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

**Washington, D.C.  20549**

 

**Form10-QSB**

 

**ý****                    ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2005**

 

**For the transition period from                    to                   **

 

**Commission file number     0-28604**

 

**ENCISION INC.**

(Exact name ofsmall business issuer as specified in its charter)

 

| **Colorado**                                                   |   | **84-1162056**                        |
|----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of                               |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)                                |   |                                  |
|                                                           |   |                                  |
| **6797  Winchester Circle, Boulder, Colorado**  **80301** |
| (Address of principal  executive offices)                      |
|                                                           |   |                                  |
| **(303)  444-2600**                                            |
| (Registrant’s telephone  number)                          |

 

**Check whether the issuer (1)filed all reports required to be filed by Section 13 of 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.**

**Yes  ****ý****  No  ****o**

 

**Indicate by checkmark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).**

**Yes****o**** No****ý**

 

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

 
| **Common  Stock, No par**  **value** |   | **6,397,646  Shares**              |
|-------------------------------------------|--------|------------------------------------|
| Class                                     |   | (outstanding at October  31, 2005) |

 

**Transitional Small Business Disclosure Format**

 

**Yes  ****o No****ý**

 

 

----

 

**ENCISION INC.**

 

**FORM 10-QSB**

 

**For the Quarter Ended September30, 2005**

 

**INDEX**

 
| **PART  I.**  |            | **UNAUDITED FINANCIAL INFORMATION** |                                                                                                          |
|---------------|-----------------|------------------------------------------|---------------------------------------------------------------------------------------------------------------|
|          |            |                                     |                                                                                                          |
| ** **    | **ITEM 1** | -                                        | Condensed  Interim Financial Statements:                                                                      |   |
|          |            | -                                        | Condensed  Balance Sheets as of September 30, 2005 and March 31, 2005                                         |   |
|          |            |                                     | –   Condensed Statements of Operations for the  Three Months Ended September 30, 2005 and 2004 |   |
|          |            | -                                        | Condensed  Statements of Operations for the Six Months Ended September 30, 2005 and 2004                      |   |
|          |            | -                                        | Condensed  Statements of Cash Flows for the Six Months Ended September 30, 2005 and 2004                      |   |
|          |            | -                                        | 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 4**      | -                                        | Submission  of Matters to a Vote of Security Holders                                                          |   |
|          |            |                                     |                                                                                                          |
| ** **    | **ITEM 6**      | -                                        | Exhibits                                                                                                      |   |
|          |            |                                     |                                                                                                          |
| ** **    | **SIGNATURE**   |                                     |

 

2

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**PART I                  FINANCIAL INFORMATION**

 

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

 

ENCISION INC.

 

CONDENSED BALANCE SHEETS

 
| ** **                                                                                                                                   | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|---------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**          | ** ** | **2005**      | ** ** |
| ** **                                                                                                                                   | ** ** | **(unaudited)**   | ** ** | **(audited)** | ** ** |
| ASSETS                                                                                                                                       |       |              |       |          |       |
| Cash and cash  equivalents                                                                                                                   |       | $                 | 832,186    |          | $          | 1,472,385 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $54,500 and $19,000,  respectively                                           |       | 1,119,812         |       | 866,710       |       |
| Inventory, net of  reserve for obsolescence of $65,000 and $65,000, respectively                                                             |       | 1,417,740         |       | 1,210,582     |       |
| Prepaid expenses                                                                                                                             |       | 88,874            |       | 103,150       |       |
| Total current  assets                                                                                                                        |       | 3,458,612         |       | 3,652,827     |       |
|                                                                                                                                         |       |              |       |          |       |
| EQUIPMENT, at cost:                                                                                                                          |       |              |       |          |       |
| Furniture,  fixtures and equipment                                                                                                           |       | 968,325           |       | 860,352       |       |
| Customer-site  equipment                                                                                                                     |       | 588,224           |       | 540,692       |       |
| Less -  accumulated depreciation                                                                                                             |       | (1,177,425        | )          | (1,085,130    | )          |
| Equipment, net                                                                                                                               |       | 379,124           |       | 315,914       |       |
| PATENTS, net of accumulated amortization of $86,261 and  $80,183, respectively                                                               |       | 157,298           |       | 117,764       |       |
| OTHER ASSETS                                                                                                                                 |       | 23,158            |       | 20,210        |       |
| Total assets                                                                                                                                 |       | $                 | 4,018,192  |          | $          | 4,106,715 |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                   |       |              |       |          |       |
| CURRENT LIABILITIES:                                                                                                                         |       |              |       |          |       |
| Accounts payable                                                                                                                             |       | $                 | 368,948    |          | $          | 532,657 |   |
| Accrued  compensation                                                                                                                        |       | 207,109           |       | 138,042       |       |
| Other accrued  liabilities                                                                                                                   |       | 528,281           |       | 462,489       |       |
| Total current  liabilities                                                                                                                   |       | 1,104,338         |       | 1,133,188     |       |
|                                                                                                                                         |       |              |       |          |       |
| 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, 6,377,646 (September 30, 2005) and  6,313,146 (Mar. 31, 2005) shares outstanding |       | 18,908,073        |       | 18,824,935    |       |
| Accumulated  (deficit)                                                                                                                       |       | (15,994,219       | )          | (15,851,408   | )          |
| Total  shareholders’ equity                                                                                                             |       | 2,913,854         |       | 2,973,527     |       |
| Total  liabilities and shareholders’ equity                                                                                             |       | $                 | 4,018,192  |          | $          | 4,106,715 |   |

 

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

 

3

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ENCISION INC.

 

CONDENSED STATEMENTS OFOPERATIONS

(Unaudited)

 
| ** **                                                                               | ** ** | **For the Three Months  Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
|                                                                                     |       |                                          |       |   |   |
| REVENUE, NET                                                                             |       | $                                             | 2,302,454  |   | $ | 2,065,949 |   |
|                                                                                     |       |                                          |       |   |   |
| COST OF SALES                                                                            |       | 925,618                                       |       | 870,547 |   |
| Gross profit                                                                             |       | 1,376,836                                     |       | 1,195,402 |   |
|                                                                                     |       |                                          |       |   |   |
| OPERATING EXPENSES:                                                                      |       |                                          |       |   |   |
| Sales and  marketing                                                                     |       | 930,285                                       |       | 718,550 |   |
| General and  administrative                                                              |       | 343,618                                       |       | 337,441 |   |
| Research and  development                                                                |       | 263,511                                       |       | 196,554 |   |
| Total operating  expenses                                                                |       | 1,537,414                                     |       | 1,252,545 |   |
| (LOSS) FROM OPERATIONS                                                                   |       | (160,578                                      | )          | (57,143 | ) |
|                                                                                     |       |                                          |       |   |   |
| OTHER INCOME (EXPENSE):                                                                  |       |                                          |       |   |   |
| Interest income                                                                          |       | 6,765                                         |       | 2,728 |   |
| Other (expense),  net                                                                    |       | (7,693                                        | )          | (2,001 | ) |
| NET (LOSS)                                                                               |       | $                                             | (161,506   | ) | $ | (56,416 | ) |
| NET (LOSS) PER SHARE:                                                                    |       |                                          |       |   |   |
| Basic and  diluted net (loss) per common share                                           |       | $                                             | (0.03      | ) | $ | (0.01 | ) |
|                                                                                     |       |                                          |       |   |   |
| Weighted average  shares used in computing basic and diluted net (loss) per common share |       | 6,370,926                                     |       | 6,123,166 |   |

 

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

 

4

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ENCISION INC.

 

CONDENSED STATEMENTS OFOPERATIONS

(Unaudited)

 
| ** **                                                                               | ** ** | **For the Six Months  Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                    | ** ** | **2004** | ** ** |
|                                                                                     |       |                                        |       |   |   |
| REVENUE, NET                                                                             |       | $                                           | 4,591,082  |   | $ | 3,829,213 |   |
|                                                                                     |       |                                        |       |   |   |
| COST OF SALES                                                                            |       | 1,829,816                                   |       | 1,617,847 |   |
| Gross profit                                                                             |       | 2,761,266                                   |       | 2,211,366 |   |
| OPERATING EXPENSES:                                                                      |       |                                        |       |   |   |
| Sales and  marketing                                                                     |       | 1,799,548                                   |       | 1,478,932 |   |
| General and  administrative                                                              |       | 603,745                                     |       | 690,286 |   |
| Research and  development                                                                |       | 504,303                                     |       | 390,411 |   |
| Total operating  expenses                                                                |       | 2,907,596                                   |       | 2,559,629 |   |
| (LOSS) FROM OPERATIONS                                                                   |       | (146,330                                    | )          | (348,263 | ) |
|                                                                                     |       |                                        |       |   |   |
| OTHER INCOME (EXPENSE):                                                                  |       |                                        |       |   |   |
| Interest income                                                                          |       | 13,172                                      |       | 4,395 |   |
| Other (expense),  net                                                                    |       | (9,653                                      | )          | (3,483 | ) |
| NET (LOSS)                                                                               |       | $                                           | (142,811   | ) | $ | (347,351 | ) |
|                                                                                     |       |                                        |       |   |   |
| NET (LOSS) PER SHARE:                                                                    |       |                                        |       |   |   |
| Basic and  diluted net (loss) per common share                                           |       | $                                           | (0.02      | ) | $ | (0.06 | ) |
|                                                                                     |       |                                        |       |   |   |
| Weighted average  shares used in computing basic and diluted net (loss) per common share |       | 6,343,914                                   |       | 5,989,241 |   |
|                                                                                          |            |                                             |            |  |  |  |  |  |

 

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

 

5

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ENCISION INC.

 

CONDENSED STATEMENTS OFCASH FLOWS

(Unaudited)

 
|                                                                              |       | **For the Six Months**  |       |
|-----------------------------------------------------------------------------------|------------|-------------------------|------------|
|                                                                              |       | **Ended September 30,** |       |
| ** **                                                                        | ** ** | **2005**                | ** ** | **2004** | ** ** |
|                                                                              |       |                    |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                             |       |                    |       |   |   |
| Net (loss)                                                                        |       | $                       | (142,811   | ) | $ | (347,351 | ) |
| Adjustments to  reconcile net (loss) to net cash (used in) operating activities - |       |                    |       |   |   |
| Depreciation and  amortization                                                    |       | 98,373                  |       | 91,204 |   |
| Provision for  bad debts                                                          |       | 35,500                  |       | 16,000 |   |
| Inventory  reserves                                                               |       | —                  |       | (20,000 | ) |
| Changes in  operating assets and liabilities -                                    |       |                    |       |   |   |
| Accounts  receivable                                                              |       | (288,602                | )          | (128,309 | ) |
| Inventory                                                                         |       | (207,158                | )          | (1,026 | ) |
| Other assets                                                                      |       | 11,328                  |       | (73,006 | ) |
| Accounts payable                                                                  |       | (163,709                | )          | 68,409 |   |
| Accrued  compensation and other accrued liabilities                               |       | 134,859                 |       | 57,920 |   |
| Net cash (used  in) operating activities                                          |       | (522,220                | )          | (336,159 | ) |
|                                                                              |       |                    |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                             |       |                    |       |   |   |
| Investment in  equipment                                                          |       | (155,505                | )          | (82,441 | ) |
| Patent costs                                                                      |       | (45,612                 | )          | — |   |
| Net cash (used  in) investing activities                                          |       | (201,117                | )          | (82,441 | ) |
|                                                                              |       |                    |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                             |       |                    |       |   |   |
| Proceeds from  the exercise of stock options                                      |       | 83,138                  |       | 484,047 |   |
| Net cash  provided by financing activities                                        |       | 83,138                  |       | 484,047 |   |
|                                                                              |       |                    |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | (640,199                | )          | 65,447 |   |
|                                                                              |       |                    |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                    |       | 1,472,385               |       | 1,356,607 |   |
| CASH AND CASH EQUIVALENTS, end of period                                          |       | $                       | 832,186    |   | $ | 1,422,054 |   |
|                                                                                   |            |                         |            |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of these financial statements.

 

6

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ENCISION INC.

 

NOTES TO CONDENSEDINTERIM FINANCIAL STATEMENTS

 

SEPTEMBER 30, 2005

(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 Companybelieves its patented AEM® surgical instrument technology ischanging the marketplace for electrosurgical devices and instruments byproviding a solution to a patient safety risk in laparoscopic surgery. TheCompany’s sales to date have been made principally in the United States.

 

The Company achieved profitable operations in fiscal years 2004 and 2003.However, in each fiscal year prior to 2003 and in the fiscal year 2005, theCompany had incurred losses and had an accumulated deficit of $15,994,219 at September30, 2005. Operations have been financed primarily through issuance of commonstock.

 

During fiscal years 2004 and 2003, the Company achieved annual netincome for the first time in its history. The Company’s strategic marketing andsales plan is designed to expand the use of the Company’s products insurgically active hospitals in the United States. Management expects theseefforts to result in continued revenue increases for fiscal 2006.

 

(2)       SUMMARY OF SIGNIFICANT ACCOUNTINGPOLICIES

 

Use of Estimatesin the Preparation of Financial Statements

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions. Such estimates and assumptions affect the reportedamounts of assets and liabilities as well as disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenue and expense during the reporting period. Actual resultscould differ from those estimates.

 

Revenue Recognition

 

Revenue from product sales is recorded when theCompany ships the product and title has passed to the customer, provided thatthe Company has evidence of a customer arrangement and can conclude thatcollection is probable. The Company’s shipping policy is FOB Shipping Point.The Company recognizes revenue from sales to stocking distributors when thereis no right of return, other than for normal warranty claims. The Company hasno ongoing obligations related to product sales, except for normal warranty.

 

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 ofFinancial Instruments

 

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

 

Concentration of CreditRisk

 

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 receivable 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

 

7

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

 

The net accounts receivable balance at September 30, 2005 of $1,119,812included $77,005, or approximately 7% from two customers. The net accountsreceivable balance at March 31, 2005 of $866,710 included $73,339, orapproximately 8%, from one customer.

 

Warranty Accrual

 

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

 

Inventories

 

Inventories are stated 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:

 

| ** **                      | ** ** | **September 30,** | ** ** | **March 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|---------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2005**      | ** ** |
|                            |       |              |       |          |       |
| Raw materials                   |       | $                 | 948,855    |          | $          | 738,850 |   |
| Finished goods                  |       | 533,885           |       | 536,732       |       |
|                            |       | 1,482,740         |       | 1,275,582     |       |
| Less - Reserve for obsolescence |       | (65,000           | )          | (65,000       | )          |
|                            |       | $                 | 1,417,740  |          | $          | 1,210,582 |   |

 

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, undiscounted and without interest, areinsufficient to recover the carrying amount of the asset. If deemed impaired,the long-lived asset is reduced to its estimated fair value. Long-lived assetsto be disposed of are reported at the lower of their carrying amount orestimated fair value less cost to sell.

 

Patents

 

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

 

Accrued Liabilities

 

The Company has accrued $177,000 related to warrantyclaims, $79,922 related to sales commissions and $128,430 related to rentnormalization and has included these amounts in accrued liabilities in theaccompanying balance sheets as of September 30, 2005.

 

8

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Income Taxes 

 

The Company accounts for income taxes under theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accountingfor Income Taxes” (“SFAS No. 109”). SFAS No. 109 requires recognition ofdeferred income 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. Duringfiscal year 2005, no tax benefit was obtained from the Company’s loss. As aresult, no tax benefit is reflected in the accompanying statements ofoperations. During the first six months of fiscal year 2006, no tax benefit wasobtained from the Company’s loss. As a result, no tax benefit is reflected inthe accompanying statements of operations. Should the Company achievesufficient, sustained income in the future, the Company may conclude that someor all of the valuation allowance should be reversed.

 

Research and DevelopmentExpenses

 

The Company expenses research and development costsfor products and processes as incurred.

 

Stock-BasedCompensation  

 

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 September 30,2005 would have been reported as follows:

 
| Three months ended September 30, 2005                      |   |    |     |
|------------------------------------------------------------|--------|---------|----------|
| Net (Loss)                                                 |   |    |     |
| As Reported                                                |   | $       | (161,506 | ) |
| Stock-based  compensation based upon estimated fair values |   | (55,739 | )        |
| Pro forma                                                  |   | $       | (217,245 | ) |
| Pro Forma Net (Loss) Per Basic and Diluted Common  Share   |   |    |     |
| As Reported                                                |   | $       | (0.03    | ) |
| Pro Forma                                                  |   | $       | (0.03    | ) |
|                                                       |   |    |     |
| Three months ended September 30, 2004                      |   |    |     |
| Net (Loss)                                                 |   |    |     |
| As Reported                                                |   | $       | (56,416  | ) |
| Stock-based  compensation based upon estimated fair values |   | (36,548 | )        |
| Pro forma                                                  |   | $       | (92,964  | ) |
| Pro Forma Net (Loss) Per Basic and Diluted Common  Share   |   |    |     |
| As Reported                                                |   | $       | (0.01    | ) |
| Pro Forma                                                  |   | $       | (0.02    | ) |

 

Segment Reporting

 

The Company has concluded that it has one operating segment.

 

Basic and Diluted Incomeand Loss per Common Share

 

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

 

9

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For the six month period ended September 30, 2005, the Company had currently-exercisablestock options outstanding that could create future dilution to the Company’scommon shareholders and are not currently classified as outstanding commonshares of the Company. The common stock number is based on specific conversionor issuance assumptions pursuant to the corresponding terms of each instrument.Potential stock issuance excluded from earnings per share because their effectwas anti-dilutive was 536,717 for the six months ended September 30, 2005.

 

Recent AccountingPronouncements

 

Inventory Costs

 

In November 2004, the FASB issued FASB Statement No. 151, which revisedARB No.43, relating to inventory costs. This revision is to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts and wasted material (spoilage). This Statement requires that these itemsbe recognized as a current period charge regardless of whether they meet thecriterion specified in ARB 43. In addition, this Statement requires theallocation of fixed production overheads to the costs of conversion be based onnormal capacity of the production facilities. This Statement is effective forfinancial statements for fiscal years beginning after June 15, 2005. Earlierapplication is permitted for inventory costs incurred during fiscal yearsbeginning after the date this Statement was issued. The Company believes thisStatement will have no impact on the financial statements of the Company onceadopted.

 

Exchanges of NonmonetaryAssets

 

In December 2004, the FASB issued FASB Statement No. 153. ThisStatement addresses the measurement of exchanges of nonmonetary assets. Theguidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, isbased on the principle that exchanges of nonmonetary assets should be measuredbased on the fair value of the assets exchanged. The guidance in that Opinion,however, included certain exceptions to that principle. This Statement amends Opinion29 to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetaryassets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. This Statement is effectivefor financial statements for fiscal years beginning after June 15, 2005.Earlier application is permitted for nonmonetary asset exchanges incurredduring fiscal years beginning after the date of this Statement is issued. TheCompany believes this Statement will have no impact on the financial statementsof the Company once adopted.

 

Share-Based Payments

 

In December 2004, the FASB issued a revision to FASB Statement No. 123,Accounting for Stock Based Compensation. This Statement supersedes APB OpinionNo. 25, Accounting for Stock Issued to Employees, and its relatedimplementation guidance.  This Statementestablishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services. It also addressestransactions in which an entity incurs liabilities in exchange for goods orservices that are based on the fair value of the entity’s equity instruments orthat may be settled by the issuance of those equity instruments.  This Statement focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. This Statement does not change the accountingguidance for share-based payment transactions with parties other than employeesprovided in Statement 123 as originally issued and EITF Issue No. 96-18, “Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services.” This Statement does notaddress the accounting for employee share ownership plans, which are subject toAICPA Statement of Position 93-6, Employers’ Accounting for Employee StockOwnership Plans.

 

A public entity will initially measure the cost of employee servicesreceived in exchange for an award of liability instruments based on its currentfair value; the fair value of that award will be re-measured subsequently ateach reporting date through the settlement date.  Changes in fair value during the requisiteservice period will be recognized as compensation cost over that period. Anonpublic entity may elect to measure its liability awards at their intrinsicvalue through the date of settlement.

 

The grant-date fair value of employee share options and similarinstruments will be estimated using the option-pricing models adjusted for theunique characteristics of those instruments (unless observable market pricesfor the same or similar instruments are available).

 

Excess tax benefits, as defined by this Statement, will be recognizedas an addition to paid-in-capital. Cash retained as a result of those excesstax benefits will be presented in the statement of cash flows as financing cashinflows. The write-off of deferred tax assets relating to unrealized taxbenefits associated with recognized compensation cost will be recognized asincome tax expense unless there are excess tax benefits from previous awardsremaining in paid-in capital to which it can be offset.

 

The notes to the financial statements of both public and nonpublicentities will disclose information to assist users of financial information tounderstand the nature of share-based payment transactions and the effects ofthose transactions on the financial statements.

 

10

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The effective date for public entities that file as small businessissuers will be as of the beginning of the first interim or annual reportingperiod that begins after December 15, 2005. The Company intends to comply withthis Statement at the scheduled effective date for the relevant financialstatements of the Company.

 

Accounting Changes andError Corrections

 

In May 2005, the FASB issued FASB Statement 154, Accounting Changes andError Corrections.  This Statementreplaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3,Reporting Accounting Changes in Interim Financial Statements, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. This Statement applies to all voluntary changes in accountingprinciple. The Company believes this Statement will have no impact on thefinancial statements of the Company.

 

(3)       COMMITMENTSAND CONTINGENCIES

 

The Company currently leases its facilities under noncancelable leaseagreements through August 14, 2009 at 6797 Winchester Circle, Boulder,Colorado. The minimum future lease payments are as follows:

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

 

The Company is subject to regulation by the UnitedStates Food and Drug Administration (“FDA”). The FDA provides regulationsgoverning the manufacture and sale of the Company’s products and regularlyinspects the Company and other manufacturers to determine their compliance withthese regulations. As of September 30, 2005 the Company believes it was insubstantial compliance with all known regulations. FDA inspections areconducted periodically at the discretion of the FDA. The Company was lastinspected in May 2005 and was notified of six potential deficiencies from thatinspection, none of which the Company believes to be material.

 

The results of operations for the quarter ended September30, 2005 should not be taken as an indication of the results of operations forall or any part of the balance of the year.

 

(4)       BASISOF PRESENTATION

 

The condensed interim financial statements includedherein have been prepared by the Company, without audit, pursuant to the rulesand regulations of the Securities and Exchange Commission. Certain informationand footnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations, although the Company believesthat the disclosures made are adequate to make the information presented notmisleading. The condensed interim financial statements and notes thereto shouldbe read in conjunction with the financial statements and the notes thereto,included in the Company’s Annual Report to the Securities and ExchangeCommission for the fiscal year ended March 31, 2005, filed on Form 10-KSB onJune 29, 2005.

 

The accompanying condensed interim financialstatements have been prepared, in all material respects, in conformity with thestandards of accounting measurements set forth in Accounting Principles BoardOpinion No. 28 and reflect, in the opinion of management, all adjustmentsnecessary to summarize fairly the financial position and results of operationsfor such periods in accordance with accounting principles generally accepted inthe United 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 OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Certain statementscontained in this section on Management’s Discussion and Analysis are nothistorical facts, including statements about the Company’s strategies andexpectations about new and existing products, market demand, acceptance of newand existing products, technologies and opportunities, market and industrysegment growth, and return on investments in products and markets. Thesestatements are forward looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995 and involve substantial risks anduncertainties that may cause actual results to differ materially from thoseindicated by the forward looking statements. All forward looking statements inthis section on Management’s Discussion and Analysis are based on informationavailable to the Company on the date of this document, and the Company assumesno obligation to update such forward looking statements. Readers of this Form10-QSB are strongly encouraged to review the section entitled *“Factors Which May Affect Future Performance and Financial Condition.”*

 

**General**

 

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

 

Encision was founded to address market opportunities created by theincrease in minimally-invasive surgery (“MIS”) and surgeons’ preference forusing electrosurgery devices in these procedures. The product opportunity wascreated by surgeons’ continued widespread demand for using monopolarelectrosurgery instruments which, when used in laparoscopic surgery, aresusceptible to causing inadvertent collateral tissue damage outside the surgeon’sfield of view. The risk of unintended electrosurgical burn injury to thepatient in laparoscopic surgery has been well documented. This risk poses athreat to patient safety and creates liability exposure for surgeons andhospitals that do not adequately address the issue.

 

Encision’s patented AEM technology provides surgeons with the desiredtissue effects, while preventing stray electrosurgical energy that can causeunintended and unseen tissue injury. AEM Laparoscopic Instruments areequivalent to conventional instruments in functionality but they incorporate “activeelectrode monitoring” technology to dynamically and continuously monitor theflow of electrosurgical current, thereby helping to prevent patient injury.With Encision’s “shielded and monitored” instruments, surgeons are able toperform electrosurgical procedures more safely and effectively than is possibleusing conventional instruments. In addition, the AEM instruments are costcompetitive with conventional “non-shielded, non-monitored” instruments. Theresult is advanced patient safety at comparable cost and with no change insurgeon technique.

 

AEM technology has been recommended and endorsed by sources from allgroups involved in minimally-invasive surgery. Surgeons, nurses, biomedicalengineers, the medicolegal community, malpractice insurance carriers andelectrosurgical device manufacturers advocate the use of AEM technology.Recommendations from the malpractice insurance and medicolegal communitiescomplement the broad clinical endorsements AEM technology has garnered over thepast few years.

 

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

 

The Company has focused its marketing strategies to date on expandingthe market awareness of the AEM technology and its broad independentendorsements, and has continued efforts to improve and expand the AEM productline. Accordingly, the Company is currently focusing on modernizing itsaccepted AEM instruments to include ergonomics and user functionalities forwhich surgeons have been expressing a preference. The Company recentlyannounced enTouchTM, an ergonomically-designed handle for its articulatinginstruments, and further new additions to the AEM product line are planned forintroduction in fiscal year 2007.

 

When a hospital changes to AEM technology it provides recurring revenueto the Company from sales of replacement instruments. Management believes thatthere is no directly competing technology to supplant AEM products once thehospital has changed. The replacement market of reusable and disposable AEMproducts in changed hospitals represents over 90% of Encision’s revenue overthe past six months and this revenue stream is expected to grow as the base ofnewly changed hospitals continues to grow. In addition, the Company intends todevelop disposable versions of more of its AEM products in order to meet marketdemands and expand the Company’s revenue opportunities.

 

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The Company achieved profitable operations in fiscal years 2004 and2003. However, in each fiscal year prior to 2003 and in the fiscal year 2005,the Company incurred losses and had an accumulated deficit of $15,994,219 at September30, 2005. Operations have been financed primarily through issuance of commonstock.

 

During the six months ended September 30, 2005, the Company used $522,220of cash in its operations and used $155,505 for investments in equipment. As ofSeptember 30, 2005, the Company had $832,186 in cash and cash equivalentsavailable to fund future operations, a decrease of $640,199 from March 31, 2005.The Company’s working capital was $2,354,274 at September 30, 2005.

 

**Historical Perspective**

 

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 international patent agencies. Patents were issued in1994, 1996, 1997, 1998 and 2002.

 

As the Company evolved, it was clear to the Company that its ‘activeelectrode monitoring’ technology needed to be integrated into the standardlaparoscopic instrument design. As the development program proceeded, it alsobecame apparent that the merging of electrical and mechanical engineering skillsin the instrument development process for the Company’s patented, integratedelectrosurgical instruments was a complex and difficult task. As a result,instruments with integrated AEM technology were not completed for severalyears. 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 anexpanded line of AEM Laparoscopic Instruments was accomplished over the past twoyears. The Company is now turning its focus to developing next generationversions of its AEM instruments to better meet market demands, particularlydemand for improved ergonomics and simplified user functionalities. Thiscoincides with the independent endorsements for AEM technology. Recommendationsfrom the malpractice insurance and medicolegal communities complement the broadclinical endorsements AEM technology has garnered over the past few years. TheCompany recently announced the introduction of enTouch, anergonomically-designed handle for its articulating instruments, and further newadditions to the AEM product line are planned for introduction in fiscal year2007.

 

**Outlook**

 

*Installed Base of AEM Monitoring Equipment*:  The Company believes that the installed baseof AEM monitors has the potential for increasing as the inherent risksassociated with monopolar laparoscopic electrosurgery become more widelyacknowledged and as the Company focuses on increasing its sales efficiency. TheCompany expects that the replacement sales of electrosurgical instruments andaccessories will increase as additional hospitals adopt AEM technology. TheCompany believes that the efforts to improve the quality of salesrepresentatives carrying the AEM product line, along with increased marketingefforts and the introduction of next generation products, may provide the basisfor increased revenue and returning to profitable operations. However thesemeasures, or any others that the Company may adopt, may not result in eitherincreased revenue or returning to profitable operations. Furthermore, most of theCompany’s next generation products are in the early stages of development.Further additions to the AEM product lineare planned for introduction in fiscal year 2007.

 

The Company believes the unique performance of the AEMtechnology and its breadth of independent endorsements provides an opportunityfor continued market share growth. The Company believes that market awareness andclinical credibility of the AEM technology, as well as awareness of itsendorsements is continually improving and that this will benefit the Company’s salesefforts for the remainder of fiscal 2006. The Company’s objective in theremainder of fiscal 2006 is to maintain expense controls while optimizing salesexecution in the field, expand market awareness of the AEM technology andmaximize the number of additional hospital accounts to AEM instruments, whileretaining existing hospital customers. In addition, acceptance of AEM productsdepends on surgeons’ preference for the Company’s instruments, which depends onfactors such as ergonomics and ease of use in addition to the technologicaladvantage of AEM products. If surgeons prefer other instruments to the Company’s,the Company’s business results will suffer.

 

*Possibility of Continued Operating Losses*:  The Company achieved profitable operations infiscal years 2004 and 2003. However, in fiscal years prior to 2003 and in thefiscal year 2005 the Company incurred losses and had an accumulated deficit of $15,994,219at September 30, 2005. The Company has made significant strides towardimproving its operating results. Due to the ongoing need to develop, optimizeand train the direct sales managers and the independent sales representativenetwork, the need to support development of refinements to the Company’sproduct line and the need to increase sustained revenues to a level adequate tocover fixed and variable operating costs, the Company may operate at a net lossfrom time to time.

 

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*Revenue Growth*:  The Company expects to generate increasedrevenue in the U.S. from sales to new hospital customers and expanded sales inexisting hospitals as the network of direct and independent salesrepresentatives become more efficient. The Company believes that the visibilityand credibility of the independent clinical endorsements for AEM technologywill contribute to new hospital accounts and increased revenues in fiscal 2006. The Company also expects that supplieragreements with Novation and Premier, which together represent over 3,000 U.S.hospitals will expose more hospitals to the benefits of AEM technology and maystimulate new hospital accounts and increased revenues. The Company alsoexpects to increase market share gains through promotional programs of placingCompany-owned AEM monitors at no charge into hospitals that commit tostandardize on AEM instruments. However all of these efforts to increase marketshare and grow revenues will depend in part on the Company’s ability to expandthe efficiency and effective coverage range of its direct and independent salesrepresentatives.

 

The Company also has longer term initiatives in place to improve theCompany’s prospects.  The Company expectsthat development of next generation versions of its AEM products will betterposition the products in the marketplace and improve the Company’s retentionrate at hospitals that have changed to AEM technology, enabling the Company togrow its revenue. The Company may also exploreoverseas markets to assess opportunities for revenue growth internationally.Finally, the Company intends to explore opportunities to capitalize on itsproven AEM technology via licensing arrangements and strategic alliances. Theseefforts to generate additional revenue and further the market penetration ofthe Company’s products are longer term in nature and may not materialize.  Even if the Company is able to successfullydevelop next generation products or identify potential international markets orstrategic partners, the Company may not be able to capitalize on theseopportunities.

 

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

 

*Sales and Marketing Expenses*: TheCompany continues its efforts to expand domestic and international distributioncapability and it believes that sales andmarketing expenses will decrease as a percentage of net revenue with increasingsales volume.

 

*Research and Development Expenses*:Research and development expenses areexpected to increase modestly to support development of refinements to our AEMproduct line, further expanding the instrument options for the surgeon. Furtheradditions to the AEM product line are planned for introduction in fiscal year2007.

 

**Results of Operations**

 

*For the three months ended September 30, 2005compared to the three months ended September 30, 2004.*

 

*Net revenue*.  Revenue for the quarter ended September 30, 2005,was $2,302,454, compared to $2,065,949 for the quarter ended September 30, 2004,an increase of 11%. The increase is attributableto new hospital accounts and favorable trends in the mix of disposable productsusing our AEM technology, partially offset by business lost from hospitals thatpreviously changed to AEM technology. The Company opened 12 new hospitalaccounts to AEM technology in the three months ended September 30, 2005 versus eightnew hospital accounts for AEM technology in the three months ended September 30,2004. New hospital prospectsremain strong and we have seen an increased rate of new hospital accountsduring the past three months. We have added new sales managers and independentsales representatives in an effort to capitalize on identified marketopportunities. It will take a number ofmonths before new sales managers and new independent sales representatives generatenew hospital accounts, but we expect that the combination of these newadditions will provide the focus that is needed to achieve market gains.

 

*Gross profit*.  Gross profit for the quarter ended September30, 2005 of $1,376,836 increased by 15% from the quarter ended September 30, 2004gross profit of $1,195,402. Gross profit as a percentage of revenue (grossmargin) increased from 58% for the quarter ended September 30, 2004 to 60% inthe quarter ended September 30, 2005. The increasein gross margin was primarily the result of additional absorption ofmanufactured and assembled costs due to higher levels of production and sales,and reduced inventory costs compared with one year ago. For the threemonths ended September 30, 2005, the Company provided $22,858 in AEM monitorsat no charge to newly changed hospitals as part of a sales incentive program.

 

*Sales and marketing expenses*.  Sales and marketing expenses of $930,285 forthe quarter ended September 30, 2005 increased by 29% compared to $718,550 forthe quarter ended September 30, 2004. Theincrease was a result of compensation for increased sales employees, increasedcommissions as a result of higher revenue and increased marketing costs for thelaunch of our new handle, enTouch. Increased sales and marketing expenseswere reduced by reduced sales samples cost.

 

*General and administrative expenses*.  General and administrative expenses of$343,618 for the quarter ended September 30, 2005 increased by 2% compared to $337,441for the quarter ended September 30, 2004. The increase is the result of an increase in bad debt expense compared with one yearago.

 

*Research and development expenses*.  Research and development expenses of $263,511for the quarter ended September 30, 2005 increased by 34% compared to $196,554for the quarter ended September 30, 2004. The increase is a result of increasesin

 

14

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compensation for additional employees, inventory usagecosts and outside services to support development of refinements to our productline.

 

*Net loss. *Netloss was $(161,506) for the quarter ended September 30, 2005 compared to a net lossof $(56,416) for the quarter ended September 30, 2004. The net loss was aresult of increased revenue and increased gross margin that was reduced by anincrease in total operating expenses, as explained above, that increased at ahigher percentage than the percentage increase of revenue.

 

*For the six months ended September 30, 2005compared to the six months ended September 30, 2004.*

 

*Net revenue*.  Revenue for the six months ended September30, 2005, was $4,591,082, compared to $3,829,213 for the six months endedSeptember 30, 2004, an increase of 20%. Theincrease is attributable to new hospital accounts and favorable trends in themix of disposable products using our AEM technology, partially offset bybusiness lost from hospitals that previously changed to AEM technology. TheCompany opened 24 new hospital accounts to AEM technology in the six monthsended September 30, 2005 versus 15 new hospital accounts for AEM technology inthe six months ended September 30, 2004.

 

*Gross profit*.  The gross profit for the six months endedSeptember 30, 2005 of $2,761,266 increased by 25% from the six months endedSeptember 30, 2004 gross profit of $2,211,366. Gross profit as a percentage ofrevenue (gross margin) increased from 58% for the six months ended September30, 2004 to 60% in the six months ended September 30, 2005. The increase in gross margin was primarily theresult of additional absorption of manufactured and assembled costs due tohigher levels of production and sales, and reduced inventory costs comparedwith one year ago. For the six months ended September 30, 2005, theCompany provided $47,532 in AEM monitors at no charge to newly changedhospitals as part of a sales incentive program.

 

*Sales and marketing expenses*.  Sales and marketing expenses of $1,799,548for the six months ended September 30, 2005 increased by 22% compared to$1,478,932 for the six months ended September 30, 2004. The increase was a result of compensation for increased sales employees,increased commissions as a result of higher revenue and increased marketingcosts for the launch of our new handle, enTouch. Increased sales andmarketing expenses were reduced by reduced sales samples cost. Sales andmarketing expenses for the six months ended September 30, 2004 included costsrelated to the Company’s resolution of an arbitration dispute with one of itsdistributors on July 23, 2004.. The Company had previously notified thedistributor that it was in breach of its Distributor Agreement with the Companyin several respects, and that if the distributor did not cure the breaches theAgreement could be terminated. The distributor disputed the Company’s positionand asserted that the Company had breached the Agreement. The dispute wasproceeding in arbitration pursuant to the terms of the Agreement when theparties agreed to settle the matter. As a result of the settlement, the Companypaid a total of $201,000, including legal and arbitrator fees, and recognizedthe related expense during the first quarter of FY 2005

 

*General and administrative expenses*.  General and administrative expenses of$603,745 for the six months ended September 30, 2005 decreased by 13% comparedto $690,286 for the six months ended September 30, 2004. The decrease is theresult of decreases in legal and tax feescompared with one year ago.

 

*Research and development expenses*.  Research and development expenses of $504,303for the six months ended September 30, 2005 increased by 29% compared to$390,411 for the six months ended September 30, 2004. The increase is a resultof increases in compensation for additional employees, inventory usage costsand outside services to support development of refinements to our product line.

 

*Net loss. *Netloss was $(142,811) for the six months ended September 30, 2005 compared to anet loss of $(347,351) for the six months ended September 30, 2004. The netloss was a result of an increase in total operating expenses, as explainedabove, that increased at a higher percentage than the percentage increase ofrevenue.

 

**Liquidity and Capital Resources**

 

To date, operating funds have been provided primarily by sales ofcommon stock and warrants to purchase the Company’s common stock, which totaled$18,908,073 through September 30, 2005, and, to a lesser degree, funds providedby sales of the Company’s products.

 

The Company’s operations used $522,220 of cash in the six months ended September30, 2005 on sales of $4,591,082. Prior to fiscal 2003 and in fiscal 2005, theuse of cash in our operations resulted primarily from the funding of theCompany’s annual net losses. These amounts of cash generated from and used inoperations are not indicative of the expected cash to be generated from or usedin operations in fiscal year 2006 (“FY 06”). As of September 30, 2005, theCompany had $832,186 in cash and cash equivalents available to fund futureoperations. Working capital was $2,354,274 at September 30, 2005 compared to $2,519,639at March 31, 2005. Current liabilities were $1,104,338 at September 30, 2005,compared to $1,133,188 at March 31, 2005.

 

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The Company has a leasefor its facilities under noncancelable lease agreements through August 14,2009. The minimum future lease payments are as follows:

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

 

Capital expenditures inthe six months ended September 30, 2005 ($155,505) include the capitalization($47,532) of AEM monitors placed in hospitals under various promotionalprograms. Placing Company-owned AEM monitors into hospitals at no charge tofacilitate their use of AEM instruments is an initiative to accelerate newhospital accounts to AEM instruments. Under these promotional programs theCompany maintains ownership of the AEM monitor and the cost is capitalized anddepreciated as cost of sales over the projected five year life of the asset.

 

The Company’s FY 06operating plan is focused on increasing new hospital accounts to AEM products,retaining existing hospital customers, growing revenue, increasing grossprofits and conserving cash. The Company also is investing in research anddevelopment efforts to develop next generation versions of the AEM productline. The Company can not predict with certainty the expected revenue, grossprofit, net income or loss and usage of cash and cash equivalents for FY 06.However, management believes that its cash resources will be sufficient to fundits operations for at least the next twelve months under its current operatingplan. If management is unable to manage the Company’s business operations inline with budget expectations, it could have a material adverse effect on theCompany’s business viability, financial position, results of operations andcash flows. Further, if the Company is not successful in sustainingprofitability and remaining at least cash flow break-even, additional capitalmay be required to maintain ongoing operations.

 

**Income Taxes**

 

As of March 31, 2005, netoperating loss carryforwards totaling approximately $16,100,000 are availableto reduce taxable income in the future. The net operating loss carryforwardsexpire, if not previously utilized, at various dates beginning in the fiscalyear ended March 31, 2008. The Company has not paid income taxes since itsinception. The Tax Reform Act of 1986 and other income tax regulations containprovisions which may limit the net operating loss carryforwards available to beused in any given year, if certain events occur, including changes in ownershipinterests. The Company has established a valuation allowance for the entireamount of its deferred tax asset since inception due to its history of losses.Should the Company achieve sufficient, sustained income in the future, theCompany may conclude that some or all of the valuation allowance should bereversed. If some or all of the valuation allowance were reversed, then, to theextent of the reversal, a tax benefit would be recognized which would result inan increase to income.

 

## **Contractual Obligations**

 

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

 

## **AtSeptember 30, 2005, the Company’s commitments under these obligations were asfollows:**

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

 

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## **Critical Accounting Policies and Estimates**

 

TheCompany’s critical accounting policies have not changed from those reported inthe Company’s annual report on Form 10-KSB for the year ended March 31, 2005.

 

**FactorsWhich May Affect Future Performance and Financial Condition**:

 

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

 

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

 

*1.         Our products may not be accepted by themarket*.  The success ofour products and our financial condition depends on the acceptance of AEMproducts by the medical community in commercially viable quantities during fiscalyear 2006 and beyond. We cannot predict how quickly or how broadly AEM productswill be accepted by the medical community. We need to continually educate themarketplace about the**potentialhazards involved in the use of conventional electrosurgical products duringminimally-invasive surgical procedures and the expected benefits associatedwith the use of AEM products. If we are unsuccessful in educating themarketplace about our technology and the hazards of conventional instruments,we will not create sufficient demand by hospitals and surgeons for AEM productsand our financial condition, results of operations and cash flows could beadversely affected.

 

*2.         We need to continually develop andtrain our network of direct and independent sales representatives and expandour distribution efforts in order to be successful.* Ourattempts to develop and train a network of direct and 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 direct and independent sales reps change their productlines, product focus and personnel. We may not be able to obtain full coverageof the U.S. by direct and independent sales representatives as quickly asanticipated. The independent sales representative network has inherent flawsand inefficiencies, which can include conflicts of interest and competingproducts. Optimizing the quality of the network and the performance of directand independent sales representatives in the U.S. is an ongoing challenge. Wemay also 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 direct andindependent sales representatives and optimize their performance couldadversely affect our financial results.

 

*3.         We may need additional funding tosupport our operations.* We were**formedin 1991 and have incurred losses of $16 million since that date. We haveprimarily financed research, development and operational activities with salesof our common stock. At September 30, 2005, we had $832,186 in cash availableto fund future operations. We may have profitable operations in FY 2006 butthere is no guarantee we will do so. We may find that investment in sales andmarketing initiatives, merited by market opportunity, may result in the Companyoperating at a net loss from quarter to quarter. We may also find ourselves at acompetitive disadvantage due to our constrained liquidity.

 

*4.         We may not be able to competesuccessfully against current manufacturers of conventional (“unshielded,unmonitored”) electrosurgical instruments or against competitors whomanufacture products that are based on surgical technologies that arealternatives to monopolar electrosurgery. *The electrosurgical products market is intenselycompetitive. We expect that manufacturers of “unshielded, unmonitored”electrosurgical instruments will resist any loss of market share that mightresult from the presence of our “shielded and monitored” instruments in themarketplace. We also believe that manufacturers of products that are based uponsurgical technologies that are alternatives to monopolar electrosurgery are ourcompetitors. These technologies include bipolar electrosurgery, the harmonicscalpel and lasers. The alternative technologies may gain market share and newcompetitive technologies may be developed and introduced. Most of ourcompetitors and potential competitors have significantly greater financial,technical, product development, marketing and other resources than we do. Mostof our competitors also currently have substantial installed customer bases inthe medical products market and have significantly greater market recognitionthan we have. As a result of these factors, our competitors may be able torespond more quickly to new or emerging technologies and changes in customerrequirements or to devote greater resources to the development, promotion andsale of their products. It is possible that new competitors or new alliancesamong competitors may emerge and rapidly acquire significant market share. Thecompetitive pressures we face may materially adversely affect our financialposition, results of operations and cash flows, and this may hinder our abilityto respond to competitive threats.

 

*5.         If we do not continually enhance ourproducts and keep pace with rapid technological changes, we may not be able toattract 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

 

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subject to rapidtechnological change, resulting in frequent new product introductions and enhancementsof existing products, as well as the risk of product obsolescence. While we arecurrently developing new products and enhancing our existing product lines, wemay not be successful in completing the development of the new products orenhancements. In addition, we must respond effectively to technological changesby continuing to enhance our existing products to incorporate emerging orevolving standards. We may not be successful in developing and marketingproduct enhancements or new products that respond to technological changes orevolving industry standards. We may experience difficulties that could delay orprevent the successful development, introduction and marketing of thoseproducts, and our new products and product enhancements may not adequately meetthe requirements of the marketplace and achieve commercially viable levels ofmarket acceptance. If any potential new products, upgrades, or enhancements aredelayed, or if any potential new products, upgrades, or enhancements experiencequality problems or do not achieve such market acceptance, or if new productsmake our existing products obsolete, our financial position, results ofoperations and cash flows would be materially adversely affected.

 

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

 

*7.         If we fail to comply with the extensiveregulatory requirements governing the manufacturing of our products, we couldbe subject to fines, suspensions or withdrawals of regulatory approvals,product recalls, suspension of manufacturing, operating restrictions and/orcriminal prosecution.* The manufacturing of our products issubject to extensive regulatory requirements administered by the Food and DrugAdministration and other regulatory bodies. Inspection of our manufacturingfacilities and processes can be conducted at any time, without prior notice, bythe agencies. In addition, future changes in regulations or interpretationsmade by the Food and Drug Administration or other regulatory bodies, withpossible retroactive effect, could adversely affect us. Changes in existingregulations or adoption of new regulations or policies could prevent us fromobtaining, or affect the timing of, future regulatory approvals or clearances.We may not be able to obtain necessary regulatory approvals or clearances on atimely basis in the future, or at all. Delays in receipt of, failure to receivesuch approvals or clearances and/or failure to comply with existing or futureregulatory requirements would have a material adverse effect on our financialposition, results of operations and cash flows.

 

*8.         Our current patents, trade secrets andknow-how may not provide a competitive advantage, the pending applications maynot result in patents being issued, and our competitors may design around anypatents issued to us.* Our success will continue to depend inpart on our ability to maintain patent protection for our products andprocesses, to preserve our trade secrets and to operate without infringing theproprietary rights of third parties. We have four issued U.S. patents onseveral technologies embodied in our AEM Monitoring System, AEM Instruments andrelated accessories and we have applied for additional U.S. patents. Inaddition, we have four issued foreign patents. The validity and breadth ofclaims coverage in medical technology patents involve complex legal and factualquestions and may be highly uncertain. Also, patents may not protect ourproprietary information and know-how or provide adequate remedies for us in theevent of unauthorized use or disclosure of such information, and others may beable to develop, independently, such information. There has been substantiallitigation regarding patent and other intellectual property rights in themedical device industry. Litigation may be necessary to enforce patents issuedto us, to protect trade secrets or know-how owned by us, to defend us againstclaimed infringement of the rights of others or to determine the ownership,scope or validity of our proprietary rights or those of others. Any such claimsmay require us to incur substantial litigation expenses and to divertsubstantial time and effort of management personnel and could substantiallydecrease the amount of capital available for our operations. An adversedetermination in litigation involving the proprietary rights of others couldsubject us to significant liabilities to third parties, could require us toseek licenses from third parties, and could prevent us from manufacturing,selling or using our products. The occurrence of any such actual or threatenedlitigation or the effect on our business of such litigation may materiallyadversely affect our financial position, results of operations and cash flows.Additionally, our assessment that a patent is no longer of value could resultin a significant charge against our earnings.

 

*9.         We depend on single source suppliersfor certain of the key components and sub-contractors to provide much of ourproducts 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.****We rely on subcontractors to provide products, either inthe form of finished goods or sub-assemblies that we then assemble

 

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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 fluctuation in futurequarterly results may cause our stock price to fluctuate.* Weexpect that our operating results could fluctuate significantly from quarter toquarter in the future and will depend upon a number of factors, many of whichare outside our control. These factors include the extent to which our AEMtechnology and related accessories gain market acceptance; our investments inmarketing, sales, research and development and administrative personnelnecessary to support growth; our ability to expand our market share; actions ofcompetitors and general economic conditions. The market value of our commonstock has dramatically fluctuated in the past and is likely to fluctuate in thefuture. Any deviation could have an immediate and significant negative impacton the market price of our stock.

 

*11.      Our common stock is thinly traded, theprices at which it trades are volatile and the buying or selling actions of afew shareholders may adversely affect our stock price. *As of September 30, 2005,we had a public float, which is defined as shares outstanding minus shares heldby our officers, directors, or holders of greater than 5% of our outstandingcommon stock, of 2,922,105 shares or 46% of the outstanding common stock. Theaverage number of shares traded in any given day over the past year has beenrelatively 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, thinly traded securities such asour common stock have experienced extreme price and volume fluctuations that donot necessarily relate to operating performance. In addition, as of September30, 2005, Vern D. Kornelsen, one of our directors, and an entity controlled byMr. Kornelsen owned an aggregate of 1,878,443 shares of our common stock, orapproximately 29% of our common stock outstanding. As a result, Mr. Kornelsenmay be able to exert substantial influence over matters requiring action by ourshareholders, and in the event Mr. Kornelsen were to elect to sell some or allof the common stock he controls, it could have a significant adverse effect onthe price of our common stock.

 

*12.      Our insurance coverage for productliability 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.      We depend on certain key personnel.* We are highly dependent on a limited number ofkey management personnel, particularly our President and CEO, John R. Serinoand Chairman of the Board, Roger C. Odell. Our loss of key personnel to death,disability or termination, or our inability to hire and retain qualifiedpersonnel, could have a material adverse effect on our financialposition, results of operations and cash flow.

 

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**ITEM 3  ****-  CONTROLSAND PROCEDURES**

 

(a) The Company hascarried out an evaluation under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andPrincipal Accounting and Financial Officer, of the effectiveness of theCompany’s disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14c of the Securities and Exchange Act of 1934 (the “Exchange Act”)). Basedupon that evaluation, the Chief Executive Officer and the Principal Accountingand Financial Officer concluded as of September 30, 2005 that the Company’sdisclosure controls and procedures were effective in ensuring that informationrequired to be disclosed by the Company under the Exchange Act was recorded,processed, summarized and reported within the time periods specified under theExchange Act rules and forms.

 

(b) During the quarterended September 30, 2005, there were no changes in the Company’s internalcontrol over financial reporting or in other factors that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting, nor were there any significant deficienciesor material weaknesses in such disclosure controls and procedures or internalcontrol over financial reporting requiring corrective actions. As a result nocorrective actions were taken.

 

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

 

**ITEM 4****                                                       ****Submission of Matters to a Voteof Security Holders**

 

(i)                                     The following person were elected director ofEncision Inc. for terms expiring in 2006:

 
| ** **        | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|-------------------|------------|---------------|------------|--------------------|------------|
|              |       |          |       |               |       |
| Bruce L. Arfmann  |       | 5,362,426     |       | 463,375            |       |
| Robert H. Fries   |       | 5,370,205     |       | 455,666            |       |
| Vern D. Kornelsen |       | 5,234,270     |       | 591,601            |       |
| David W. Newton   |       | 5,360,044     |       | 465,827            |       |
| Roger C. Odell    |       | 5,257,084     |       | 568,787            |       |
| John R. Serino    |       | 5,360,544     |       | 465,327            |       |
| George A. Stewart |       | 5,362,491     |       | 463,380            |       |

 

(ii)                                  Ratification of appointment of Gordon, Hughes& Banks, LLP to serve as Company’s Independent Auditors in 2006:

 
| Votes  for     |   | 5,811,287 |   |   |   |
|----------------|--------|-----------|--------|--------|--------|
| Votes  against |   | 6,000     |   |   |   |
| Abstentions    |   | 8,584     |   |   |   |

 

**ITEM****6  **-                                           EXHIBITS

 
| 31.1 | Certification of Chief  Executive Officer under Rule 13a-14(a)                    |
|------|-----------------------------------------------------------------------------------|
| 31.2 | Certification of  Principal Financial and Accounting Officer under Rule 13a-14(a) |
| 32.1 | 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                          |     | November 11, 2005 |
| Marcia McHaffie     |       |                         | Principal  Accounting Officer & |     |   |
|                |       | Principal  Financial Officer |                                |     |

 

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