-home orders. However, we cannot predict the impact of the progression of the COVID pandemic on future results due to a variety of factors, including the continued good health of our employees, the ability of suppliers to continue to operate and deliver, our ability and our customers to maintain operations, continued access to transportation resources, the changing needs and priorities of customers, any further government and/or public actions taken in response to the pandemic and ultimately the length of the pandemic. We will continue to closely monitor the COVID pandemic in order to ensure the safety of our people and our ability to serve our customers and patients worldwide.

On April 20, 2020, we entered into a Master Services Agreement (“MSA”) with Auris Health, Inc. (“Auris Health”), which is based in Redwood City, CA and a part of Johnson & Johnson Medical Devices Companies. The MSA (and the initial related Statement of Work thereunder) were effective as of March 3, 2020. Under the MSA, we and Auris Health collaborated on the development of equipment designed to enable the compatibility of our AEM technology with monopolar instruments produced by Auris Health. The MSA had a term of up to three years, but either party could terminate the MSA sooner upon 10 business days’ prior written notice. 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.

Possibility of Operating Losses: We have an accumulated deficit of $21,544,039 at September 30, 2022. A significant portion of our operating funds have been provided by issuances of our common stock and warrants, and the exercise of stock options to purchase our common stock. Should our liquidity be diminished in the future because of operating losses, we may be required to seek additional capital. We have made strides toward improving our operating results but due to the ongoing need to develop, optimize and train our direct sales managers and the independent sales representative network, the need to support the development of refinements to our product line, 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. Sustained losses, or our inability to generate sufficient cash flow from operations to fund our obligations, may result in a need to raise additional capital.

Revenue Growth: We expect to generate increased product revenue in the U.S. from sales to new customers and from expanded sales to existing customers as the medical device industry stabilizes and our network of direct and independent sales representatives becomes more efficient. We believe that the visibility and credibility of the independent clinical endorsements for AEM technology will contribute to new accounts and increased product revenue in fiscal year 2023. We also expect to increase market share through promotional programs of placing our AEM monitors at no charge into hospitals that commit to standardize with AEM instruments. However, all of these efforts to increase market share and grow product revenue will depend in part on our ability to expand the efficiency and effective coverage range of our direct and independent sales representatives, as well as maintain and in some cases, improve the quality of our product offerings. The omission or delay of elective surgeries would negatively impact the extent and timing of revenue growth. Service revenue represents design, development and product supply revenue from our agreements with strategic partners.

We also have longer-term initiatives in place to improve our prospects. We expect that development of next generation versions of our AEM products will better position our products in the marketplace and improve our retention rate at hospitals and surgery centers that have changed to AEM technology, enabling us to grow our sales. We are exploring overseas markets to assess opportunities for sales growth internationally. Finally, we intend to explore opportunities to capitalize on our proven AEM technology via licensing arrangements and strategic alliances. These efforts to generate additional sales and further the market penetration of our products are longer term in nature and may not materialize. Even if we are able to successfully develop next generation products or identify potential international markets or strategic partners, we may not be able to capitalize on these opportunities.

Gross Profit and Gross Margins: Gross profit and gross margins can be expected to fluctuate from quarter to quarter as a result of product sales mix, sales volume and service revenue. Gross margins on products manufactured or assembled by us are expected to improve at higher levels of production and sales.

Sales and Marketing Expenses: We continue to refine our domestic and international distribution capability, and we believe that sales and marketing expenses will decrease as a percentage of net sales with increasing sales volume.

Research and Development Expenses: Research and development expenses are expected to increase to support quality improvement efforts and development of refinements to our AEM product line and new products, which will further expand options for surgeons and hospitals.

Results of Operations

For the quarter ended September 30, 2022 compared to the quarter ended September 30, 2021.

Net Product revenue. Net product revenue for the quarter ended September 30, 2022 was $1,704,365 compared to $1,895,196 for the quarter ended September 30, 2021, a decrease of 10%. The decrease of product net revenue is attributable to supply chain issues which resulted in lost business from hospitals that used AEM technology during the year. With those supply chain issues resolved, we anticipate most of those hospitals again using AEM technology over the next several quarters.

Net Service revenue. Net service revenue for the quarter ended September 30, 2022 was none compared to $217,649 for the quarter ended September 30, 2021. Net service revenue for the quarter ended September 30, 2021 was for engineering services performed under a Master Services Agreement with Auris Health.

Gross profit. Gross profit for the quarter ended September 30, 2022 of $832,013 represented a decrease of 12% from gross profit of $944,575 for the quarter ended September 30, 2021. Gross profit decreased as a result of lower total revenue. Gross profit on net revenue as a percentage of sales (gross margin) was 49% for the quarter ended September 30, 2022 and 45% for the quarter ended September 30, 2021. Gross profit on net revenue increased as a result of higher operation efficiencies.

Sales and marketing expenses. Sales and marketing expenses of $489,700 for the quarter ended September 30, 2022 represented a decrease of 13% from sales and marketing expenses of $561,545 for the quarter ended September 30, 2021. The decrease was the result of lower advertising, outside services and commissions on lower revenue. The decrease was partially offset by an increase to trade samples.

General and administrative expenses. General and administrative expenses of $397,664 for the quarter ended September 30, 2022 represented an increase of 17% from general and administrative expenses of $340,485 for the quarter ended September 30, 2021. The increase was the result of an increase to compensation and a decrease to negative cost allocations for the quarter ended September 30, 2021.

Research and development expenses. Research and development expenses of $223,053 for the quarter ended September 30, 2022 represented an increase of 5% compared to $213,162 for the quarter ended September 30, 2021. The increase was the result of a decrease to negative cost allocations for the quarter ended September 30, 2021. The increase was partially offset by reduced test and prototype materials.

Net loss. Net loss was $279,320 for the quarter ended September 30, 2022 compared to net income of $359,567 for the quarter ended September 30, 2021. The net decrease was principally a result of extinguishment of debt income of $533,118 for the quarter ended September 30, 2021.

For the six months ended September 30, 2022 compared to the six months ended September 30, 2021.

Net Product revenue. Net product revenue for the six months ended September 30, 2022 was $3,400,094 compared to $3,613,600 for the six months ended September 30, 2021, a decrease of 6%. The decrease of AEM product net revenue is attributable to business lost from hospitals that used AEM technology during the year and supply chain issues.  

Net Service revenue. Net service revenue for the six months ended September 30, 2022 was $458,333 compared to $507,689 for the six months ended September 30, 2021, a decrease of 10%. Net service revenue for the six months ended September 30, 2021 was for engineering services performed under a Master Services Agreement with Auris Health. Net service revenue for the six months ended September 30, 2022 was for engineering services performed under a Supply Agreement with Auris Health.

Gross profit. Gross profit for the six months ended September 30, 2022 of $2,116,470 represented an increase of 7% from gross profit of $1,971,542 for the six months ended September 30, 2021. Gross profit increased as a result of higher total revenue and higher margined service revenue. Gross profit on net revenue as a percentage of sales (gross margins) was 55% for the six months ended September 30, 2022 and 48% for the six months ended September 30, 2021.

Sales and marketing expenses. Sales and marketing expenses of $992,667 for the six months ended September 30, 2022 represented a decrease of 11% from sales and marketing expenses of $1,090,019 for the six months ended September 30, 2021. The decrease was the result of lower commissions and advertising.

General and administrative expenses. General and administrative expenses of $741,783 for the six months ended September 30, 2022 represented an increase of 11% from general and administrative expenses of $667,205 for the six months ended September 30, 2021. The increase was the result of a negative bad debt reserve and a decrease to negative cost allocations for the six months ended September 30, 2021.

Research and development expenses. Research and development expenses of $393,521 for the six months ended September 30, 2022 represented an increase of 1% compared to $390,037 for the six months ended September 30, 2021. The increase was the result of a decrease to negative cost allocations for the six months ended September 30, 2021and partially reduced by lower test materials used.

Net loss. Net loss was $14,720 for the six months ended September 30, 2022 compared to net income of $352,726 for the six months ended September 30, 2021. The net decrease was principally a result of extinguishment of debt income of $533,118 for the six months ended September 30, 2021.

The results of operations for the three and six months ended September 30, 2022 are not necessarily indicative of the results of operations for all or any part of the balance of the fiscal year.

Liquidity and Capital Resources

To date, a significant portion of our operating funds have been provided by issuances of our common stock and warrants, the exercise of stock options to purchase our common stock, loans, and (in some periods) by operating profits. Common stock and additional paid in capital totaled $24,316,790 from inception through September 30, 2022.

On August 4, 2020, we received $150,000 principal 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, 2020 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 $774 beginning on August 1, 2023 through the maturity date of August 1, 2050. The Note may be prepaid in part or in full, at any time, without penalty.

During January 2021, 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.

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.

On April 17, 2020, we entered into an unsecured promissory note under the PPP for a principal amount of $598,567. The PPP was established under the Consolidated Appropriations Act of 2020, enacted December 27, 2020. Under the terms of the CARES Act, a PPP loan recipient may apply for, and be granted, forgiveness for all or a portion of loans granted under the PPP. Such forgiveness will be determined based upon the use of loan proceeds for payroll costs, rent and utility costs, and the maintenance of employee and compensation levels. In the quarter that ended December 31, 2020, we achieved the requirements for forgiveness, and all of the $598,567 was forgiven. We recognized the forgiveness as extinguishment of debt income of $598,567.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.

Our operations used $337,509 of cash during the six months ended September 30, 2022 on net revenue of $3,858,727. The amounts of cash provided by operations for the six months ended September 30, 2022 are not necessarily indicative of the expected amounts of cash to be generated from or used in operations in fiscal year 2023. At September 30, 2022, we had $536,839 in cash available to fund future operations. Our working capital was $2,242,309 at September 30, 2022 compared to $2,325,331 at March 31, 2022. Current liabilities were $1,128,165 at September 30, 2022 compared to $1,276,391 at March 31, 2022. We have a noncancelable lease agreement for our facilities at 6797 Winchester Circle, Boulder, Colorado. The lease expires October 31, 2024.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which modified lease accounting for both lessees and lessors to increase transparency and comparability by recognizing lease assets and lease liabilities by lessees for those leases classified as operating leases under previous accounting standards and disclosing key information about leasing arrangements. The primary impact for us was the balance sheet recognition of right-of-use (“ROU”) assets and lease liabilities for operating leases as a lessee.

Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. ROU assets also include any initial direct costs incurred and any lease payments made at or before the lease commencement date, less lease incentives received. We use our incremental borrowing rate based on the information available at the commencement date in determining the lease liabilities as our leases do not provide an implicit rate. Lease expense is recognized on a straight-line basis over the lease term.

The minimum future lease payment, by fiscal year, as of September 30, 2022 is as follows:

The minimum future EIDL payment, by fiscal year, as of September 30, 2022 is as follows:

The minimum future principal U.S. Bank payment, by fiscal year, as of September 30, 2022 is as follows:

The minimum future principal U.S. Bank payment, by fiscal year, as of September 30, 2022 is as follows:

Aside from the operating lease, EIDL loan and U.S. Bank loans, we do not have any material contractual commitments requiring settlement in the future.

As of September 30, 2022, the following table shows our contractual obligations for the periods presented:

Our fiscal year 2023 operating plan is focused on increasing new accounts, retaining existing customers, growing revenue, increasing gross profits and conserving cash. We are investing in research and development efforts to develop next generation versions of the AEM product line. We have invested in manufacturing property and equipment to manufacture disposable scissors inserts internally and to reduce our cost of product revenue. We cannot predict with certainty the expected revenue, gross profit, net income or loss and usage of cash for fiscal year 2023. If we are unable to manage our business operations in line with budget expectations, it could have a material adverse effect on our business viability, financial position, results of operations and cash flows.

Income Taxes

As of March 31, 2022, net operating loss carryforwards totaling approximately $7.7 million are available to reduce taxable income in the future. The net operating loss carryforwards expire, if not previously utilized, at various dates beginning in the fiscal year ending March 31, 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 ownership interests. 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. If some or all of the valuation allowance were reversed, then, to the extent of the reversal, a tax benefit would be recognized which would result in an increase to net income.

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, 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 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 record deferred revenue when funds are received prior to the recognition of the associated revenue. We record a contract liability to deferred revenue which includes customer prepayments and is included in other accrued liabilities.

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.

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 warranties. The warranty accrual is based on 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 realizable value based on assumptions about future demand and market conditions. If actual 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. To the extent that our estimates prove to be too high, and we ultimately utilize or sell inventory previously determined to be impaired, we may record a reversal of the provision in the period of such determination.

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 maintain 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 five 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 useful lives of our patents 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.

We currently estimate forfeitures for stock-based compensation expense related to employee stock options at 40% and evaluate the forfeiture rate quarterly. Other assumptions that are used in calculating stock-based compensation expense include risk-free interest rate, expected life, expected volatility and expected dividend.