**U. S. Securities and ExchangeCommission**

**Washington, D.C. 20549**

 

## **Form 10-QSB**

## ** **

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

 

**For the quarterly period ended December 31, 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                        |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)                         |       |                                 |
|                                                   |       |                                 |
| **6797 Winchester Circle, Boulder, Colorado****80301** |
| (Address of principal executive offices)               |
|                                                   |       |                                 |
| **(303) 444-2600**                                     |
| (Registrant’s telephone number)                   |

 

**Check whether the issuer (1) filed all reports required to 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     **

 

**Indicateby checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).**

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

 

**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** | ** ** | **6,398,146 Shares**                   |
|--------------------------------|------------|----------------------------------------|
| Class                          |       | (outstanding at January 31, 2006) |

 

**TransitionalSmall Business Disclosure Format**

 

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

 

 

----

 

**ENCISION INC.**

 

**FORM 10-QSB**

 

**For the Quarter Ended December 31, 2005**

 

**INDEX**

 
| **PART I.**  | **UNAUDITED FINANCIAL  INFORMATION** |                                                                                                  |                                                                                        |
|-------------------|-------------------------------------------|-------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
|              |                                      |
|              | **ITEM 1**                           | -                                                                                                     | Condensed Interim Financial  Statements:                                                    |   |
|              | -                                         | Condensed  Balance Sheets as of December 31, 2005 and March 31, 2005                        |                                                                                        |
|              | -                                         | Condensed  Statements of Operations for  the Three  Months Ended December 31, 2005 and 2004 |                                                                                        |
|              | -                                         | Condensed  Statements of Operations for the Nine Months Ended December 31, 2005 and  2004        |                                                                                        |
|              | -                                         | Condensed  Statements of Cash Flows for the Nine Months Ended December 31, 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** | ** **   | **FINANCIAL  INFORMATION**                  |
|-----------------|--------------|---------------------------------------------|
|            |
| **ITEM 1**      |  – | **CONDENSED  INTERIM FINANCIAL STATEMENTS** |
|                 |              |                                             |  |  |

 

ENCISION INC.

 

CONDENSED BALANCESHEETS

 
| ** **                                                                                                                                            | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                            | ** ** | **(unaudited)**             | ** ** | **(audited)**            | ** ** |
| ASSETS                                                                                                                                                |       | ** **                  |       | ** **               |       |
| Cash and cash equivalents                                                                                                                             |       | $                           | 725,847    |                     | $          | 1,472,385 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $50,500 and $19,000, respectively                                                     |       | 1,006,946                   |       | 866,710                  |       |
| Inventory, net of reserve for obsolescence of  $45,000 and $65,000, respectively                                                                      |       | 1,625,892                   |       | 1,210,582                |       |
| Prepaid expenses                                                                                                                                      |       | 138,396                     |       | 103,150                  |       |
| Total current assets                                                                                                                                  |       | 3,497,081                   |       | 3,652,827                |       |
| EQUIPMENT, at  cost:                                                                                                                                  |       |                        |       |                     |       |
| Furniture, fixtures and equipment                                                                                                                     |       | 969,060                     |       | 860,352                  |       |
| Customer-site equipment                                                                                                                               |       | 589,199                     |       | 540,692                  |       |
| Less - accumulated depreciation                                                                                                                       |       | (1,209,500                  | )          | (1,085,130               | )          |
| Equipment, net                                                                                                                                        |       | 348,759                     |       | 315,914                  |       |
| PATENTS, net of  accumulated amortization of $89,300 and $80,183, respectively                                                                        |       | 154,869                     |       | 117,764                  |       |
| OTHER ASSETS                                                                                                                                          |       | 23,483                      |       | 20,210                   |       |
| Total assets                                                                                                                                          |       | $                           | 4,024,192  |                     | $          | 4,106,715 |   |
|                                                                                                                                                  |       |                        |       |                     |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                             |       |                        |       |                     |       |
|                                                                                                                                                  |       |                        |       |                     |       |
| CURRENT  LIABILITIES:                                                                                                                                 |       |                        |       |                     |       |
| Accounts payable                                                                                                                                      |       | $                           | 491,943    |                     | $          | 532,657 |   |
| Accrued compensation                                                                                                                                  |       | 130,927                     |       | 138,042                  |       |
| Other accrued liabilities                                                                                                                             |       | 628,409                     |       | 462,489                  |       |
| Total current liabilities                                                                                                                             |       | 1,251,279                   |       | 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, 6,398,146 (December 31, 2005) and 6,313,146 (Mar. 31,  2005) shares outstanding |       | 18,920,885                  |       | 18,824,935               |       |
| Accumulated (deficit)                                                                                                                                 |       | (16,147,972                 | )          | (15,851,408              | )          |
|                                                                                                                                                  |       |                        |       |                     |       |
| Total shareholders’ equity                                                                                                                       |       | 2,772,913                   |       | 2,973,527                |       |
|                                                                                                                                                  |       |                        |       |                     |       |
| Total liabilities and shareholders’ equity                                                                                                       |       | $                           | 4,024,192  |                     | $          | 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 December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
|                                                                                     |       |                                              |       |   |   |
| REVENUE, NET                                                                             |       | $                                                 | 2,116,936  |   | $ | 2,097,841 |   |
|                                                                                     |       |                                              |       |   |   |
| COST OF SALES                                                                            |       | 851,478                                           |       | 913,728 |   |
| Gross profit                                                                             |       | 1,265,458                                         |       | 1,184,113 |   |
|                                                                                     |       |                                              |       |   |   |
| OPERATING EXPENSES:                                                                      |       | 924,958                                           |       | 799,552 |   |
| Sales and marketing                                                                      |       | 280,927                                           |       | 260,367 |   |
| General and administrative                                                               |       | 218,667                                           |       | 267,141 |   |
| Research and development                                                                 |       | 1,424,552                                         |       | 1,327,060 |   |
| Total operating expenses                                                                 |       | (159,094                                          | )          | (142,947 | ) |
| (LOSS) FROM OPERATIONS                                                                   |       |                                              |       |   |   |
|                                                                                     |       |                                              |       |   |   |
| OTHER INCOME (EXPENSE):                                                                  |       |                                              |       |   |   |
| Interest income                                                                          |       | 7,910                                             |       | 4,177 |   |
| Other (expense), net                                                                     |       | (2,569                                            | )          | (4,548 | ) |
| NET (LOSS)                                                                               |       | $                                                 | (153,753   | ) | $ | (143,318 | ) |
|                                                                                     |       |                                              |       |   |   |
| NET (LOSS) PER SHARE:                                                                    |       |                                              |       |   |   |
| Basic and diluted net (loss) per common share                                            |       | $                                                 | (0.02      | ) | $ | (0.02 | ) |
|                                                                                     |       |                                              |       |   |   |
| Weighted average shares used in computing basic and  diluted net (loss) per common share |       | 6,391,389                                         |       | 6,267,474 |   |

 

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

 

4

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ENCISION INC.

 

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 
| ** **                                                                               | ** ** | **For the  Nine Months  Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
|                                                                                     |       |                                              |       |   |   |
| REVENUE, NET                                                                             |       | $                                                 | 6,708,017  |   | $ | 5,927,055 |   |
|                                                                                     |       |                                              |       |   |   |
| COST OF SALES                                                                            |       | 2,681,293                                         |       | 2,531,576 |   |
| Gross profit                                                                             |       | 4,026,724                                         |       | 3,395,479 |   |
|                                                                                     |       |                                              |       |   |   |
| OPERATING EXPENSES:                                                                      |       |                                              |       |   |   |
| Sales and marketing                                                                      |       | 2,724,507                                         |       | 2,278,484 |   |
| General and administrative                                                               |       | 884,672                                           |       | 950,653 |   |
| Research and development                                                                 |       | 722,969                                           |       | 657,552 |   |
| Total operating expenses                                                                 |       | 4,332,148                                         |       | 3,886,689 |   |
| (LOSS) FROM OPERATIONS                                                                   |       | (305,424                                          | )          | (491,210 | ) |
|                                                                                     |       |                                              |       |   |   |
| OTHER INCOME (EXPENSE):                                                                  |       |                                              |       |   |   |
| Interest income                                                                          |       | 21,081                                            |       | 8,572 |   |
| Other (expense), net                                                                     |       | (12,221                                           | )          | (8,031 | ) |
| NET (LOSS)                                                                               |       | $                                                 | (296,564   | ) | $ | (490,669 | ) |
|                                                                                     |       |                                              |       |   |   |
| NET (LOSS) PER SHARE:                                                                    |       |                                              |       |   |   |
| Basic and diluted net (loss) per common share                                            |       | $                                                 | (0.05      | ) | $ | (0.08 | ) |
|                                                                                     |       |                                              |       |   |   |
| Weighted average shares used in computing basic and  diluted net (loss) per common share |       | 6,359,797                                         |       | 6,082,323 |   |

 

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

 

5

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ENCISION INC.

 

CONDENSED STATEMENTS OFCASH FLOWS

(Unaudited)

 
| ** **                                                                        | ** ** | **For the Nine Months  Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                         | ** ** | **2004** | ** ** |
|                                                                              |       |                                             |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                             |       |                                             |       |   |   |
| Net (loss)                                                                        |       | $                                                | (296,564   | ) | $ | (490,669 | ) |
| Adjustments to reconcile net (loss) to net cash (used  in) operating activities - |       |                                             |       |   |   |
| Depreciation and amortization                                                     |       | 133,487                                          |       | 141,213 |   |
| Provision for bad debts                                                           |       | 31,500                                           |       | (20,500 | ) |
| Inventory reserves                                                                |       | (20,000                                          | )          | (15,000 | ) |
| Changes in operating assets and liabilities -                                     |       |                                             |       |   |   |
| Accounts receivable                                                               |       | (171,736                                         | )          | (62,630 | ) |
| Inventory                                                                         |       | (395,310                                         | )          | (36,609 | ) |
| Other assets                                                                      |       | (38,519                                          | )          | (59,932 | ) |
| Accounts payable                                                                  |       | (40,714                                          | )          | 38,536 |   |
| Accrued compensation and other accrued liabilities                                |       | 158,805                                          |       | 68,687 |   |
| Net cash (used in) operating activities                                           |       | (639,051                                         | )          | (436,904 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                             |       |                                             |       |   |   |
| Investment in equipment                                                           |       | (157,215                                         | )          | (116,407 | ) |
| Patent costs                                                                      |       | (46,222                                          | )          | — |   |
| Net cash (used in investing activities)                                           |       | (203,437                                         | )          | (116,407 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                             |       |                                             |       |   |   |
| Proceeds from the exercise of stock options                                       |       | 95,950                                           |       | 484,047 |   |
| Net cash provided by financing activities                                         |       | 95,950                                           |       | 484,047 |   |
|                                                                              |       |                                             |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | (746,538                                         | )          | (69,264 | ) |
|                                                                              |       |                                             |       |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                    |       | 1,472,385                                        |       | 1,356,607 |   |
| CASH AND CASH EQUIVALENTS, end of period                                          |       | $                                                | 725,847    |   | $ | 1,287,343 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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ENCISION INC.

 

NOTES TO CONDENSEDINTERIM FINANCIAL STATEMENTS

 

DECEMBER 31, 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 $16,147,972 at December 31, 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 carrying values of cash and cash equivalents andshort-term receivables and payables approximate their fair value due to theirshort maturities.

 

Concentrationof Credit Risk

 

The Company has no significantoff-balance sheet concentrations of credit risk such as foreign exchangecontracts, options contracts or other foreign hedging arrangements. The Companymaintains the majority of its cash balances with two financial institutions inthe 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

 

7

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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 December 31, 2005 of $1,006,946 included $104,265,or approximately 10% from three customers. 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 historicalexperience and is also affected by product failure rates and material usageincurred in correcting a product failure. Should actual product failure ratesor material usage costs differ from the Company’s estimates, revisions to theestimated warranty liability would be required.

 

Inventories

 

Inventories are stated 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 thefollowing:

 

| ** **                      | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
|---------------------------------|------------|-----------------------------|------------|--------------------------|------------|
|                            |       |                        |       |                     |       |
| Raw materials                   |       | $                           | 1,163,902  |                     | $          | 738,850 |   |
| Finished goods                  |       | 506,990                     |       | 536,732                  |       |
|                            |       | 1,670,892                   |       | 1,275,582                |       |
| Less - Reserve for obsolescence |       | (45,000                     | )          | (65,000                  | )          |
|                            |       | $                           | 1,625,892  |                     | $          | 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 adouble-declining basis for a period of 5 years. Leasehold improvements aredepreciated over the shorter of the remaining lease term or the estimated usefullife of the asset. Maintenance and repairs are expensed as incurred and majoradditions, replacements and improvements are capitalized.

 

Long-LivedAssets 

 

Long-lived assets arereviewed for impairment whenever events or changes in circumstances indicate thatthe 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 $197,000related to warranty claims, $119,866 related to sales commissions and $125,202related to rent normalization and has included these amounts in accruedliabilities in the accompanying balance sheets as of December 31, 2005.

 

8

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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 nine months of fiscal year 2006, no tax benefit was obtained from theCompany’s loss. As a result, no tax benefit is reflected in the accompanyingstatements of operations. Should the Company achieve sufficient, sustainedincome in the future, the Company may conclude that some or all of thevaluation 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 the Company had accounted for its stock-basedcompensation plans in accordance with SFAS 123, the Company’s net income orloss and pro forma net income or loss per basic and diluted common share forthe three months ended December 31, 2005 would have been reported asfollows:

 
| **Three months ended December 31,  2005**             | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|
| Net (Loss)                                                 |       |       |       |
| As Reported                                                |       | $          | (153,753   | ) |
| Stock-based compensation based upon estimated fair  values |       | (53,672    | )          |
| Pro forma                                                  |       | $          | (207,425   | ) |
| Pro Forma Net (Loss) Per Basic and Diluted Common  Share   |       |       |       |
| As Reported                                                |       | $          | (0.02      | ) |
| Pro Forma                                                  |       | $          | (0.03      | ) |

 
| **Three months ended December 31, 2004**              | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|
| Net (Loss)                                                 |       |       |       |
| As Reported                                                |       | $          | (143,318   | ) |
| Stock-based compensation based upon estimated fair  values |       | (44,543    | )          |
| Pro forma                                                  |       | $          | (187,861   | ) |
| Pro Forma Net  (Loss) Per Basic and Diluted Common Share   |       |       |       |
| As Reported                                                |       | $          | (0.02      | ) |
| Pro Forma                                                  |       | $          | (0.03      | ) |

 

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.

 

9

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For the nine month periodended December 31, 2005, the Company had currently-exercisable stockoptions outstanding that could create future dilution to the Company’s commonshareholders and are not currently classified as outstanding common shares ofthe Company. The common stock number is based on specific conversion orissuance assumptions pursuant to the corresponding terms of each instrument.Potential stock issuance excluded from earnings per share because their effectwas anti-dilutive was 516,217 for the nine months ended December 31, 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 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 standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices. It also addresses transactions in which an entity incurs liabilitiesin exchange for goods or services that are based on the fair value of theentity’s equity instruments or that may be settled by the issuance ofthose equity instruments. This Statement focuses primarily on accounting fortransactions in which an entity obtains employee services in share-basedpayment transactions. This Statement does not change the accounting guidancefor share-based payment transactions with parties other than employees providedin Statement 123 as originally issued and EITF Issue No. 96-18, “Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services.” This Statement does notaddress the accounting for employee share ownership plans, which are subject toAICPA Statement of Position 93-6, Employers’ Accounting for Employee StockOwnership Plans.

 

A public entity 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 fair value during the requisite service periodwill be recognized as compensation cost over that period. A nonpublic entity may electto measure its liability awards at their intrinsic value through the date ofsettlement.

 

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 expense unlessthere are excess tax benefits from previous awards remaining in paid-in capitalto 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.

 

10

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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.

 

AccountingChanges and Error Corrections

 

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.

 

(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 lease paymentswhich are as follows as of December 31, 2005:

 
| **Year ended March 31,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2006                          |       | $          | 43,413     |   |
| 2007                          |       | 154,179    |       |
| 2008                          |       | 166,930    |       |
| 2009                          |       | 172,685    |       |
| 2010                          |       | 65,566     |       |
|                          | ** ** | $          | 602,773    | ** ** |

## ** **

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 December 31, 2005the Company believes it was in substantial compliance with all knownregulations. FDA inspections are conducted periodically at the discretion ofthe FDA. The Company was last inspected in May 2005 and was notified ofsix potential deficiencies from that inspection, none of which the Companybelieves to be material.

 

The results of operationsfor the quarter ended December 31, 2005 should not be taken as anindication of the results of operations for all or any part of the balanceof 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. Alladjustments are of a normal recurring nature. The results of operations for themost recent interim period are not necessarily indicative of the results to beexpected for the full year.

 

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| **ITEM 2**  | **-** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  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 andinvolve substantial risks and uncertainties that may cause actual resultsto differ materially from those indicated by the forward looking statements.All forward looking statements in this section on Management’s Discussionand Analysis are based on information available to the Company on the date ofthis document, and the Company assumes no obligation to update such forwardlooking statements. Readers of this Form 10-QSB are strongly encouraged toreview the 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 devices andlaparoscopic instruments by providing a solution to a well documented patientsafety 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 electrosurgicalprocedures more safely and effectively than is possible using conventionalinstruments. In addition, the AEM instruments are cost competitive withconventional “non-shielded, non-monitored” instruments. The result is advancedpatient safety at comparable cost and with no change in surgeon technique.

 

AEM technology has beenrecommended and endorsed by sources from all groups involved in minimally-invasivesurgery. Surgeons, nurses, biomedical engineers, the medicolegal community,malpractice insurance carriers and electrosurgical device manufacturersadvocate the use of AEM technology. Recommendations from the malpracticeinsurance and medicolegal communities complement the broad clinicalendorsements AEM technology has garnered over the past few years.

 

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 AEMproducts can have in the market and in advancing patient safety in surgerynationwide. These agreements do not involve purchase commitments but theCompany expects these relationships to expand the market visibility of AEMtechnology and smooth the procurement process for new hospital customers.

 

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 currentlyfocusing on modernizing its accepted AEM instruments to include ergonomics anduser functionalities for which surgeons have been expressing a preference. Duringthe three months ended December 31, 2005, the Company announced enTouchTM,an ergonomically-designed handle for its articulating instruments, and furthernew additions to the AEM product line are planned for introduction in fiscalyear 2007.

 

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 nine monthsand this revenue stream is expected to grow as the base of newly changedhospitals continues to grow. In addition, the Company intends to developdisposable versions of more of its AEM products in order to meet market demandsand expand the Company’s revenue opportunities.

 

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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 incurred losses andhad an accumulated deficit of $16,147,972 at December 31, 2005. Operationshave been financed primarily through issuance of common stock.

 

During the nine monthsended December 31, 2005, the Company used $639,051 of cash in its operationsand used $157,215 for investments in equipment. As of December 31, 2005,the Company had $725,847 in cash and cash equivalents available to fund futureoperations, a decrease of $746,538 from March 31, 2005. The Company’sworking capital was $2,245,802 at December 31, 2005.

 

**HistoricalPerspective**

 

The Company was organizedin 1991 and spent several years developing the AEM monitoring system andprotective sheaths to adapt to conventional electrosurgical instruments. Duringthis period, the Company conducted product trials and applied for patents withthe United States Patent Office and with 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 fiscal 2001,a sufficiently broad product line was available to provide hospital operatingrooms with AEM instruments in most of the designs common for laparoscopicsurgery.

 

The launch of an expandedline of AEM instruments was accomplished over the past two years. The Companyis now turning its focus to developing next generation versions of its AEMinstruments to better meet market demands, particularly demand for improvedergonomics and simplified user functionalities. This coincides with theindependent endorsements for AEM technology. Recommendations from themalpractice insurance and medicolegal communities complement the broad clinicalendorsements AEM technology has garnered over the past few years. During thethree months ended December 31, 2005, the Company recently announced theintroduction of enTouch, an ergonomically-designed handle for its articulatinginstruments, and further new additions to the AEM product line are planned forintroduction in fiscal year 2007.

 

**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 anticipates that the efforts to improve the quality of sales representativescarrying the AEM product line, along with increased marketing efforts and theintroduction of next generation products, may provide the basis forincreased revenue and returning to profitable operations. However thesemeasures, or any others that the Company may adopt, may not result ineither increased revenue or returning to profitable operations. Furthermore, mostof the Company’s next generation products are in the early stages ofdevelopment. Further additions to the AEM product line are planned forintroduction in fiscal year 2007.

 

The Company believes theunique performance of the AEM technology and its breadth of independentendorsements provides an opportunity for continued market share growth. In theCompany’s view, market awareness and clinical credibility of the AEM technology,as well as awareness of its endorsements are continually improving, and theCompany expects that this will benefit the Company’s sales efforts for theremainder of fiscal 2006. The Company’s objective in the remainder of fiscal 2006is to maintain expense controls while optimizing sales execution in the field,expand market awareness of the AEM technology and maximize the number ofadditional hospital accounts to AEM instruments, while retaining existinghospital customers. In addition, acceptance of AEM products depends on surgeons’preference for the Company’s instruments, which depends on factors such asergonomics and ease of use in addition to the technological advantage of AEMproducts. If surgeons prefer other instruments to the Company’s, the Company’s businessresults will suffer.

 

*Possibilityof Continued Operating Losses*:  The Company achieved profitable operations infiscal years 2004 and 2003. However, in fiscal years prior to 2003 and in thefiscal year 2005 the Company incurred losses and had an accumulated deficit of $16,147,972at December 31, 2005. The Company has made strides toward improving itsoperating results. Due to the ongoing need to develop, optimize and train thedirect sales managers and the independent sales representative network, theneed to support development of refinements to the Company’s product line andthe need to increase sustained revenues to a level adequate to cover fixed andvariable operating costs, the Company may operate at a net loss from timeto time. Sustained losses, or an inability of the Company to generatesufficient cash flow from operations to fund its obligations, may resultin a need to raise additional capital.

 

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*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 willexpose more hospitals to the benefits of AEM technology and may stimulatenew hospital accounts and increased revenues. The Company also expects toincrease market share gains through promotional programs of placingCompany-owned AEM monitors at no charge into hospitals that commit tostandardize on AEM instruments. However all of these efforts to increase marketshare and grow revenues will depend in part on the Company’s ability toexpand the efficiency and effective coverage range of its direct andindependent sales representatives.

 

The Company also haslonger term initiatives in place to improve the Company’s prospects. TheCompany expects that development of next generation versions of its AEMproducts will better position the products in the marketplace and improve theCompany’s retention rate at hospitals that have changed to AEM technology,enabling the Company to grow its revenue. The Company may also exploreoverseas markets to assess opportunities for revenue growth internationally.Finally, the Company intends to explore opportunities to capitalize on itsproven AEM technology via licensing arrangements and strategic alliances. Theseefforts to generate additional revenue and further the market penetration ofthe Company’s products are longer term in nature and may not materialize. Evenif the Company is able to successfully develop next generation products oridentify potential international markets or strategic partners, the Company may notbe able to capitalize 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 theCompany’s AEM product line, further expanding the instrument options for thesurgeon. Further additions to the AEM product line are planned for introductionin fiscal year 2007.

 

**Resultsof Operations**

 

*For the threemonths ended December 31, 2005 compared to the three months ended December 31,2004.*

 

*Netrevenue.*Revenue for the quarter ended December 31, 2005,was $2,116,936 compared to $2,097,841 for the quarter ended December 31, 2004,an increase of 1%. The increase is attributable to the addition of some new hospitalaccounts, partially offset by business lost from hospitals that previouslychanged to AEM technology. The Company opened five new hospital accounts to AEMtechnology in the three months ended December 31, 2005 versus 12 newhospital accounts for AEM technology in the three months ended December 31,2004. New hospital prospects remain strong. The Company has changed and addednew sales managers and independent sales representatives in an effort tocapitalize on identified market opportunities. It will take a number of monthsbefore new sales managers and new independent sales representatives generatenew hospital accounts, but the Company expects that the combination of thesenew additions will provide the focus that is needed to achieve market gains.

 

*Grossprofit*. Gross profit for the quarter ended December 31, 2005of $1,265,458 increased by 7% from the quarter ended December 31, 2004gross profit of $1,184,113. Gross profit as a percentage of revenue (grossmargin) increased from 56% for the quarter ended December 31, 2004 to 60%in the quarter ended December 31, 2005. The increase in gross margin wasprimarily the result of additional absorption of manufactured and assembledcosts due to higher levels of production and sales, and reduced inventory costscompared with one year ago. For the three months ended December 31, 2005,the Company provided $975 in AEM monitors at no charge to newly changedhospitals as part of a sales incentive program.

 

*Sales andmarketing expenses*. Sales and marketing expenses of $924,958 forthe quarter ended December 31, 2005 increased by 16% compared to $799,552for the quarter ended December 31, 2004. The increase was a result ofcompensation for increased sales employees and increased commissions. Increasedsales and marketing expenses were reduced by reduced sales samples cost.

 

*Generaland administrative expenses*. General and administrativeexpenses of $280,927 for the quarter ended December 31, 2005 increased by 8%compared to $260,367 for the quarter ended December 31, 2004. The increaseis primarily the result of an increase in baddebt expense compared with one year ago’s decrease in bad debt expense.

 

*Researchand development expenses*. Research and development expensesof $218,667 for the quarter ended December 31, 2005 decreased by 18%compared to $267,141 for the quarter ended December 31, 2004. The decreaseis a result of a reclassification to cost of sales of certain costs asengineering costs ($35,517), and decreases in outside services and relocationexpenses incurred in connection with the Company’s move to a new facility in2004.

 

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*Net loss. *Net loss was $(153,753)for the quarter ended December 31, 2005 compared to a net loss of$(143,318) for the quarter ended December 31, 2004. The net loss was aresult of increased total operating expenses, as explained above, partiallyoffset by an increase in gross profit.

 

*For the ninemonths ended December 31, 2005 compared to the nine months ended December 31,2004.*

 

*Netrevenue*. Revenue for the nine months ended December 31,2005, was $6,708,017, compared to $5,927,055 for the nine months ended December 31,2004, an increase of 13%. The increase isattributable to new hospital accounts, partially offset by business lost fromhospitals that previously changed to AEM technology. The Company opened 29 newhospital accounts to AEM technology in the nine months ended December 31,2005 versus 27 new hospital accounts for AEM technology in the nine monthsended December 31, 2004.

 

*Grossprofit*. The gross profit for the nine months ended December 31,2005 of $4,026,724 increased by 19% from the nine months ended December 31,2004 gross profit of $3,395,479. Gross profit as a percentage of revenue (grossmargin) increased from 57% for the nine months ended December 31, 2004 to60% in the nine months ended December 31, 2005. The increase in grossmargin was primarily the result of additional absorption of manufactured andassembled costs due to higher levels of production and sales, and reducedinventory costs compared with one year ago. For the nine months ended December 31,2005, the Company provided $48,507 in AEM monitors at no charge to newlychanged hospitals as part of a sales incentive program.

 

*Sales andmarketing expenses*. Sales and marketing expenses of $2,724,507for the nine months ended December 31, 2005 increased by 20% compared to$2,278,484 for the nine months ended December 31, 2004. The increase was aresult of compensation for increased sales employees, increased commissions asa result of higher revenue and increased marketing costs for the launch of theCompany’s new handle, enTouch. Increased sales and marketing expenses werereduced by reduced sales samples cost. Sales and marketing expenses for the ninemonths ended December 31, 2004 included costs related to the Company’sresolution of an arbitration dispute with one of its distributors on July 23,2004. The Company had previously notified the distributor that it was in breachof its Distributor Agreement with the Company in several respects, and that ifthe distributor did not cure the breaches the Agreement could be terminated.The distributor disputed the Company’s position and asserted that the Companyhad breached the Agreement. The dispute was proceeding in arbitration pursuantto the terms of the Agreement when the parties agreed to settle the matter. Asa result of the settlement, the Company paid a total of $201,000, includinglegal and arbitrator fees, and recognized the related expense during the firstquarter of FY 2005

 

*Generaland administrative expenses.*General and administrativeexpenses of $884,672 for the nine months ended December 31, 2005 decreasedby 7% compared to $950,653 for the nine months ended December 31, 2004.The decrease is the result of decreases in legal and tax fees compared with oneyear ago. An increased allowance for bad debts expense partially reduced decreasedgeneral and administrative expenses.

 

*Researchand development expenses.*Research and development expensesof $722,969 for the nine months ended December 31, 2005 increased by 10%compared to $657,552 for the nine months ended December 31, 2004. Theincrease is a result of increases in compensation for additional employees,inventory usage costs and test and prototype material costs to supportdevelopment of refinements to the Company’s product line. The expense wasdecreased by a reclassification to cost of sales of certain costs asengineering costs ($119,125).

 

*Net loss.*Net loss was $(296,564) for the nine months ended December 31,2005 compared to a net loss of $(490,669) for the nine months ended December 31,2004. The net loss was a result of an increase in total operating expenses, asexplained above, that increased at a lower percentage than the percentageincrease of gross profit.

 

**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 $18,920,885 through December 31,2005, and, to a lesser degree, funds provided by sales of the Company’sproducts.

 

The Company’s operationsused $639,051 of cash in the nine months ended December 31, 2005 on salesof $6,708,017. Prior to fiscal 2003 and in fiscal 2005, the use of cash in theCompany’s operations resulted primarily from the funding of annual net losses.These amounts of cash generated from and used in operations are not indicativeof the expected cash to be generated from or used in operations in fiscal year2006 (“FY 06”). As of December 31, 2005, the Company had $725,847 in cashand cash equivalents available to fund future operations. Working capital was $2,245,802at December 31, 2005 compared to $2,519,639 at March 31, 2005.Current liabilities were $1,251,279 at December 31, 2005, compared to$1,133,188 at March 31, 2005.

 

If the Company is notsuccessful in obtaining profitability and positive cash flow, additionalcapital may be required to maintain ongoing operations. The Company hasexplored and is continuing to explore options to provide additional financingto fund future

 

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operations as well asother possible courses of action. Such actions include, but are not limited to,securing a line of credit, sales of debt or equity securities (which may resultin dilution to existing shareholders), licensing of technology, strategicalliances and other similar actions. There can be no assurance that the Companywill be able to obtain additional funding (if needed) through a sale of itscommon stock or loans from financial institutions or other third parties orthrough any of the actions discussed above. If the Company cannot sustainprofitable operations and additional capital is unavailable, lack of liquiditycould have a material adverse effect on its business viability, financialposition, results of operations and cash flows.

 

The Company leases itsfacilities under a noncancelable lease agreement, the minimum future leasepayments which are as follows as of December 31, 2005:

 
| **Year ended March 31,** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2006                          |       | $          | 43,413     |   |
| 2007                          |       | 154,179    |       |
| 2008                          |       | 166,930    |       |
| 2009                          |       | 172,685    |       |
| 2010                          |       | 65,566     |       |
|                          | ** ** | $          | 602,773    | ** ** |

 

Capital expenditures inthe nine months ended December 31, 2005 ($157,215) include thecapitalization ($48,507) of AEM monitors placed in hospitals under variouspromotional programs. Placing Company-owned AEM monitors into hospitals at nocharge to facilitate their use of AEM instruments is an initiative toaccelerate new hospital accounts to AEM instruments. Under these promotionalprograms the Company maintains ownership of the AEM monitor and the cost iscapitalized and depreciated as cost of sales over the projected five year lifeof 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 and cashflows.. If the Company is not successful in achieving profitability andpositive cash flow, additional capital may be required to maintain ongoingoperations.

 

**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 events occur,including changes in ownership interests. The Company has established avaluation allowance for the entire amount of its deferred tax asset sinceinception due to its history of losses. Should the Company achieve sufficient,sustained income in the future, the Company may conclude that some or allof the valuation 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.

 

## **Critical AccountingPolicies and Estimates**

## ** **

The Company’s criticalaccounting policies have not changed from those reported in the Company’sannual report on Form 10-KSB for the year ended March 31, 2005.

 

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

 

You should carefully considerthe risk factors described below. If any of the following risk factors actuallyoccur, the Company’s business, prospects, financial condition or results ofoperations would likely suffer. In such case, the trading price of the Company’scommon stock could fall resulting in the loss of all or part of yourinvestment. You should look at all these risk factors in total. Some riskfactors may stand on their own. Some risk factors may affect (or beaffected by) other risk factors. You should not assume the Company hasidentified these connections. You should not assume that the Company willalways update these and future risk factors 

 

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in a timely manner. TheCompany is not undertaking any obligation to update these risk factors toreflect events or circumstances after the date of this report or to reflect theoccurrence of unanticipated events.

 

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 ourproducts and our financial condition depends on the acceptance of AEM productsby the medical community in commercially viable quantities during fiscal year2006 and beyond. We cannot predict how quickly or how broadly AEM products willbe accepted by the medical community. We need to continually educate themarketplace about the**potentialhazards involved in the use of conventional electrosurgical products duringminimally-invasive surgical procedures and the expected benefits associatedwith the use of AEM products. If we are unsuccessful in educating themarketplace about our technology and the hazards of conventional instruments,we will not create sufficient demand by hospitals and surgeons for AEM productsand our financial condition, results of operations and cash flows could beadversely affected.

 

*2.**                                      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 notbe able 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 $16.1 millionsince that date. We have primarily financed research, development andoperational activities with sales of our common stock. At December 31,2005, we had $725,847 in cash available to fund future operations. We may findthat investment in sales, marketing, research and development initiatives,merited by market opportunity, may result in the Company operating at anet loss from quarter to quarter. We may also find ourselves at acompetitive disadvantage due to our constrained 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 electrosurgicalproducts market is intensely competitive. We expect that manufacturers of “unshielded,unmonitored” electrosurgical instruments will resist any loss of market sharethat might result from the presence of our “shielded and monitored” instrumentsin the marketplace. We also believe that manufacturers of products that arebased upon surgical technologies that are alternatives to monopolarelectrosurgery are our competitors. These technologies include bipolarelectrosurgery, the harmonic scalpel and lasers. The alternative technologies may gainmarket share and new competitive technologies may be developed andintroduced. Most of our competitors and potential competitors havesignificantly greater financial, technical, product development, marketing andother resources than we do. Most of our competitors also currently havesubstantial installed customer bases in the medical products market and havesignificantly greater market recognition than we have. As a result of thesefactors, our competitors may be able to respond more quickly to new oremerging technologies and changes in customer requirements or to devote greaterresources to the development, promotion and sale of their products. It ispossible that new competitors or new alliances among competitors may emergeand rapidly acquire significant market share. The competitive pressures we facemay materially adversely affect our financial position, results ofoperations and cash flows, and this may hinder our ability to respond to competitivethreats.

 

*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 ofcustomers through the timely development and successful introduction of productupgrades, enhancements and new products. These upgrades, enhancements and newproducts are subject to significant technical risks. The medical device marketis subject 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 and enhancingour existing product lines, we may not be successful in completing thedevelopment of the new products or enhancements. In addition, we must respondeffectively to technological changes by continuing to enhance our existingproducts 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 may experiencedifficulties that could delay or prevent the successful development,introduction and marketing of those products, and our new products and productenhancements may not adequately meet the requirements of the marketplaceand achieve commercially viable levels of market acceptance. If any potentialnew products, 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.

 

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*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 distributionof our products in the United States and other countries are subject toextensive regulation by numerous governmental authorities including, but notlimited to, the Food and Drug Administration. Under the Federal Food, Drug andCosmetic Act, medical devices must receive clearance from the Food and DrugAdministration through the Section 510(k) pre-market notification processor through the more lengthy pre-market approval process before they can be soldin the United States. The process of obtaining required regulatory approvals islengthy and has required the expenditure of substantial resources. There can beno assurance that we will be able to continue to obtain the necessaryapprovals. As part of our strategy, we also intend to pursuecommercialization of our products in international markets. Our products aresubject to regulations that vary from country to country. The process ofobtaining foreign regulatory approvals in certain countries can be lengthy andrequire the expenditure of substantial resources. We may not be able toobtain necessary regulatory approvals or clearances on a timely basis or atall, 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.* The manufacturingof our products is subject to extensive regulatory requirements administered bythe Food and Drug Administration and other regulatory bodies. Inspection of ourmanufacturing facilities and processes can be conducted at any time, withoutprior notice, by the agencies. In addition, future changes in regulations orinterpretations made by the Food and Drug Administration or other regulatorybodies, with possible retroactive effect, could adversely affect us. Changes inexisting regulations or adoption of new regulations or policies could preventus from obtaining, or affect the timing of, future regulatory approvals orclearances. We may not be able to obtain necessary regulatory approvals orclearances on a timely basis in the future, or at all. Delays in receipt of,failure to receive such approvals or clearances and/or failure to comply withexisting or future regulatory requirements would have a material adverse effecton our financial position, results of operations and cash flows.

 

*8.**                                      Ourcurrent patents, trade secrets and know-how may not provide a competitiveadvantage, the pending applications may not result in patents beingissued, and our competitors may design around any patents issued to us.*Our success will continue to depend in part on our ability to maintainpatent protection for our products and processes, to preserve our trade secretsand to operate without infringing the proprietary rights of third parties. Wehave four issued U.S. patents on several technologies embodied in our AEM MonitoringSystem, AEM Instruments and related accessories and we have applied foradditional U.S. patents. In addition, we have four issued foreign patents. Thevalidity and breadth of claims coverage in medical technology patents involvecomplex legal and factual questions and may be highly uncertain. Also,patents may not protect our proprietary information and know-how orprovide adequate remedies for us in the event of unauthorized use or disclosureof such information, and others may be able to develop, independently,such information. There has been substantial litigation regarding patent andother intellectual property rights in the medical device industry. Litigation may benecessary to enforce patents issued to us, to protect trade secrets or know-howowned by us, to defend us against claimed infringement of the rights of othersor to determine the ownership, scope or validity of our proprietary rights orthose of others. Any such claims may require us to incur substantiallitigation expenses and to divert substantial time and effort of managementpersonnel and could substantially decrease the amount of capital available forour operations. An adverse determination in litigation involving theproprietary rights of others could subject us to significant liabilities tothird parties, could require us to seek licenses from third parties, and couldprevent us from manufacturing, selling or using our products. The occurrence ofany such actual or threatened litigation or the effect on our business of such litigationmay materially adversely affect our financial position, results ofoperations and cash flows. Additionally, our assessment that a patent is nolonger of value could result in a significant charge against our earnings.

 

*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 or limitation in supply from existingsuppliers could have a material adverse effect on our ability to manufactureour products until a new source of supply is located.* Although we believethat there are alternative suppliers, any interruption in the supply of keycomponents could have a material adverse effect on us. A sudden increase incustomer demand may create a backorder situation as lead times for some ofour critical materials are in excess of 12 weeks.****Werely on subcontractors to provide products, either in the form of finishedgoods or sub-assemblies that we then assemble and test. While thesesub-contractors reduce our total cost of manufacturing, they may not be asresponsive to increased demand as we would be if we had our manufacturingcapacity entirely in-house, which may limit our growth strategy andrevenues.

 

*10.**                               Thepotential fluctuation in future quarterly results may cause our stockprice to fluctuate.* 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.

 

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*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 December 31, 2005, we had a public float, which isdefined as shares outstanding minus shares held by our officers, directors, orholders of greater than 5% of our outstanding common stock, of 2,922,605 sharesor 46% of the outstanding common stock. The average number of shares traded inany given day over the past year has been relatively small compared to thepublic float. Thus, the actions of a few shareholders either buying or sellingshares of our common stock may adversely affect the price of the shares.Historically, thinly traded securities such as our common stock haveexperienced extreme price and volume fluctuations that do not necessarilyrelate to operating performance. In addition, as of December 31, 2005,Vern D. Kornelsen, one of our directors, and an entity controlled by Mr. Kornelsenowned an aggregate of 1,878,443 shares of our common stock, or approximately29% of our common stock outstanding. As a result, Mr. Kornelsen may beable to exert substantial influence over matters requiring action by ourshareholders, and in the event Mr. Kornelsen were to elect to sell some orall of the common stock he controls, it could have a significant adverse effecton the price of our common stock.

 

*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 liability insurancepolicy up to the amount of $5,000,000 that includes coverage for productliability claims. Liability claims may be excluded from the policy, may exceedthe coverage limits of the policy, or the insurance may not continue to beavailable on commercially reasonable terms or at all. Consequently, a productliability claim or other claim with respect to uninsured liabilities or inexcess of insured liabilities could have a material adverse effect on ourfinancial position, results of operations and cash flows.

 

*13.**                               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****        –**  **CONTROLS AND 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 Accounting andFinancial Officer concluded as of December 31, 2005 that the Company’sdisclosure controls and procedures were effective in ensuring that informationrequired to be disclosed by the Company under the Exchange Act was recorded,processed, summarized and reported within the time periods specified under theExchange Act rules and forms.

 

(b) During thequarter ended December 31, 2005, there were no changes in the Company’sinternal control over financial reporting or in other factors that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting, nor were there any significantdeficiencies or material weaknesses in such disclosure controls and proceduresor internal control over financial reporting requiring corrective actions. As aresult no corrective actions were taken.

 

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| **PART II.**    |   | **OTHER  INFORMATION**                                                                           |
|----------------------|--------|--------------------------------------------------------------------------------------------------|
| ** **           |   |                                                                                             |
| ** **           |   |                                                                                             |
| **ITEM****6 **- |   | EXHIBITS                                                                                         |
|                 |
|                 |   | 31.1 Certification  of Chief Executive Officer under Rule 13a-14(a)                    |
|                 |   | 31.2 Certification  of Principal Financial and Accounting Officer under Rule 13a-14(a) |
|                 |   | 32.1 Certification  of Periodic Reports pursuant to Sarbanes-Oxley Act of 2002              |
|                      |        |                                                                                                  |  |

 

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**SIGNATURE**

 

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 |     |       | February 13, 2006 |   |
| Marcia McHaffie                       |       | Principal Accounting Officer & |       |     |       |
|                                  |       | Principal Financial Officer             |       |     |       |
|                                       |            |                                         |            |          |            |  |  |

 

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