**U. S. Securities and ExchangeCommission**

**Washington, D.C. 20549**

 

## **Form 10-QSB**

 

ý         **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES****EXCHANGE ACT OF 1934**

 

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

 

**For the transition period from           to        **

 

**Commission file number     0-28604**

 

**ENCISION INC.**

(Exact name of small business issuer as specified in its charter)

 
| **Colorado**                                                    | ** ** | **84-1162056**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

**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 befiled by Section 13 of 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.**

 

**Yes ****ý           No  ****o**

 

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

 

| **Common Stock, No par value** | ** ** | **6,368,146 Shares**                |
|--------------------------------|------------|-------------------------------------|
| Class                          |       | (outstanding at July 31, 2005) |

 

**TransitionalSmall Business Disclosure Format**

 

**Yes ****o           No  ****ý**

 

 

----

 

**ENCISION INC.**

 

**FORM 10-QSB**

 

**For the Quarter Ended June 30, 2005**

 

**INDEX**

 
| **PART I.**  | **UNAUDITED FINANCIAL  INFORMATION** |                                                                                         |
|-------------------|-------------------------------------------|----------------------------------------------------------------------------------------------|
|              |                                      |                                                                                         |   |
| **ITEM 1**   | -                                         | Condensed Interim Financial Statements:                                                      |   |
|              | -                                         | Condensed  Balance Sheets as of  June 30, 2005 and March 31, 2005                  |   |
|              | -                                         | Condensed  Statements of Operations for  the Three Months Ended June 30, 2005 and 2004  |   |
|              | -                                         | Condensed  Statements of Cash Flows for  the Three Months Ended June 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 6**        | -                                         | Exhibits                                                                                     |   |
|              |                                      |                                                                                         |   |
| **SIGNATURE**     |                                      |

 

2

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**PART I****                                                       FINANCIALINFORMATION**

 

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

 

ENCISION INC.

 

CONDENSED BALANCESHEETS

 
| ** **                                                                                                                                        | ** ** | **June 30,** | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                                                                                        | ** ** | **2005**          | ** ** | **2005**           | ** ** |
| ** **                                                                                                                                        | ** ** | **(unaudited)**   | ** ** | **(audited)**      | ** ** |
| ASSETS                                                                                                                                            |       |              |       |               |       |
|                                                                                                                                              |       |              |       |               |       |
| Cash and cash equivalents                                                                                                                         |       | $                 | 1,114,709  |               | $          | 1,472,385 |   |
| Accounts receivable, net of allowance for doubtful accounts  of $25,000 and $19,000, respectively                                                 |       | 1,141,412         |       | 866,710            |       |
| Inventory, net of reserve for obsolescence of  $65,000 and $65,000, respectively                                                                  |       | 1,365,559         |       | 1,210,582          |       |
| Prepaid expenses                                                                                                                                  |       | 134,402           |       | 103,150            |       |
| Total current assets                                                                                                                              |       | 3,756,082         |       | 3,652,827          |       |
| EQUIPMENT, at cost:                                                                                                                               |       |              |       |               |       |
| Furniture, fixtures and equipment                                                                                                                 |       | 957,170           |       | 860,352            |       |
| Customer-site equipment                                                                                                                           |       | 565,366           |       | 540,692            |       |
| Less - accumulated depreciation                                                                                                                   |       | (1,142,492        | )          | (1,085,130         | )          |
| Equipment, net                                                                                                                                    |       | 380,044           |       | 315,914            |       |
| PATENTS, net of accumulated amortization of $83,222 and  $80,183, respectively                                                                    |       | 122,123           |       | 117,764            |       |
| OTHER ASSETS                                                                                                                                      |       | 20,210            |       | 20,210             |       |
| Total assets                                                                                                                                      |       | $                 | 4,278,459  |               | $          | 4,106,715 |   |
|                                                                                                                                              |       |              |       |               |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                         |       |              |       |               |       |
|                                                                                                                                              |       |              |       |               |       |
| CURRENT LIABILITIES:                                                                                                                              |       |              |       |               |       |
| Accounts payable                                                                                                                                  |       | $                 | 492,197    |               | $          | 532,657 |   |
| Accrued compensation                                                                                                                              |       | 220,754           |       | 138,042            |       |
| Other accrued liabilities                                                                                                                         |       | 497,495           |       | 462,489            |       |
| Total current liabilities                                                                                                                         |       | 1,210,446         |       | 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, 6,367,146 (June 30, 2005) and 6,313,146 (Mar. 31, 2005)  shares outstanding |       | 18,900,726        |       | 18,824,935         |       |
| Accumulated (deficit)                                                                                                                             |       | (15,832,713       | )          | (15,851,408        | )          |
| Total shareholders’ equity                                                                                                                   |       | 3,068,013         |       | 2,973,527          |       |
| Total liabilities and shareholders’ equity                                                                                                   |       | $                 | 4,278,459  |               | $          | 4,106,715 |   |

 

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

 

3

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ENCISION INC.

 

CONDENSED STATEMENTS OFOPERATIONS

(Unaudited)

 
| ** **                                                                            | ** ** | **For the Three Months** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                            | ** ** | **Ended June 30,**  | ** ** |
| ** **                                                                            | ** ** | **2005**                 | ** ** | **2004** | ** ** |
|                                                                                  |       |                     |       |   |   |
| REVENUE, NET                                                                          |       | $                        | 2,288,628  |   | $ | 1,763,264 |   |
|                                                                                  |       |                     |       |   |   |
| COST OF SALES                                                                         |       | 904,197                  |       | 747,300 |   |
| Gross profit                                                                          |       | 1,384,431                |       | 1,015,964 |   |
| OPERATING EXPENSES:                                                                   |       |                     |       |   |   |
| Sales and marketing                                                                   |       | 869,263                  |       | 760,382 |   |
| General and administrative                                                            |       | 260,127                  |       | 352,845 |   |
| Research and development                                                              |       | 240,792                  |       | 193,857 |   |
| Total operating expenses                                                              |       | 1,370,182                |       | 1,307,084 |   |
| INCOME (LOSS) FROM OPERATIONS                                                         |       | 14,249                   |       | (291,120 | ) |
|                                                                                  |       |                     |       |   |   |
| OTHER INCOME (EXPENSE):                                                               |       |                     |       |   |   |
| Interest income                                                                       |       | 6,408                    |       | 1,667 |   |
| Other (expense), net                                                                  |       | (1,962                   | )          | (1,482 | ) |
| NET INCOME (LOSS)                                                                     |       | $                        | 18,695     |   | $ | (290,935 | ) |
|                                                                                  |       |                     |       |   |   |
| NET INCOME (LOSS) PER SHARE:                                                          |       |                     |       |   |   |
| Basic and diluted net income (loss) per common share                                  |       | $                        | 0.00       |   | $ | (0.05 | ) |
|                                                                                  |       |                     |       |   |   |
| Weighted average shares used in computing basic net  income (loss) per common share   |       | 6,316,605                |       | 5,853,845 |   |
|                                                                                  |       |                     |       |   |   |
| Weighted average shares used in computing diluted  net income (loss) per common share |       | 6,355,630                |       | 5,853,845 |   |

 

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

 

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ENCISION INC.

 

CONDENSED STATEMENTS OFCASH FLOWS

(Unaudited)

 
| ** **                                                                                           | ** ** | **For the Three Months** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                           | ** ** | **Ended June 30,**  | ** ** |
| ** **                                                                                           | ** ** | **2005**                 | ** ** | **2004** | ** ** |
|                                                                                                 |       |                     |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                |       |                     |       |   |   |
| Net income (loss)                                                                                    |       | $                        | 18,695     |   | $ | (290,935 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities - |       |                     |       |   |   |
| Depreciation and amortization                                                                        |       | 60,401                   |       | 44,208 |   |
| Provision for bad debts                                                                              |       | 6,000                    |       | 3,000 |   |
| Inventory reserves                                                                                   |       | —                   |       | 5,000 |   |
| Changes in operating assets and liabilities -                                                        |       |                     |       |   |   |
| Accounts receivable                                                                                  |       | (280,702                 | )          | 104,056 |   |
| Inventory                                                                                            |       | (154,977                 | )          | (73,414 | ) |
| Other assets                                                                                         |       | (31,252                  | )          | (85,103 | ) |
| Accounts payable                                                                                     |       | (40,460                  | )          | 17,601 |   |
| Accrued compensation and other accrued liabilities                                                   |       | 117,718                  |       | 284,405 |   |
| Net cash provided by (used in) operating activities                                                  |       | (304,577                 | )          | 8,818 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                |       |                     |       |   |   |
| Investment in equipment                                                                              |       | (121,492                 | )          | (40,178 | ) |
| Patent costs                                                                                         |       | (7,398                   | )          | — |   |
| Net cash (used in) investing activities                                                              |       | (128,890                 | )          | (40,178 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                |       |                     |       |   |   |
| Proceeds from the exercise of stock options                                                          |       | 75,791                   |       | 84,142 |   |
| Net cash provided by financing activities                                                            |       | 75,791                   |       | 84,142 |   |
|                                                                                                 |       |                     |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                 |       | (357,676                 | )          | 52,782 |   |
|                                                                                                 |       |                     |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                                       |       | 1,472,385                |       | 1,356,607 |   |
| CASH AND CASH EQUIVALENTS, end of period                                                             |       | $                        | 1,114,709  |   | $ | 1,409,389 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

5

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ENCISION INC.

 

NOTES TO CONDENSED INTERIMFINANCIAL STATEMENTS

 

JUNE 30, 2005

(Unaudited)

 

(1)                                  ORGANIZATIONAND NATURE OF BUSINESS

 

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

 

The Company achievedprofitable operations in fiscal years 2004 and 2003. However, in each fiscalyear prior to 2003 and in the fiscal year 2005, the Company had incurred lossesand had an accumulated (deficit) of $(15,832,713) at June 30, 2005.Operations have been financed primarily through issuance of common stock.

 

During fiscal years 2004and 2003, the Company achieved annual net income for the first time in itshistory. The Company’s strategic marketing and sales plan is designed to expandthe use of the Company’s products in surgically active hospitals in the UnitedStates. Management expects these efforts to result in continued revenueincreases for fiscal 2006.

 

(2)                                  SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Useof Estimates in the Preparation of Financial Statements

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions. Such estimates and assumptions affect the reported amounts ofassets and liabilities as well as disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expense during the reporting period. Actual results could differfrom those estimates.

 

RevenueRecognition

 

Revenue from productsales is recorded when the Company ships the product and title has passed tothe customer, provided that the Company has evidence of a customer arrangementand can conclude that collection is probable. The Company’s shipping policy isFOB Shipping Point. The Company recognizes revenue from sales to stockingdistributors when there is no right of return, other than for normal warrantyclaims. The Company has no ongoing obligations related to product sales, exceptfor normal warranty.

 

Cashand Cash Equivalents

 

For purposes of reportingcash flows, the Company considers all cash and highly liquid investments withan original maturity of three months or less to be cash equivalents.

 

FairValue of Financial Instruments

 

The Company’s financialinstruments consist of cash and cash equivalents and short-term tradereceivables and payables.  The carryingvalues of cash and cash equivalents and short-term receivables and payablesapproximate their fair value due to their short maturities.

 

Concentrationof Credit Risk

 

The Company has nosignificant off-balance sheet concentrations of credit risk such as foreignexchange contracts, options contracts or other foreign hedging arrangements.The Company maintains the majority of its cash balances with two financialinstitutions in the form of demand deposits and money market funds.

 

Accounts receivable aretypically unsecured and are derived from transactions with and from entities inthe healthcare industry primarily located in the United States. Accordingly,the Company may be exposed to credit risk generally associated with the

 

6

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healthcare industry. TheCompany maintains allowances for doubtful accounts for estimated lossesresulting from the inability of its customers to make required payments.

 

The net accountsreceivable balance at June 30, 2005 of $1,141,412 included $197,693, orapproximately 17%, and from one customer. The net accounts receivable balanceat March 31, 2005 of $866,710 included $73,339, or approximately 8%, fromone customer.

 

WarrantyAccrual

 

The Company provides forthe estimated cost of product warranties at the time revenue is recognized.While the Company engages in extensive product quality programs and processes,including actively monitoring and evaluating the quality of its componentsuppliers, the Company’s warranty obligation is based upon historical experienceand is also affected by product failure rates and material usage incurred incorrecting a product failure. Should actual product failure rates or materialusage costs differ from the Company’s estimates, revisions to the estimatedwarranty liability would be required.

 

Inventories

 

Inventories are stated atthe lower of cost (first-in, first-out basis) or market. The Company reducesinventory for estimated obsolete or unmarketable inventory equal to thedifference between the cost of inventory and the estimated market value basedupon assumptions about future demand and market conditions. If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required. Inventory consisted of the following:

 

| ** **                      | ** ** | **June 30,** | ** ** | **March 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                      | ** ** | **2005**          | ** ** | **2005**           | ** ** |
| Raw materials                   |       | $                 | 983,588    |               | $          | 738,850 |   |
| Finished goods                  |       | 446,971           |       | 536,732            |       |
|                            |       | 1,430,559         |       | 1,275,582          |       |
| Less - Reserve for obsolescence |       | (65,000           | )          | (65,000            | )          |
|                            |       | $                 | 1,365,559  |               | $          | 1,210,582 |   |

 

Propertyand Equipment

 

Property and equipmentare stated at cost, with depreciation computed primarily on a double-decliningbasis over the estimated useful life of the asset, generally three to fiveyears. Company-owned AEM Monitors at customer sites are depreciated on a double-decliningbasis for a period of 5 years. Leasehold improvements are depreciated over theshorter of the remaining lease term or the estimated useful life of the asset.Maintenance and repairs are expensed as incurred and major additions,replacements and improvements are capitalized.

 

Long-LivedAssets 

 

Long-lived assets arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. A long-lived assetis considered impaired when estimated future cash flows related to the asset,undiscounted and without interest, are insufficient to recover the carryingamount of the asset. If deemed impaired, the long-lived asset is reduced to itsestimated fair value. Long-lived assets to be disposed of are reported at thelower of their carrying amount or estimated fair value less cost to sell.

 

Patents

 

The costs of applying forpatents are capitalized and amortized on a straight-line basis over the lesserof the patent’s economic or legal life (17 years in the United States).Capitalized costs are expensed if patents are not granted. The Company reviewsthe carrying value of its patents periodically to determine whether the patentshave continuing value and such reviews could result in the conclusion that therecorded amounts have been impaired.

 

AccruedLiabilities

 

The Company has accrued $150,000related to warranty claims, $143,136 related to sales commissions and $118,467related to rent normalization and has included these amounts in accruedliabilities in the accompanying balance sheets as of June 30, 2005.

 

7

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IncomeTaxes 

 

The Company accounts forincome taxes under the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 109, “Accounting for Income Taxes” (“SFAS No. 109”).SFAS No. 109 requires recognition of deferred income tax assets andliabilities for the expected future income tax consequences, based on enactedtax laws, of temporary differences between the financial reporting and taxbases of assets and liabilities. SFAS No. 109 also requires recognition ofdeferred tax assets for the expected future tax effects of all deductibletemporary differences, loss carryforwards and tax credit carryforwards.Deferred tax assets are then reduced, if deemed necessary, by a valuationallowance for the amount of any tax benefits which, more likely than not basedon current circumstances, are not expected to be realized. During fiscal year2005, no tax benefit was obtained from the Company’s loss. As a result, no taxbenefit is reflected in the accompanying statements of operations. During thefirst three months of fiscal year 2006, the Company utilized net operating losscarryforwards to entirely offset its tax liability. As a result, no taxprovision is reflected in the accompanying statements of operations. Should theCompany achieve sufficient, sustained income in the future, the Company mayconclude that some or all of the valuation allowance should be reversed.

 

Researchand Development Expenses

 

The Company expensesresearch and development costs for products and processes as incurred.

 

Stock-BasedCompensation  

 

The Company has adoptedthe disclosure-only provisions of SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS No. 123”), and applies AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB No. 25”), and related interpretations in accounting for stockoptions granted to employees.  If theCompany had accounted for its stock-based compensation plans in accordance withSFAS 123, the Company’s net income or loss and pro forma net income or loss perbasic and diluted common share for the three months ended June 30, 2005would have been reported as follows:

 
| Three months  ended June 30, 2005                          |   |    |    |
|-----------------------------------------------------------------|--------|---------|---------|
| Net Income (Loss)                                               |   |    |    |
| As Reported                                                     |   | $       | 18,695  |   |
| Stock-based compensation based upon estimated fair  values      |   | (54,209 | )       |
| Pro forma                                                       |   | $       | (35,514 | ) |
| Pro Forma Net Income (Loss) Per Basic and Diluted  Common Share |   |    |    |
| As Reported                                                     |   | $       | 0.00    |   |
| Pro Forma                                                       |   | $       | (0.01   | ) |

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

 

SegmentReporting

 

The Company has concludedthat it has one operating segment.

 

Basicand Diluted Income and Loss per Common Share

 

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

 

For the three monthperiod ended June 30, 2005, the Company had financial instruments thatcould create future dilution to the Company’s common shareholders and are notcurrently classified as outstanding common shares of the Company. The commonstock number is based on specific conversion or issuance assumptions pursuantto the corresponding terms of each instrument. Potential stock issuanceexcluded from earnings per share because their effect was anti-dilutive was 398,200for the three months ended June 30, 2005.

 

RecentAccounting Pronouncements

 

InventoryCosts

 

In November 2004,the FASB issued FASB Statement No. 151, which revised ARB No.43, relatingto inventory costs. This revision is to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs and wasted material(spoilage). This Statement requires that these items be recognized as a currentperiod charge regardless of whether they meet the criterion specified in ARB43. In addition, this Statement requires the allocation of fixed productionoverheads to the costs of conversion be based on

 

8

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normal capacity of theproduction facilities. This Statement is effective for financial statements forfiscal years beginning after June 15, 2005. Earlier application ispermitted for inventory costs incurred during fiscal years beginning after thedate this Statement was issued. The Company believes this Statement will haveno impact on the financial statements of the Company once adopted.

 

Exchangesof Nonmonetary Assets

 

In December 2004,the FASB issued FASB Statement No. 153. This Statement addresses themeasurement of exchanges of nonmonetary assets. The guidance in APB Opinion No. 29,Accounting for Nonmonetary Transactions, is based on the principle thatexchanges of nonmonetary assets should be measured based on the fair value ofthe assets exchanged. The guidance in that Opinion, however, included certainexceptions to that principle. This Statement amends Opinion 29 to eliminate theexception for nonmonetary exchanges of similar productive assets and replacesit with a general exception for exchanges of nonmonetary assets that do nothave commercial substance. A nonmonetary exchange has commercial substance ifthe future cash flows of the entity are expected to change significantly as aresult of the exchange. This Statement is effective for financial statementsfor fiscal years beginning after June 15, 2005. Earlier application ispermitted for nonmonetary asset exchanges incurred during fiscal yearsbeginning after the date of this Statement is issued. The Company believes thisStatement will have no impact on the financial statements of the Company onceadopted.

 

Share-BasedPayments

 

In December 2004,the FASB issued a revision to FASB Statement No. 123, Accounting for StockBased Compensation. This Statement supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementationguidance.  This Statement establishes standardsfor the accounting for transactions in which an entity exchanges its equityinstruments for goods or services. It also addresses transactions in which anentity incurs liabilities in exchange for goods or services that are based onthe fair value of the entity’s equity instruments or that may be settled by theissuance of those equity instruments. This Statement focuses primarily on accounting for transactions in whichan entity obtains employee services in share-based payment transactions. ThisStatement does not change the accounting guidance for share-based paymenttransactions with parties other than employees provided in Statement 123 asoriginally issued and EITF Issue No. 96-18, “Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services.” This Statement does not addressthe accounting for employee share ownership plans, which are subject to AICPAStatement of Position 93-6, Employers’ Accounting for Employee Stock OwnershipPlans.

 

A public entity willinitially measure the cost of employee services received in exchange for anaward of liability instruments based on its current fair value; the fair valueof that award will be re-measured subsequently at each reporting date throughthe settlement date.  Changes in fairvalue during the requisite service period will be recognized as compensationcost over that period. A nonpublic entity may elect to measure its liabilityawards at their intrinsic value through the date of settlement.

 

The grant-date fair valueof employee share options and similar instruments will be estimated using theoption-pricing models adjusted for the unique characteristics of thoseinstruments (unless observable market prices for the same or similarinstruments are available).

 

Excess tax benefits, asdefined by this Statement, will be recognized as an addition topaid-in-capital. Cash retained as a result of those excess tax benefits will bepresented in the statement of cash flows as financing cash inflows. Thewrite-off of deferred tax assets relating to unrealized tax benefits associatedwith recognized compensation cost will be recognized as income tax expenseunless there are excess tax benefits from previous awards remaining in paid-incapital to which it can be offset.

 

The notes to thefinancial statements of both public and nonpublic entities will discloseinformation to assist users of financial information to understand the natureof share-based payment transactions and the effects of those transactions onthe financial statements.

 

The effective date forpublic entities that file as small business issuers will be as of the beginningof the first interim or annual reporting period that begins after December 15,2005. The Company intends to comply with this Statement at the scheduledeffective date for the relevant financial statements of the Company.

 

RecentAccounting Pronouncements

 

In May 2005, theFASB issued FASB Statement 154, Accounting Changes and Error Corrections. ThisStatement replaces APB Opinion No. 20, Accounting Changes, and FASBStatement No. 3, Reporting Accounting Changes in Interim FinancialStatements, and changes the requirements for the accounting for and reportingof a change in accounting principle. This Statement applies to all voluntarychanges in accounting principle. The Company believes this Statement will haveno impact on the financial statements of the Company.

 

9

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(3)                                  COMMITMENTSAND CONTINGENCIES

 

The Company currentlyleases its facilities under noncancelable lease agreements through August 14,2009 at 6797 Winchester Circle, Boulder, Colorado. The minimum future leasepayments are as follows:

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

 

On July 23, 2004,the Company resolved a dispute with one of its distributors. The Company hadpreviously notified the distributor that it was in breach of its DistributorAgreement with the Company in several respects, and that if the distributor didnot cure the breaches the Agreement could be terminated. The distributordisputed the Company’s position and asserted that the Company had breached theAgreement. The dispute was proceeding in arbitration pursuant to the terms ofthe Agreement when the parties agreed to settle the matter. As a result of thesettlement, the Company paid a total of $201,000, including legal andarbitrator fees, and recognized the related expense during the first quarter ofFY 2005. The distributor’s purchases represented approximately 6% of theCompany’s revenue in FY 2004.

 

The Company is subject toregulation by the United States Food and Drug Administration (“FDA”). The FDAprovides regulations governing the manufacture and sale of the Company’sproducts and regularly inspects the Company and other manufacturers todetermine their compliance with these regulations. As of June 30, 2005 theCompany believes it was in substantial compliance with all known regulations. FDAinspections are conducted periodically at the discretion of the FDA. TheCompany was last inspected in May 2005 and was notified of six potentialdeficiencies from that inspection, none of which the Company believes to bematerial.

 

The results of operationsfor the quarter ended June 30, 2005 should not be taken as an indicationof the results of operations for all or any part of the balance of the year.

 

(4)                                  BASISOF PRESENTATION

 

The condensed interimfinancial statements included herein have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the Securities andExchange Commission. Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted pursuant to such rules andregulations, although the Company believes that the disclosures made areadequate to make the information presented not misleading. The condensedinterim financial statements and notes thereto should be read in conjunctionwith the financial statements and the notes thereto, included in the Company’sAnnual Report to the Securities and Exchange Commission for the fiscal yearended March 31, 2005, filed on Form 10-KSB on June 29, 2005.

 

The accompanyingcondensed interim financial statements have been prepared, in all materialrespects, in conformity with the standards of accounting measurements set forthin Accounting Principles Board Opinion No. 28 and reflect, in the opinionof management, all adjustments necessary to summarize fairly the financialposition and results of operations for such periods in accordance withaccounting principles generally accepted in the United States of America.  All adjustments are of a normal recurringnature. The results of operations for the most recent interim period are notnecessarily indicative of the results to be expected for the full year.

 

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**ITEM 2     ****-     MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Certain statements contained in this section on Management’sDiscussion and Analysis are not historical facts, including statements aboutthe Company’s strategies and expectations about new and existing products,market demand, acceptance of new and existing products, technologies andopportunities, market and industry segment growth, and return on investments inproducts and markets. These statements are forward looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995 and involvesubstantial risks and uncertainties that may cause actual results to differmaterially from those indicated by the forward looking statements. All forwardlooking statements in this section on Management’s Discussion and Analysisare based on information available to the Company on the date of this document,and the Company assumes no obligation to update such forward lookingstatements. Readers of this Form 10-QSB are strongly encouraged to reviewthe section entitled *“Factors Which May AffectFuture Performance and Financial Condition.”*

 

**General**

 

Encision Inc. (“Encision”or “the Company”), a medical device company based in Boulder, Colorado, hasdeveloped and launched innovative technology that is emerging as a standard ofcare in minimally-invasive surgery. The Company believes its patented AEM®Surgical Instruments are changing the marketplace for electrosurgical devicesand laparoscopic instruments by providing a solution to a well documentedpatient safety risk in laparoscopic surgery.

 

Encision was founded toaddress market opportunities created by the increase in minimally-invasivesurgery (“MIS”) and surgeons’ preference for using electrosurgery devices inthese procedures. The product opportunity was created by surgeons’ continuedwidespread demand for using monopolar electrosurgery instruments which, whenused in laparoscopic surgery, are susceptible to causing inadvertent collateraltissue damage outside the surgeon’s field of view. The risk of unintendedelectrosurgical burn injury to the patient in laparoscopic surgery has beenwell documented. This risk poses a threat to patient safety and createsliability exposure for surgeons and hospitals that do not adequately addressthe issue.

 

Encision’s patented AEMtechnology provides surgeons with the desired tissue effects, while preventingstray electrosurgical energy that can cause unintended and unseen tissueinjury. AEM Laparoscopic Instruments are equivalent to conventional instrumentsin functionality but they incorporate “active electrode monitoring” technologyto dynamically and continuously monitor the flow of electrosurgical current,thereby helping to prevent patient injury. With Encision’s “shielded andmonitored” instruments, surgeons are able to perform electrosurgical proceduresmore safely and effectively than is possible using conventional instruments. Inaddition, the AEM instruments are cost competitive with conventional “non-shielded,non-monitored” instruments. The result is advanced patient safety at comparablecost and with no change in surgeon technique.

 

AEM technology has beenrecommended and endorsed by sources from all groups involved inminimally-invasive surgery. Surgeons, nurses, biomedical engineers, the medicolegalcommunity, malpractice insurance carriers and electrosurgical devicemanufacturers advocate the use of AEM technology. The breadth of endorsementscontinues to expand with the recognition of active electrode monitoringtechnology as an *AORN Recommended Practice* by theAssociation of periOperative Registered Nurses and with insurance andmedicolegal endorsements.

 

The Company has focusedits marketing strategies to date on expanding the market awareness of the AEMtechnology and its broad independent endorsements, and has continued efforts toimprove and expand the AEM product line. Accordingly, the Company is currently focusing on modernizing itsaccepted AEM instruments to include ergonomics and user functionalities forwhich surgeons have been expressing a preference. This coincides with theendorsements for AEM technology. Recommendations from the malpractice insuranceand medicolegal communities complement the broad clinical endorsements AEMtechnology has garnered over the past few years. New additions to the AEMproduct line are planned for introduction in fiscal year 2006.

 

Adding furthercredibility to the benefits of Encision’s AEM technology are the Company’ssupplier agreements with Novation and Premier, two of the largest GroupPurchasing Organizations (GPO) in the United States. Together, Novation andPremier represent over 3,000 hospitals and over 50% of all surgery in the U.S.Management believes that these GPO supplier agreements give further indicationthat AEM technology is gaining broader acceptance in the market. Managementbelieves that having the nation’s leading medical purchasing groups recognizethe value of the Company’s technology reflects the potential impact that AEMinstruments products can have in the market and in advancing patient safety insurgery nationwide. These agreements do not involve purchase commitments butthe Company expects these relationships to expand the market visibility of AEMtechnology and smooth the procurement process for new hospital customers.

 

When a hospital changesto AEM technology it provides recurring revenue to the Company from sales ofreplacement instruments. Management believes that there is no directlycompeting technology to supplant AEM products once the hospital has changed.The replacement market of reusable and disposable AEM products in changedhospitals represents over 90% of Encision’s revenue over the past three monthsand this revenue stream is expected to grow as the base of newly changedhospitals continues to grow. In

 

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addition, the Companyintends to develop disposable versions of more of its AEM products in order tomeet market demands and expand the Company’s revenue opportunities.

 

The Company achievedprofitable operations in fiscal years 2004 and 2003. However, in each fiscalyear prior to 2003 and in the fiscal year 2005, the Company had incurred lossesand had an accumulated (deficit) of $(15,832,713) at June 30, 2005.Operations have been financed primarily through issuance of common stock.

 

During the three monthsended June 30, 2005, the Company used $304,577 of cash in its operationsand used $121,492 for investments in equipment. As of June 30, 2005, theCompany had $1,114,709 in cash and cash equivalents available to fund futureoperations, a decrease of $357,676 from March 31, 2005. The Company’sworking capital was $2,545,636 at June 30, 2005.

 

**HistoricalPerspective**

 

The Company was organizedin 1991 and spent several years developing the AEM monitoring system and protectivesheaths to adapt to conventional electrosurgical instruments. During thisperiod, the Company conducted product trials and applied for patents with theUnited States Patent Office and with the International patent agencies. Patentswere issued in 1994, 1996, 1997, 1998 and 2002.

 

As the Company evolved,it was clear to the Company that its ‘active electrode monitoring’ technologyneeded to be integrated into the standard laparoscopic instrument design. Asthe development program proceeded, it also became apparent that the merging ofelectrical and mechanical engineering skills in the instrument developmentprocess for the Company’s patented, integrated electrosurgical instruments wasa complex and difficult task. As a result, instruments with integrated AEMtechnology were not completed for several years. Prior to offering a full rangeof laparoscopic electrosurgical instrumentation, it was difficult for hospitalsto commit to the AEM solution, as the Company did not have adequate comparablesurgical instrument options to match what the surgeon demanded. As of fiscal2001, a sufficiently broad product line was available to provide hospitaloperating rooms with AEM Instruments in most of the designs common forlaparoscopic surgery.

 

The launch of an expandedline of AEM Laparoscopic Instruments was accomplished over the past two years.The Company is now turning its focus to developing next generation versions ofits AEM instruments to better meet market demands, particularly demand forimproved ergonomics and simplified user functionalities. This coincides withthe independent endorsements for AEM technology. Recommendations from themalpractice insurance and medicolegal communities complement the broad clinicalendorsements AEM technology has garnered over the past few years. New additionsto the AEM product line are planned for introduction in fiscal year 2006.

 

**Outlook**

 

*InstalledBase 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, theCompany’s next generation products are in the early stages of development. Itis anticipated that some of these products will be available for sale duringthe second half of fiscal year 2006.

 

*Possibilityof Continued Operating Losses*:  The Company achieved profitable operations infiscal years 2004 and 2003. However, in each fiscal year prior to 2003 and inthe fiscal year 2005 the Company had incurred losses and had an accumulated(deficit) of $(15,832,713) at June 30, 2005. The Company has madesignificant strides toward improving its operating results. Approximately $423,000of cash was used in the Company’s activities in fiscal 2005. Due to the ongoingneed to develop, optimize and train the direct sales managers and theindependent sales representative network, the need to support development ofrefinements to our product line and the need to increase sustained revenues toa level adequate to cover fixed and variable operating costs, the Company mayoperate at a net loss from time to time.

 

*RevenueGrowth*:  The Companyexpects to generate increased revenue in the U.S. from sales to new hospitalcustomers and expanded sales in existing hospitals as the network of direct andindependent sales representatives become more efficient. The Company believesthat the visibility and credibility of the independent clinical endorsementsfor AEM technology will contribute to new hospital accounts and increasedrevenues in fiscal 2006. The Company also expects that supplier agreements withNovation and Premier, which together represent over 3,000 U.S. hospitals, andwith a potential additional supplier agreement that the Company is currentlypursuing, 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

 

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increase market share andgrow revenues will depend in part on the Company’s ability to expand theefficiency and effective coverage range of its direct and independent salesrepresentatives.

 

The Company also haslonger term initiatives in place to improve the Company’s prospects.  The Company expects that development of nextgeneration versions of its AEM products will better position the products inthe marketplace and improve the Company’s retention rate at hospitals that havechanged to AEM technology, enabling the Company to grow its revenue. TheCompany may also explore overseas markets to assess opportunities for revenuegrowth internationally. Finally, the Company intends to explore opportunities tocapitalize on its proven AEM technology via licensing arrangements andstrategic alliances. These efforts to generate additional revenue and furtherthe market penetration of the Company’s products are longer term in nature andmay not materialize.  Even if the Companyis able to successfully develop next generation products or identify potentialinternational markets or strategic partners, the Company may not be able tocapitalize on these opportunities.

 

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

 

*Sales andMarketing Expenses*: The Company continues its efforts toexpand domestic and international distribution capability and it believes thatsales and marketing expenses will decrease as a percentage of net revenue withincreasing sales volume.

 

*Researchand Development Expenses*: Research and development expensesare expected to increase modestly to support development of refinements to ourAEM product line, further expanding the instrument options for the surgeon. Newadditions to the AEM product line are planned for introduction in fiscal year2006.

 

**Resultsof Operations**

 

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

 

*Netrevenue*.  Revenue forthe quarter ended June 30, 2005, was $2,288,628, compared to $1,763,264for the quarter ended June 30, 2004, an increase of 30%. The increase is attributable to new hospital accountsand favorable trends in the mix of disposable products using our AEMtechnology, partially offset by business lost from hospitals that previouslychanged to AEM technology. The Company opened twelve new hospital accounts toAEM technology in the three months ended June 30, 2005 versus seven newhospital accounts for AEM technology in the three months ended June 30, 2004.New hospital prospects remainstrong and we have seen an increased rate of new hospital accounts during thepast three months. While it will take anumber of months before new sales managers and independent salesrepresentatives generate new hospital accounts, the combination of the newadditions is intended to provide the field focus necessary to achieve marketgains.

 

*Grossprofit*.  The grossprofit for the quarter ended June 30, 2005 of $1,384,431 increased by 36%from the quarter ended June 30, 2004 gross profit of $1,015,964. Grossprofit as a percentage of revenue (gross margin) increased from 58% for thequarter ended June 30, 2004 to 60% in the quarter ended June 30, 2005.The increase in gross margin was primarily the result of additional absorptionof manufactured and assembled costs due to higher levels of production andsales, and reduced inventory costs compared with one year ago. For the threemonths ended June 30, 2005, the Company provided $24,674 in AEM monitorsat no charge to newly changed hospitals as part of a sales incentive program.

 

*Sales andmarketing expenses*. Sales and marketing expenses of $869,263 for the quarter ended June 30,2005 increased by 14% compared to $760,382 for the quarter ended June 30, 2004.The increase was a result of compensation for increased sales employees,increased commissions as a result of higher revenue and travel cost. Increased salesand marketing expenses were reduced by reduced sales samples cost. Sales andmarketing expenses for the quarter ended June 30, 2004 included costsrelated to resolution of an arbitration dispute. On July 23, 2004, theCompany resolved a dispute with one of its distributors. The Company hadpreviously notified the distributor that it was in breach of its DistributorAgreement with the Company in several respects, and that if the distributor didnot cure the breaches the Agreement could be terminated. The distributordisputed the Company’s position and asserted that the Company had breached theAgreement. The dispute was proceeding in arbitration pursuant to the terms ofthe Agreement when the parties agreed to settle the matter. As a result of thesettlement, the Company paid a total of $201,000, including legal andarbitrator fees, and recognized the related expense during the first quarter ofFY 2005.

 

*Generaland administrative expenses*. General and administrative expenses of $260,127 for the quarter ended June 30,2005 decreased by 26% compared to $352,845 for the quarter ended June 30, 2004.The decrease is the result of decreases in legaland tax fees compared with one year ago.

 

*Researchand development expenses*. Research and development expenses of $240,792 for the quarter ended June 30,2005 increased by 24% compared to $193,857 for the quarter ended June 30, 2004.The increase is a result of increases in compensation for additional employeesand test and prototype material costs to support development of refinements toour product line.

 

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*Netincome (loss). *Netincome of $18,695 for the quarter ended June 30, 2005 compared to a net lossof $(290,935) for the quarter ended June 30, 2004. The net income was aresult of increased revenue and increased gross margin and was reduced by anincrease in total operating expenses, as explained above, that increased at alower percentage than the percentage increase of revenue.

 

**Liquidityand Capital Resources**

 

To date, operating fundshave been provided primarily by sales of common stock and warrants to purchasethe Company’s common stock, which totaled $18,900,726 through June 30, 2005,and, to a lesser degree, funds provided by sales of the Company’s products.

 

The Company’s operationsused $304,577 of cash in the three months ended June 30, 2005 on sales of$2,288,628. Prior to fiscal 2003 and in fiscal 2005, the use of cash in ouroperations resulted primarily from the funding of the Company’s annual netlosses. These amounts of cash generated from and used in operations are notindicative of the expected cash to be generated from or used in operations in fiscalyear 2006 (“FY 06”). As of June 30, 2005, the Company had $1,114,709 incash and cash equivalents available to fund future operations. Working capitalwas $2,545,636 at June 30, 2005 compared to $2,519,639 at March 31, 2005.Current liabilities were $1,210,446 at June 30, 2005, compared to$1,133,188 at March 31, 2005.

 

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 three months ended June 30, 2005 ($121,492) include the capitalization($24,674) 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 06 operatingplan is focused on increasing new hospital accounts to AEM products, retainingexisting hospital customers, growing revenue, increasing gross profits andconserving cash. The Company also is investing in research and developmentefforts to develop next generation versions of the AEM product line. TheCompany can not predict with certainty the expected revenue, gross profit, netincome or loss and usage of cash and cash equivalents for FY 06. However,management believes that its cash resources will be sufficient to fund itsoperations 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.

 

The Company believes theunique performance of the AEM technology and its breadth of independentendorsements provides an opportunity for continued market share growth. TheCompany believes that the market awareness of the AEM technology and itsendorsements is continually improving and that this will benefit the salesefforts in FY 06. The Company believes that the Company entered FY 06 havingachieved improvements in the clinical credibility of its technology. TheCompany’s objective in the remainder of FY 06 is to maintain expense controlswhile optimizing sales execution in the field, expand market awareness of theAEM technology and maximize the number of additional hospital accounts to AEMinstruments, while retaining existing hospital customers. In addition,acceptance of AEM products depends on surgeons’ preference for our instruments,which depends on factors such as ergonomics and ease of use in addition to ourtechnological advantage. If surgeons prefer other instruments to ours due tothese factors, our business results will suffer.

 

**IncomeTaxes**

 

As of March 31, 2005,net operating loss carryforwards totaling approximately $16,100,000 areavailable to reduce taxable income in the future. The net operating losscarryforwards expire, if not previously utilized, at various dates beginning inthe fiscal year ended March 31, 2008. The Company has not paid incometaxes since its inception. The Tax Reform Act of 1986 and other income taxregulations contain provisions which may limit the net operating losscarryforwards available to be used in any given year, if certain

 

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events occur, includingchanges in ownership interests. The Company has established a valuationallowance for the entire amount of its deferred tax asset since inception dueto its history of losses. Should the Company achieve sufficient, sustainedincome in the future, the Company may conclude that some or all of thevaluation allowance should be reversed. If some or all of the valuationallowance were reversed, then, to the extent of the reversal, a tax benefitwould be recognized which would result in an increase to income.

 

## **Contractual Obligations**

## ** **

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

 

## **At June 30, 2005, the Company’s commitments underthese obligations were as follows:**

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

 

## **Critical AccountingPolicies and Estimates**

 

Our discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenue and expenses, andrelated disclosure of contingent assets and liabilities. On an on-going basis,we evaluate our estimates, including those related to bad debts, inventories,sales returns, warranty, contingencies and litigation. We base our estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions. We believe the followingcritical accounting policies involve our more significant judgments andestimates used in the preparation of our financial statements.

 

We maintain allowancesfor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required, which would increase ourexpenses during the periods in which any such allowances were made. The amountrecorded as a provision for bad debt in each period is based upon ourassessment of the likelihood that we will be paid on our outstandingreceivables, based on customer-specific as well as general considerations. Tothe extent that our estimates prove to be too high, and we ultimately collect areceivable previously determined to be impaired, we may record a reversal ofthe provision in the period of such determination.

 

We provide for theestimated cost of product warranties at the time revenue is recognized. Whilewe engage in extensive product quality programs and processes, includingactively monitoring and evaluating the quality of our component suppliers, wehave experienced some costs related to warranty. The warranty accrual is basedupon historical experience and is adjusted based on current experience. Shouldactual warranty experience differ from our estimates, revisions to theestimated warranty liability would be required.

 

We reduce 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. Any write-downs of inventory would reduce our reported netincome during the period in which such write-downs were applied. To the extentthat our estimates prove to be too high, and we ultimately utilize or sellinventory previously determined to be impaired, we may record a reversal of theprovision in the period of such determination.

 

We recognize deferredincome tax assets and liabilities for the expected future income taxconsequences, based on enacted tax laws, of temporary differences between thefinancial reporting and tax bases of assets and liabilities. Deferred taxassets are then reduced, if deemed necessary, by a valuation allowance for theamount of any tax benefits which, more likely than not based on currentcircumstances, are not expected to be realized. Should we achieve sufficient,sustained income in the future, we may conclude that all or some of thevaluation allowance should be reversed

 

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We depreciate ourproperty and equipment primarily on a double-declining basis over the estimateduseful life of the asset, generally three to five years. Our owned, consignmentAEM Monitors are depreciated on a double-declining basis for a period of 5years. Leasehold improvements are depreciated over the shorter of the remaininglease term or the estimated useful life of the asset. Maintenance and repairsare expensed as incurred and major additions, replacements and improvements arecapitalized.

 

We amortize our patentcosts over their estimated useful lives, which is typically the remainingstatutory life. From time to time, we may be required to adjust these livesbased on advances in technology, competitor actions, and the like. We reviewthe recorded amounts of patents at each period end to determine if theircarrying amount is still recoverable based on our expectations regarding salesof related products. Such an assessment, in the future, may result in aconclusion that the assets are impaired, with a corresponding charge againstearnings.

 

**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.**                                      Ourproducts may not be accepted by the market*. The success of our products and our financial condition depends on theacceptance of AEM products by the medical community in commercially viablequantities during fiscal year 2006 and beyond. We cannot predict how quickly orhow broadly AEM products will be accepted by the medical community. We need tocontinually educate the marketplace about the**potentialhazards involved in the use of conventional electrosurgical products duringminimally-invasive surgical procedures and the expected benefits associatedwith the use of AEM products. If we are unsuccessful in educating themarketplace about our technology and the hazards of conventional instruments,we will not create sufficient demand by hospitals and surgeons for AEM productsand our financial condition, results of operations and cash flows could beadversely affected.

 

*2.**                                      Weneed to continually develop and train our network of direct and independentsales representatives and expand our distribution efforts in order to besuccessful.* Our attempts to develop and train a network of direct andindependent sales representatives in the U.S. and to expand our internationaldistribution efforts may take longer than expected and may result inconsiderable amounts of retraining effort as the direct and independent salesreps change their product lines, product focus and personnel. We may not beable to obtain full coverage of the U.S. by direct and independent salesrepresentatives as quickly as anticipated. The independent sales representativenetwork has inherent flaws and inefficiencies, which can include conflicts ofinterest and competing products. Optimizing the quality of the network and theperformance of direct and independent sales representatives in the U.S. is anongoing challenge. We may also encounter difficulties in developing ourinternational presence due to regulatory issues and our ability to successfullydevelop international distribution options. Our inability to expand our networkof direct and independent sales representatives and optimize their performancecould adversely affect our financial results.

 

*3.**                                      Wemay need additional funding to support our operations.* We were**formed in 1991 and have incurred losses of over $15.8million since that date. We have primarily financed research, development andoperational activities with sales of our common stock. At June 30, 2005,we had $1,114,709 in cash available to fund future operations. We may haveprofitable operations in FY 2006 but there is no guarantee we will do so. Wemay find that investment in sales and marketing initiatives, merited by marketopportunity, may result in the Company operating at a net loss from quarter toquarter. We may also find ourselves at a competitive disadvantage due to ourconstrained liquidity.

 

*4.**                                      Wemay not be able to compete successfully against current manufacturers ofconventional (“unshielded, unmonitored”) electrosurgical instruments or againstcompetitors who manufacture products that are based on surgical technologiesthat are alternatives to monopolar electrosurgery. *The electrosurgical products market isintensely competitive. We expect that manufacturers of “unshielded, unmonitored”electrosurgical instruments will resist any loss of market 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

 

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materially adverselyaffect our financial position, results of operations and cash flows, and thismay hinder our ability to respond to competitive threats.

 

*5.**                                      Ifwe do not continually enhance our products and keep pace with rapidtechnological changes, we may not be able to attract and retain customers.*****Our future success and financial performance will depend inpart on our ability to meet the increasingly sophisticated needs of customersthrough the timely development and successful introduction of product upgrades,enhancements and new products. These upgrades, enhancements and new productsare subject to significant technical risks. The medical device market issubject to rapid technological change, resulting in frequent new productintroductions and enhancements of existing products, as well as the risk ofproduct obsolescence. While we are currently developing new products andenhancing our existing product lines, we may not be successful in completingthe development of the new products or enhancements. In addition, we mustrespond effectively to technological changes by continuing to enhance ourexisting products to incorporate emerging or evolving standards. We may not besuccessful in developing and marketing product enhancements or new productsthat respond to technological changes or evolving industry standards. We mayexperience difficulties that could delay or prevent the successful development,introduction and marketing of those products, and our new products and productenhancements may not adequately meet the requirements of the marketplace andachieve commercially viable levels of market acceptance. If any potential newproducts, upgrades, or enhancements are delayed, or if any potential newproducts, upgrades, or enhancements experience quality problems or do notachieve such market acceptance, or if new products make our existing productsobsolete, our financial position, results of operations and cash flows would bematerially adversely affected.

 

*6.**                                      Ifgovernment regulations change or if we fail to comply with existing and/or newregulations, we might miss market opportunities and experience increased costsand limited growth.*  The research,manufacturing, marketing and distribution of our products in the United Statesand other countries are subject to extensive regulation by numerousgovernmental authorities including, but not limited to, the Food and DrugAdministration. Under the Federal Food, Drug and Cosmetic Act, medical devicesmust receive clearance from the Food and Drug Administration through the Section 510(k)pre-market notification process or through the more lengthy pre-market approvalprocess before they can be sold in the United States. The process of obtainingrequired regulatory approvals is lengthy and has required the expenditure ofsubstantial resources. There can be no assurance that we will be able tocontinue to obtain the necessary approvals. As part of our strategy, we alsointend to pursue commercialization of our products in international markets.Our products are subject to regulations that vary from country to country. Theprocess of obtaining foreign regulatory approvals in certain countries can belengthy and require the expenditure of substantial resources. We may not beable to obtain necessary regulatory approvals or clearances on a timely basisor at all, and delays in receipt of or failure to receive such approvals orclearances, or failure to comply with existing or future regulatoryrequirements would have a material adverse effect on our financial position,results of operations and cash flows.

 

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

 

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

 

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*9.**                                      Wedepend on single source suppliers for certain of the key components andsub-contractors to provide much of our products used in the manufacturing ofour products.  The loss of a supplier orlimitation in supply from existing suppliers could have a material adverseeffect on our ability to manufacture our products until a new source of supplyis located.* Although we believe that there are alternative suppliers, anyinterruption in the supply of key components could have a material adverseeffect on us. A sudden increase in customer demand may create a backorder situationas lead times for some of our critical materials are in excess of 12 weeks.****We rely on subcontractors to provide products, either inthe form of finished goods or sub-assemblies that we then assemble and test.While these sub-contractors reduce our total cost of manufacturing, they maynot be as responsive to increased demand as we would be if we had ourmanufacturing capacity entirely in-house, which may limit our growth strategyand revenues.

 

*10.**                               Thepotential fluctuation in future quarterly results may cause our stock price tofluctuate.* We expect that our operating results could fluctuatesignificantly from quarter to quarter in the future and will depend upon anumber of factors, many of which are outside our control. These factors includethe extent to which our AEM technology and related accessories gain marketacceptance; our investments in marketing, sales, research and development andadministrative personnel necessary to support growth; our ability to expand ourmarket share; actions of competitors and general economic conditions. Themarket value of our common stock has dramatically fluctuated in the past and islikely to fluctuate in the future. Any deviation could have an immediate andsignificant negative impact on the market price of our stock.

 

*11.**                               Ourcommon stock is thinly traded, the prices at which it trades are volatile andthe buying or selling actions of a few shareholders may adversely affect ourstock price. *As of June 30,2005, we had a public float, which is defined as shares outstanding minusshares held by our officers, directors, or holders of greater than 5% of ouroutstanding common stock, of 2,907,405 shares or 46% of the outstanding commonstock. The average number of shares traded in any given day over the past year hasbeen relatively small compared to the public float. Thus, the actions of a fewshareholders either buying or selling shares of our common stock may adverselyaffect the price of the shares. Historically, thinly traded securities such asour common stock have experienced extreme price and volume fluctuations that donot necessarily relate to operating performance.

 

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

 

*13.**                               Wedepend on revenue from some major stocking distributors*.  We utilize a small number of stockingdistributors, which sell AEM products to multiple hospital customers. For thequarter ended June 30, 2005, we generated revenue of $180,086 (8%) fromone of these distributors. This distributor was the same party with whom wewere in a dispute, resulting in the settlement that is described elsewhere. Aloss of ongoing revenue from a major stocking distributor could have a materialadverse effect on our revenues and cash flows. Major stocking distributors mayterminate their distribution relationship with us with little or no notice.Distributors may sell other product lines, that may overlap or compete with ourAEM products.

 

*14.**                               Wedepend on certain key personnel.* We are highly dependent on a limitednumber of key management personnel, particularly our President and CEO, John R.Serino and Chairman of the Board, Roger C. Odell. Our loss of key personnel todeath, disability or termination, or our inability to hire and retain qualifiedpersonnel, could have a material adverse effect on our financial position,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 the Company’sdisclosure 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 AccountingOfficer concluded as of June 30, 2005 that the Company’s disclosurecontrols and procedures were effective in ensuring that information required tobe disclosed by the Company under the Exchange Act was recorded, processed,summarized and reported within the time periods specified under the ExchangeAct rules and forms.

 

(b) There were nosignificant changes in the Company’s internal control over financial reportingor in other factors that could significantly affect the Company’s disclosurecontrols and procedures subsequent to the date of the evaluation discussedabove, nor any significant deficiencies or material weaknesses in suchdisclosure controls and procedures or internal control over financial reportingrequiring corrective actions. As a result no corrective actions were taken.

 

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

 

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

 

31.1        Certificationof Chief Executive Officer under Rule 13a-14(a)

31.2        Certification of PrincipalFinancial and Accounting Officer under Rule 13a-14(a)

32.1        Certification of PeriodicReports pursuant to Sarbanes-Oxley Act of 2002

 

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**SIGNATURE**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, Encision has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 

 
| **Name**            | ** ** | **Title**                    | ** **                               | **Date** |
|---------------------|------------|------------------------------|------------------------------------------|----------|
|                |       |                         |                                     |     |
|                |       |                         |                                     |     |   |
| /s/ Marcia McHaffie |       |                         | Controller                               |     | August 12,  2005 |
| Marcia McHaffie     |       |                         | Principal  Accounting Officer & |     |   |
|                |       | Principal  Financial Officer |                                     |     |

 

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