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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

## **Form 10-Q**

## ** **

| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For the quarterly periodended December 31, 2008**

 

**OR**

 

| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For the transition periodfrom                    to**

 

**Commission file number    0-28604**

 

**ENCISIONINC.**

(Exact name of registrant as specified in its charter)

 

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

 

**6797 Winchester Circle**

**Boulder, Colorado  80301**

(Address of principal executive offices)

 

**(303) 444-2600**

(Registrant’s telephone number)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 of 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes         x           No           o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large accelerated filer     o                                                        |   | Accelerated filer     o         |
|---------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|
| Non-accelerated filer       o(Do not check if a smaller reporting company) |   | Smaller reporting company     x |

 

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

 

Yes         o            No           x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date:

 

| **Common Stock, no par value** | ** ** | **6,455,100 Shares**                   |
|--------------------------------|------------|----------------------------------------|
| (Class)                        |       | (outstanding at January 31, 2009) |

 

TransitionalSmall Business Disclosure Format

 

Yes         o            No           x

 

 

 

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**ENCISION INC.**

 

**FORM 10-Q**

 

**For the Quarter Ended December 31, 2008**

 

**INDEX**

 
| ** **        | ** **    | ** **                                                                                                                     | ** ** | **Page  Number** |
|-------------------|---------------|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
| **PART I.**  |          | **FINANCIAL INFORMATION**                                                                                                      |       |             |
|              |          |                                                                                                                           |       |             |
| ** **        | **ITEM1**     | -      Condensed Interim Financial Statements:                                                        |       |             |
|              |          | -      Condensed Balance Sheets as of  December 31, 2008 and March 31, 2008                 |       | 3                |
|              |          | -      Condensed Statements of Operations for  the Three Months Ended December 31, 2008 and 2007 |       | 4                |
|              |          | -      Condensed Statements of Operations for  the Nine Months Ended December 31, 2008 and 2007  |       | 5                |
|              |          | -      Condensed Statements of Cash Flows for  the Nine Months Ended December 31, 2008 and 2007  |       | 6                |
|              |          | -      Notes to Condensed Interim Financial  Statements                                               |       | 7                |
| ** **        | ** **    |                                                                                                                           |       |             |
| ** **        | **ITEM 2**    | -      Management’s Discussion and Analysis of  Financial Condition and Results of Operations    |       | 11               |
| ** **        | ** **    |                                                                                                                           |       |             |
| ** **        | **ITEM 4**    | -      Controls and Procedures                                                                        |       | 16               |
|              |          |                                                                                                                           |       |             |
| **PART II.** |          | **OTHER INFORMATION**                                                                                                          |       |             |
|              |          |                                                                                                                           |       |             |
| ** **        | **ITEM 6**    | -      Exhibits                                                                                       |       | 17               |
|              |          |                                                                                                                           |       |             |
| ** **        | **SIGNATURE** | 18                                                                                                                             |

 

 

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**PART I****                  FINANCIAL INFORMATION**

 

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

 

**Encision Inc.**

**Condensed Balance Sheets**

**(unaudited)**

 
| ** **                                                                                                                                                                                                         | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                                                                                                                                                         | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                                                                    |       |                       |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                                                         |       | $                          | 72,380     |                    | $          | 70,995 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $14,000 at  December 31, 2008 and $15,000 at March 31, 2008                                                                              |       | 1,432,854                  |       | 1,452,770               |       |
| Inventories, net  of reserve for obsolescence of $45,000 at December 31, 2008 and $65,000  at March 31, 2008                                                                                             |       | 2,098,137                  |       | 2,270,953               |       |
| Prepaid expenses                                                                                                                                                                                                   |       | 101,569                    |       | 99,025                  |       |
| Total current  assets                                                                                                                                                                                              |       | 3,704,940                  |       | 3,893,743               |       |
| Equipment, at  cost:                                                                                                                                                                                               |       |                       |       |                    |       |
| Furniture,  fixtures and equipment                                                                                                                                                                                 |       | 1,917,515                  |       | 1,776,823               |       |
| Customer-site  equipment                                                                                                                                                                                           |       | 688,504                    |       | 644,946                 |       |
| Accumulated  depreciation                                                                                                                                                                                          |       | (1,795,277                 | )          | (1,623,432              | )          |
| Equipment, net                                                                                                                                                                                                     |       | 810,742                    |       | 798,337                 |       |
| Patents, net of  accumulated amortization of $125,909 at December 31, 2008 and $116,652  at March 31, 2008                                                                                               |       | 218,481                    |       | 199,246                 |       |
| Other assets                                                                                                                                                                                                       |       | 31,666                     |       | 53,149                  |       |
| **TOTAL  ASSETS**                                                                                                                                                                                                  |       | $                          | 4,765,829  |                    | $          | 4,944,475 |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                     | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current  liabilities:                                                                                                                                                                                              |       |                       |       |                    |       |
| Accounts payable                                                                                                                                                                                                   |       | $                          | 672,964    |                    | $          | 536,755 |   |
| Accrued  compensation                                                                                                                                                                                              |       | 293,454                    |       | 391,889                 |       |
| Other accrued  liabilities                                                                                                                                                                                         |       | 392,072                    |       | 481,106                 |       |
| Line of credit                                                                                                                                                                                                     |       | 198,942                    |       | —                  |       |
| Total current  liabilities                                                                                                                                                                                         |       | 1,557,432                  |       | 1,409,750               |       |
| Long-term debt                                                                                                                                                                                                     |       | —                     |       | 606,000                 |       |
| **Commitments  and contingencies (Note 3)**                                                                                                                                                                        | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Shareholders’  equity:                                                                                                                                                                                        |       |                       |       |                    |       |
| Preferred stock,  no par value: 10,000,000 shares authorized; none issued and outstanding                                                                                                                          |       | —                     |       | —                  |       |
| Common stock and  additional paid-in capital, no par value: 100,000,000 shares authorized;  6,455,100 and 6,447,100 shares issued and outstanding at December 31,  2008 and March 31, 2008, respectively |       | 19,523,110                 |       | 19,387,331              |       |
| Accumulated  (deficit)                                                                                                                                                                                             |       | (16,314,713                | )          | (16,458,606             | )          |
| Total  shareholders’ equity                                                                                                                                                                                   |       | 3,208,397                  |       | 2,928,725               |       |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                               |       | $                          | 4,765,829  |                    | $          | 4,944,475 |   |

 

Theaccompanying notes to financial statements are an integral part of thesecondensed statements.

 

 

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**Encision Inc.**

**Condensed Statements of Operations**

**(Unaudited)**

 
| **Three Months Ended**                        | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **NET  SALES**                                |       | $                          | 3,270,854  |                       | $          | 3,130,752 |   |
| **COST OF  SALES**                            |       | 1,191,493                  |       | 1,103,185                  |       |
| **GROSS  PROFIT**                             |       | 2,079,362                  |       | 2,027,567                  |       |
| **OPERATING  EXPENSES:**                      | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| Sales and  marketing                          |       | 1,191,079                  |       | 1,304,732                  |       |
| General and  administrative                   |       | 354,908                    |       | 330,777                    |       |
| Research and  development                     |       | 286,551                    |       | 325,028                    |       |
| Total operating  expenses                     |       | 1,832,538                  |       | 1,960,537                  |       |
| **OPERATING  INCOME**                         |       | 246,824                    |       | 67,030                     |       |
| Interest  expense, net                        |       | (14,449                    | )          | (8,293                     | )          |
| Other income  (expense), net                  |       | 535                        |       | 299                        |       |
| Interest and  other income (expense), net     |       | (13,914                    | )          | (7,994                     | )          |
| **INCOME  BEFORE PROVISION FOR INCOME TAXES** |       | 232,910                    |       | 59,036                     |       |
| Provision for  income taxes                   |       | —                     |       | —                     |       |
| **NET  INCOME**                               |       | $                          | 232,910    |                       | $          | 59,036 |   |
| Net income per  share—basic and diluted  |       | $                          | 0.04       |                       | $          | 0.01 |   |
| Weighted average  shares—basic           |       | 6,455,100                  |       | 6,447,100                  |       |
| Weighted average  shares—diluted         |       | 6,455,100                  |       | 6,450,709                  |       |

 

Theaccompanying notes to financial statements are an integral part of thesecondensed statements.

 

 

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** **

**Encision Inc.**

**Condensed Statements ofOperations**

**(Unaudited)**

 
| **Nine Months Ended**                                | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **NET  SALES**                                       |       | $                          | 9,711,029  |                       | $          | 8,882,413 |   |
| **COST OF  SALES**                                   |       | 3,714,908                  |       | 3,300,591                  |       |
| **GROSS  PROFIT**                                    |       | 5,996,121                  |       | 5,581,822                  |       |
| **OPERATING  EXPENSES:**                             | ** ** | ** **                 | ** ** | ** **                 | ** ** |
| Sales and  marketing                                 |       | 3,887,030                  |       | 3,755,460                  |       |
| General and  administrative                          |       | 1,079,861                  |       | 1,053,022                  |       |
| Research and  development                            |       | 855,764                    |       | 988,659                    |       |
| Total operating  expenses                            |       | 5,822,655                  |       | 5,797,141                  |       |
| **OPERATING  INCOME (LOSS)**                         |       | 173,466                    |       | (215,319                   | )          |
| Interest  expense, net                               |       | (50,073                    | )          | (23,292                    | )          |
| Other income  (expense), net                         |       | 20,500                     |       | 10,125                     |       |
| Interest and  other income (expense), net            |       | (29,573                    | )          | (13,167                    | )          |
| **INCOME  (LOSS) BEFORE PROVISION FOR INCOME TAXES** |       | 143,893                    |       | (228,486                   | )          |
| Provision for  income taxes                          |       | —                     |       | —                     |       |
| **NET  INCOME (LOSS)**                               |       | $                          | 143,893    |                       | $          | (228,486 | ) |
| Net income  (loss) per share—basic and diluted  |       | $                          | 0.02       |                       | $          | (0.04 | ) |
| Weighted average  shares—basic and diluted      |       | 6,453,338                  |       | 6,439,527                  |       |

 

Theaccompanying notes to financial statements are an integral part of thesecondensed statements.

 

 

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**Encision Inc.**

**Condensed Statements of CashFlows**

**(Unaudited)**

 
| **Nine Months Ended**                                                                      | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Cash flows from  operating activities:                                                     |       |                       |       |                       |       |
| Net income  (loss)                                                                         |       | $                          | 143,893    |                       | $          | (228,486 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                       |       |                       |       |
| Depreciation and  amortization                                                             |       | 181,102                    |       | 151,443                    |       |
| Stock-based  compensation expense related to stock options                                 |       | 124,259                    |       | 111,554                    |       |
| Stock-based  interest expense related to warrants                                          |       | 9,381                      |       | 9,381                      |       |
| Provision for  doubtful accounts, net                                                      |       | (1,000                     | )          | (5,000                     | )          |
| Provision for  inventory obsolescence, net                                                 |       | (20,000                    | )          | (15,000                    | )          |
| Change in  operating assets and liabilities:                                               |       |                       |       |                       |       |
| Accounts  receivable                                                                       |       | 20,916                     |       | (48,430                    | )          |
| Inventories                                                                                |       | 192,816                    |       | (312,508                   | )          |
| Prepaid expenses  and other assets                                                         |       | 9,558                      |       | 148,850                    |       |
| Accounts payable                                                                           |       | 136,209                    |       | 73,668                     |       |
| Accrued  compensation and other accrued liabilities                                        |       | (187,469                   | )          | (43,054                    | )          |
| Net cash  provided by (used in) operating activities                                       |       | 609,665                    |       | (157,582                   | )          |
| Cash flows from  investing activities:                                                     |       |                       |       |                       |       |
| Acquisition of  property and equipment                                                     |       | (184,250                   | )          | (464,030                   | )          |
| Patent costs                                                                               |       | (28,492                    | )          | (41,623                    | )          |
| Net cash (used  in) investing activities                                                   |       | (212,742                   | )          | (505,653                   | )          |
| Cash flows from  financing activities:                                                     |       |                       |       |                       |       |
| (Paydown of)  borrowings from credit facility                                              |       | (407,058                   | )          | 280,000                    |       |
| Proceeds from  the exercise of stock options                                               |       | 11,520                     |       | 45,740                     |       |
| Net cash (used  in) provided by financing activities                                       |       | (395,538                   | )          | 325,740                    |       |
| Net increase  (decrease) in cash and cash equivalents                                      |       | 1,385                      |       | (337,495                   | )          |
| Cash and cash  equivalents, beginning of period                                            |       | 70,995                     |       | 436,403                    |       |
| Cash and cash  equivalents, end of period                                                  |       | $                          | 72,380     |                       | $          | 98,908 |   |

 

Theaccompanying notes to financial statements are an integral part of thesecondensed statements.

 

 

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ENCISION INC.

 

NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS

 

DECEMBER 31, 2008

(Unaudited)

 

(1)           ORGANIZATIONAND NATURE OF BUSINESS

 

EncisionInc. is a medical device company that designs, develops, manufactures andmarkets patented surgical instruments that provide greater safety to patientsundergoing minimally-invasive surgery. We believe that our patented AEM® surgical instrument technology is changing themarketplace for electrosurgical devices and instruments by providing a solutionto a patient safety risk in laparoscopic surgery. Our sales to date have beenmade principally in the United States.

 

Wehave, except for the nine months ended December 31, 2008 and fiscal years2004 and 2003 when we achieved profitable operations, incurred losses since ourinception and have an accumulated deficit of $16,314,713 at December 31,2008. Operations have been financed primarily through issuances of our commonstock. Our liquidity has substantially diminished because of such continuingoperating losses, and we may be required to seek additional capital in thefuture.

 

Ourstrategic marketing and sales plan is designed to expand the use of ourproducts in surgically active hospitals in the United States.

 

(2)           SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

 

Basisof Presentation.  The condensedinterim financial statements included herein have been prepared by us, 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 accepted in the United States have been condensed oromitted pursuant to such rules and regulations, although we believe thatthe disclosures made are adequate to make the information presented notmisleading. The condensed interim financial statements and notes thereto shouldbe read in conjunction with the financial statements and the notes theretoincluded in our Annual Report on Form 10-KSB for the fiscal year ended March 31,2008, filed on June 28, 2008.

 

Theaccompanying condensed interim financial statements have been prepared, in allmaterial respects, in conformity with the standards of accounting measurementsset forth in Accounting Principles Board Opinion 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.  All adjustments are of a normal recurringnature. The results of operations for the most recent interim period are notnecessarily indicative of the results to be expected for the full year.

 

Useof Estimates in the Preparation of Financial Statements.  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions. Such estimates andassumptions affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of sales and expense during the reportingperiod. Actual results could differ from those estimates.

 

Cashand Cash Equivalents.  Forpurposes of reporting cash flows, we consider all cash and highly liquidinvestments with an original maturity of three months or less to be cashequivalents.

 

FairValue of Financial Instruments.  In September 2006, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) 157, “Fair Value Measurements”, which is effective forfiscal years beginning after November 15, 2007 and for interim periodswithin those years. This statement defines fair value, establishes a frameworkfor measuring fair value and expands the related disclosure requirements. Thisstatement applies under other accounting pronouncements that require or permitfair value measurements. The statement indicates, among other things, that afair value measurement assumes that the transaction to sell an asset ortransfer a liability occurs in the principal market for the asset or liabilityor, in the absence of a principal market, the most advantageous market for theasset or liability. SFAS 157 defines fair value based upon an exit price model.

 

Weadopted SFAS 157 as of April 1, 2008. Our financial instruments consist ofcash and cash equivalents and short-term trade receivables and payables. Thecarrying values of cash and cash equivalents and short-term receivables andpayables approximate their fair value due to their short maturities.

 

Concentrationof Credit Risk.  SFAS 105, “Disclosureof Information About Financial Instruments with Off-Balance Sheet Risk andFinancial Instruments with Concentrations of Credit Risk,” requires disclosureof significant concentrations of credit risk regardless of the degree of suchrisk. Financial instruments with significant credit risk include cash. Theamount of cash that we have on deposit with financial institutions may at anytime exceed the $250,000 federally insured limit at December 31, 2008.However, we believe that the financial institutions are financially sound andthe risk of loss is minimal.

 

Financialinstruments consist of cash and cash equivalents, accounts receivable andaccounts payable. The carrying value of all financial instruments approximatefair value.

 

Wehave no significant off-balance sheet concentrations of credit risk such asforeign exchange contracts, options contracts or other foreign hedgingarrangements. We maintain the majority of our cash balances with two financialinstitutions in the form of demand deposits and money market funds.

 

Accountsreceivable are typically unsecured and are derived from transactions with andfrom entities in the healthcare industry primarily located in the UnitedStates. Accordingly, we may be exposed to credit risk generally associated withthe healthcare industry. We maintain allowances for doubtful 

 

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accountsfor estimated losses resulting from the inability of our customers to makerequired payments. The net accounts receivable balance at December 31,2008 of $1,432,854 included no more than 8% from any one customer. The netaccounts receivable balance at March 31, 2008 of $1,452,770 included nomore than 4% from any one customer.

 

WarrantyAccrual.  We providefor the estimated cost of product warranties at the time sales are recognized.While we engage in extensive product quality programs and processes, includingactively monitoring and evaluating the quality of our component suppliers, ourwarranty obligation is based upon historical experience and is also affected byproduct failure rates and material usage incurred in correcting a productfailure. Should actual product failure rates or material usage costs differ fromour estimates, revisions to the estimated warranty liability would be required.

 

Inventories.  Inventories are stated at the lower of cost(first-in, first-out basis) or market. We reduce inventory for estimatedobsolete or unmarketable inventory equal to the difference between the cost ofinventory and the estimated market value based upon assumptions about futuredemand and market conditions. If actual market conditions are less favorablethan those projected by management, additional inventory write-downs may berequired. At December 31, 2008 and March 31, 2008, inventoryconsisted of the following:

 
| ** **                     | ** ** | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------------------|------------|-------------------------|------------|------------|------------|------------|------------|
| Raw materials                  |       | $                          | 1,125,710  |                    | $          | 1,296,761  |       |       |       |   |   |
| Finished goods                 |       | 1,017,427                  |       | 1,039,192               |       |       |       |       |       |
| Total gross  inventories       |       | 2,143,137                  |       | 2,335,953               |       |       |       |       |       |
| Less reserve for  obsolescence |       | (45,000                    | )          | (65,000                 | )          |       |       |       |       |
| Total net  inventories         |       | $                          | 2,098,137  |                    | $          | 2,270,953  |       |       |       |   |   |

 

Propertyand Equipment. Property and equipment are stated at cost, withdepreciation computed over the estimated useful lives of the assets, generallythree to seven years. Prior to fiscal year 2008, we utilized thedouble-declining method of depreciation for property and equipment due to theexpected usage of the property and equipment over time. This method is expectedto continue throughout the life of this equipment. Manufacturing and productionequipment acquired, but not placed in service, in fiscal year 2007 andmanufacturing and production equipment acquired after fiscal year 2007 is of adifferent technology for which the straight-line method is more appropriate.Therefore, we used the straight-line method of depreciation for this and otherproperty and equipment starting April 1, 2007. This difference indepreciation methods utilized for manufacturing and production equipment isbased on the technological differences of the equipment and does not constitutea change in accounting principle. Leasehold improvements are depreciated overthe shorter of the remaining lease term or the estimated useful life of the asset.Maintenance and repairs are expensed as incurred and major additions,replacements and improvements are capitalized.

 

Long-LivedAssets.  Long-lived assets are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. A long-lived asset isconsidered 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 for patents arecapitalized and amortized on a straight-line basis over the lesser of thepatent’s economic or legal life (17 years in the United States). Capitalizedcosts are expensed if patents are not granted. We review the carrying value ofour patents periodically to determine whether the patents have continuingvalue, and such reviews could result in the conclusion that the recordedamounts have been impaired; however, we have determined no impairment isnecessary as of December 31, 2008.

 

AccruedLiabilities.  We haveaccrued $50,000 related to warranty claims, $60,805 related to salescommissions and $26,604 related to rent normalization and have included theseamounts in accrued liabilities in the accompanying balance sheet at December 31,2008. At March 31, 2008, we had accrued $75,000 related to warrantyclaims, $107,034 related to sales commissions and $58,890 related to rentnormalization and have included these amounts in accrued liabilities in theaccompanying balance sheet at March 31, 2008.

 

IncomeTaxes.  We account for income taxesunder the provisions of SFAS 109, “Accounting for Income Taxes” (“SFAS 109”).SFAS 109 requires recognition of deferred income tax assets and liabilities forthe expected future income tax consequences, based on enacted tax laws, oftemporary differences between the financial reporting and tax bases of assetsand liabilities. SFAS 109 also requires recognition of deferred tax assets forthe expected future tax effects of all deductible temporary differences, losscarryforwards and tax credit carryforwards. Deferred tax assets are thenreduced, if deemed necessary, by a valuation allowance for the amount of anytax benefits which, more likely than not based on current circumstances, arenot expected to be realized. During the three and nine months ended December 31,2008, we reversed our deferred tax assets and valuation allowance by theeffective tax rate on loss carryforwards that were used to offset taxableincome for these periods. During fiscal year 2008, no tax benefit was obtainedfrom our loss. As a result, no tax benefit is reflected in the accompanyingstatements of operations for fiscal year 2008. Should we achieve sufficient,sustained income in the future, we may conclude that more or all of thevaluation allowance should be reversed. FASB Interpretation (FIN) No. 48,Accounting for Uncertainty in Income Taxesrequires us to make many subjectiveassumptions and judgments regarding our income tax exposures. At December 31,2008, we had no unrecognized tax benefits which would affect the effective taxrate if recognized and had no accrued interest or penalties related touncertain tax positions.

 

SalesRecognition.  Sales fromproduct sales is recorded when we ship the product and title has passed to thecustomer, provided that we have evidence of a customer arrangement and canconclude that collection is probable. Our shipping policy is FOB ShippingPoint. We recognize revenue from sales to stocking distributors when there isno right of return, other than for normal warranty claims. We have no ongoingobligations related to product sales, except for normal warranty.

 

Researchand Development Expenses.  Weexpense research and development costs for products and processes as incurred.

 

Stock-BasedCompensation.  Beginning infiscal year 2007, we adopted SFAS 123 (revised 2004), “Share-Based Payment” (“SFAS123(R)”), which requires the measurement and recognition of compensationexpense for all share-based payment awards made to employees and directors,including employee stock options, based on estimated fair values. SFAS 123(R) supersedesour previous accounting under Accounting Principles Board Opinion  25, “Accounting for Stock Issued to Employees”(“APB 25”), for periods beginning in fiscal year 2007. In March 2005, theSecurities and 

 

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ExchangeCommission issued Staff Accounting Bulletin 107 (“SAB 107”) relating to SFAS123(R). We have applied the provisions of SAB 107 in our adoption of SFAS123(R).

 

Wehave adopted SFAS 123(R) using the modified prospective transition method,which requires the application of the accounting standard as of April 1,2006, the first day of our fiscal year 2007. Our financial statements as of andfor fiscal years 2008 and 2007 reflect the impact of SFAS 123(R). In accordancewith the modified prospective transition method, our financial statements forprior periods have not been restated to reflect, and do not include, the impactof SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) forthe three and nine months ended December 31, 2008 was $45,828 and$124,259, respectively, which consisted of stock-based compensation expenserelated to grants of employee stock options. Stock-based compensation expenserelated to employee stock options during the three and nine months ended December 31,2007 was $36,340 and $111,554, respectively.

 

SFAS123(R) requires companies to estimate the fair value of share-basedpayment awards on the date of grant using an option-pricing model. The value ofthe portion of the award that is ultimately expected to vest is recognized asexpense over the requisite service periods in the accompanying statement ofoperations. Prior to the adoption of SFAS 123(R), we accounted for stock-basedawards to employees and directors using the intrinsic value method inaccordance with APB 25 as allowed under SFAS 123, “Accounting for Stock-BasedCompensation” (“SFAS 123”). Under the intrinsic value method, no stock-basedcompensation expense had been recognized in our statement of operations becausethe exercise price of our stock options granted to employees and directorsequaled the fair market value of the underlying stock at the date of grant.

 

Stock-basedcompensation expense recognized during the period is based on the value of theportion of share-based payment awards that is ultimately expected to vestduring the period. Stock-based compensation expense recognized in our statementof operations for the three months ended December 31, 2008 and 2007included compensation expense for share-based payment awards granted prior to,but not yet vested as of December 31, 2008, based on the grant date fairvalue estimated in accordance with the pro forma provisions of SFAS 123 andcompensation expense for the share-based payment awards granted subsequent to July 30,2005, based on the grant date fair value estimated in accordance with theprovisions of SFAS 123(R). Compensation expense for all share-based payment isrecognized using the straight-line, single-option method. As stock-basedcompensation expense recognized in the accompanying statements of operationsfor the three months ended December 31, 2008 and 2007 is based on awardsultimately expected to vest, it has been reduced for estimated forfeitures.SFAS 123(R) requires forfeitures to be estimated at the time of grant andrevised, if necessary, in subsequent periods if actual forfeitures differ fromthose estimates.

 

Uponadoption of SFAS 123(R), we continued to use the Black-Scholes option-pricingmodel (“Black-Scholes model”), which was previously used for our pro formainformation required under SFAS 123. Our determination of fair value ofshare-based payment awards on the date of grant using an option-pricing modelis affected by our stock price as well as assumptions regarding a number ofhighly complex and subjective variables. These variables include, but are notlimited to our expected stock price volatility over the term of the awards andactual and projected employee stock option exercise behaviors. Although thefair value of employee stock options is determined in accordance with SFAS 123(R) andSAB 107 using an option-pricing model, that value may not be indicative of thefair value observed in a willing buyer/willing seller market transaction.

 

OnNovember 10, 2005, FASB issued FASB Staff Position FAS 123(R)-3, “TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards.”We have elected to adopt the alternative transition method provided in the FASBStaff Position for calculating the tax effects of stock-based compensationpursuant to SFAS 123(R). The alternative transition method includes simplifiedmethods to establish the beginning balance of the additional paid-in capitalpool (“APIC pool”) related to the tax effects of employee stock-basedcompensation and to determine the subsequent impact on the APIC pool andstatements of cash flows of the tax effects of employee stock-basedcompensation awards that are outstanding upon adoption of SFAS 123(R).

 

SegmentReporting.  We haveconcluded that we have one operating segment.

 

(3)           BASIC AND DILUTED INCOME AND LOSSPER COMMON SHARE

 

Netincome or loss per share is calculated in accordance with SFAS 128, “EarningsPer Share” (“SFAS 128”). Under the provisions of SFAS 128, basic net income orloss per common share is computed by dividing net income or loss for the periodby the weighted average number of common shares outstanding for the period.Diluted net income or loss per common share is computed by dividing the netincome 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. The shares used in the calculation ofdilutive potential common shares exclude options to purchase shares where theexercise price was greater than the average market price of common shares forthe period. As a result of our net loss for the nine months ended December 31,2007, all potentially dilutive securities in the loss year would beanti-dilutive and were excluded from the computation of diluted loss per share,and there are no differences between basic and diluted per share amounts forthe loss year presented.

 

Thefollowing table presents the calculation of basic and diluted net loss pershare:

 
| ** **                                  | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**      | ** ** |
|---------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
| Net income  (loss)                          |       | $                          | 232,910    |                       | $          | 59,036 |   | $ | 143,893 |   | $ | (228,486 | ) |
| Weighted-average  shares — basic       |       | 6,455,100                  |       | 6,447,100                  |       | 6,453,338 |   | 6,439,527 |   |
| Effect of  dilutive potential common shares |       | —                     |       | 3,609                      |       | — |   | — |   |
| Weighted-average  shares — diluted     |       | 6,455,100                  |       | 6,450,709                  |       | 6,453,338 |   | 6,439,527 |   |
| Net income  (loss) per share — basic   |       | $                          | 0.04       |                       | $          | 0.01 |   | $ | 0.02 |   | $ | (0.04 | ) |
| Net income  (loss) per share — diluted |       | $                          | 0.04       |                       | $          | 0.01 |   | $ | 0.02 |   | $ | (0.04 | ) |
| Antidilutive  employee stock options        |       | 590,000                    |       | 381,391                    |       | 590,000 |   | 385,000 |   |

 

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(4)           COMMITMENTS AND CONTINGENCIES

 

Wecurrently lease our facilities at 6797 Winchester Circle, Boulder, Coloradounder noncancelable lease agreements through August 14, 2009. The minimumfuture lease payment by fiscal year as of December 31, 2008 is as follows:

 

 
| **Fiscal Year**                | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
| 2009 (three  months remaining) |       | $          | 62,423     |   |
| 2010                           |       | 94,804     |       |
| Total                          |       | $          | 157,227    |   |

 

Ourminimum future equipment lease payments with General Electric CapitalCorporation as of December 31, 2008, by fiscal year, are as follows:

 
| **Fiscal Year**                | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
| 2009 (three  months remaining) |       | $          | 25,469     |   |
| 2010                           |       | 101,873    |       |
| 2011                           |       | 101,873    |       |
| 2012                           |       | 101,873    |       |
| 2013                           |       | 101,873    |       |
| 2014                           |       | 8,488      |       |
| Total                          |       | $          | 441,449    |   |

 

Weare subject to regulation by the United States Food and Drug Administration (“FDA”).The FDA provides regulations governing the manufacture and sale of our productsand regularly inspects us and other manufacturers to determine compliance withthese regulations. We believe that we were in substantial compliance with allknown regulations as of December 31, 2008. FDA inspections are conductedperiodically at the discretion of the FDA. Our latest inspection by the FDAoccurred in May 2004.

 

OnNovember 10, 2006, we entered into a credit facility agreement withSilicon Valley Bank. The terms of the credit facility include a line of creditfor $2,000,000 for three years at an interest rate calculated at prime rateplus 1.25%, subject to increase upon a default. In connection with the creditfacility, we issued warrants to Silicon Valley Bank to purchase 28,000 sharesof our common stock at a per share price of $2.75. Our borrowing under thecredit facility is limited by our eligible receivables and inventory at thetime of borrowing. As of December 31, 2008, we had borrowed $198,942 fromthe credit facility and, under our eligible receivables and inventory limit,had an additional $1,507,068 available to borrow.

 

(5)           VALUATIONAND EXPENSE INFORMATION UNDER SFAS 123(R)

 

OnApril 1, 2006, we adopted SFAS 123(R), which requires the measurement andrecognition of compensation expense for all share-based payment awards made toour employees and directors, including employee stock options, based onestimated fair values. The following table summarizes stock-based compensationexpense related to employee stock options and employee stock purchases underSFAS 123(R) for the three and nine months ended December 31, 2008 and2007, which was allocated as follows:

 
| ** **                        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**      | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
| Cost of sales                     |       | $                          | 1,113      |                       | $          | — |   | $ | 1,533 |   | $ | — |   |
| Sales and  marketing              |       | 7,950                      |       | 7,051                      |       | 22,068 |   | 24,046 |   |
| General and  administrative       |       | 30,756                     |       | 24,806                     |       | 85,007 |   | 74,418 |   |
| Research and  development         |       | 6,009                      |       | 4,483                      |       | 15,651 |   | 13,090 |   |
| Stock-based  compensation expense |       | $                          | 45,828     |                       | $          | 36,340 |   | $ | 124,259 |   | $ | 111,554 |   |

 

TheBlack-Scholes model requires the use of actual employee exercise behavior dataand the application of a number of assumptions, including expected volatility,risk-free interest rate and expected dividends. Employee stock options topurchase 160,000 and 200,000 shares of stock were granted during the three andnine months ended December 31, 2008, respectively. The weighted-averageassumptions for employee stock options granted during the three and nine monthsended December 31, 2008 are summarized as follows:

 
| ** **                | ** ** | **Three Months Ended**      | ** ** | **Nine Months Ended**       | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------|------------|------------|------------|
| ** **                | ** ** | **December 31,  2008** | ** ** | **December 31,  2008** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Risk-free  interest rate  |       | 3.0                         | %          | 3.0                         | %          |       |       |       |       |
| Expected life  (in years) |       | 5.0                         |       | 5.0                         |       |       |       |       |       |
| Expected  volatility      |       | 64                          | %          | 60                          | %          |       |       |       |       |
| Expected  dividend        |       | 0                           | %          | 0                           | %          |       |       |       |       |

 

Asof December 31, 2008, $279,000 of total unrecognized compensation costsrelated to nonvested stock is expected to be recognized over a weighted-averageperiod of two years.

 

(6)           RELATED PARTY TRANSACTION

 

Wepaid consulting fees of approximately $13,000 and $42,000 to an entity owned byone of our directors during the three and nine months ended December 31,2008, respectively and approximately $16,000 and $47,000 during the three andnine months ended December 31, 2007, respectively.

 

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

 

Certain statements contained in this section on Management’s Discussionand Analysis are not historical facts, including statements about ourstrategies and expectations with respect to new and existing products, marketdemand, acceptance of new and existing products, marketing efforts,technologies and opportunities, market and industry segment growth, and returnon investments in products and markets. These statements are forward lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995 and involve substantial risks and uncertainties that may cause actualresults to differ materially from those indicated by the forward lookingstatements. All forward looking statements in this section on Management’sDiscussion and Analysis are based on information available to us on the date ofthis document, and we assume no obligation to update such forward looking statements.Readers of this Form 10-Q are strongly encouraged to review the sectionentitled *“Risk Factors”*in our Form 10-KSBfor the fiscal year ended March 31, 2008.

 

**General**

 

EncisionInc., a medical device company based in Boulder, Colorado, has developed andlaunched innovative technology that is emerging as a standard of care inminimally-invasive surgery. We believe that our patented AEM® Surgical Instruments are changing themarketplace for electrosurgical devices and laparoscopic instruments by providinga solution to a well documented patient safety risk in laparoscopic surgery.

 

Wewere founded to address market opportunities created by the increase inminimally-invasive surgery (“MIS”) and surgeons’ preference for usingelectrosurgery devices in these procedures. The product opportunity was createdby surgeons’ continued widespread demand for using monopolar electrosurgeryinstruments, which, when used in laparoscopic surgery, are susceptible tocausing inadvertent collateral tissue damage outside the surgeon’s field ofview. The risk of unintended electrosurgical burn injury to the patient inlaparoscopic surgery has been well documented. This risk poses a threat topatient safety and creates liability exposure for surgeons and hospitals thatdo not adequately address the issue.

 

Ourpatented AEM technology provides surgeons with the desired tissue effects,while preventing stray electrosurgical energy that can cause unintended andunseen tissue injury. AEM Laparoscopic Instruments are equivalent to conventionalinstruments in functionality, but they incorporate “active electrode monitoring”technology to dynamically and continuously monitor the flow of electrosurgicalcurrent, thereby helping to prevent patient injury. With our “shielded andmonitored” instruments, surgeons are able to perform electrosurgical proceduresmore safely and effectively than when using conventional instruments. Inaddition, our AEM instruments are cost competitive with conventional “non-shielded,non-monitored” instruments. The result is advanced patient safety at comparablecost and with no change in surgeon technique.

 

AEMtechnology has been recommended and endorsed by sources from various groupsinvolved in minimally-invasive surgery. Surgeons, nurses, biomedical engineers,the medicolegal community, malpractice insurance carriers and electrosurgicaldevice manufacturers advocate the use of AEM technology. Recommendations fromthe malpractice insurance and medicolegal communities complement the broadclinical endorsements AEM technology has garnered over the past few years.

 

Addingfurther credibility to the benefits of our AEM technology are our supplieragreements with Novation and Premier, two of the largest Group PurchasingOrganizations (GPOs) in the United States. Together, Novation and Premierrepresent over 3,000 hospitals which perform over 50% of all surgery in theU.S. We believe that these GPO supplier agreements give further indication thatAEM technology is gaining broader acceptance in the market. We believe thathaving the nation’s leading medical purchasing groups recognize the value ofour technology reflects the potential impact that AEM products can have in themarket and in advancing patient safety in surgery nationwide. These agreementsdo not involve purchase commitments, but we expect these relationships toexpand the market visibility of AEM technology and to ease the procurementprocess for new hospital customers.

 

Wehave focused our marketing strategies to date on expanding the market awarenessof the AEM technology and our broad independent endorsements and have continuedefforts to improve and expand the AEM product line. Accordingly, we arecurrently focusing on modernizing our accepted AEM instruments to includeergonomics and user functionalities for which surgeons have been expressing apreference. During fiscal year 2006, we announced enTouchTM, anergonomically-designed handle for our articulating instruments, and we plan tointroduce new additions to the AEM product line in fiscal year 2009. Duringfiscal year 2009, we launched our next generation of enTouch handles for AEMarticulating laparoscopic instrument inserts.

 

Whena hospital changes to AEM technology, we receive recurring sales from sales ofreplacement instruments. We believe that there is no directly competingtechnology to supplant AEM products once a hospital switches to our products.The replacement market of reusable and disposable AEM products in hospitalsthat use our AEM technology represented over 90% of our sales during the threemonths ended December 31, 2008. This sales stream is expected to grow asthe base of hospitals that switch to AEM technology continues to grow. Inaddition, we intend to develop disposable versions of more of our AEM productsin order to meet market demands and expand our sales opportunities.

 

Wehave, except for the nine months ended December 31, 2008 and fiscal years2004 and 2003 when we achieved profitable operations, incurred losses since ourinception and have an accumulated deficit of $16,314,713 at December 31,2008. Operations have been financed primarily through issuances of our commonstock. Our liquidity has substantially diminished because of such continuingoperating losses, and we may be required to seek additional capital in thefuture.

 

Duringthe nine months ended December 31, 2008, we provided $609,665 of cash fromour operations and used $184,250 for investments in equipment. As of December 31,2008, we had $72,380 in cash and cash equivalents available to fund futureoperations, an increase of $1,385 from March 31, 2008. As of December 31,2008, we had borrowed $198,942 from our $2,000,000 credit facility, a decreaseof $407,058 from March 31, 2008. Our working capital was $2,147,508 at December 31,2008 compared to $2,483,993 at March 31, 2008.

 

**HistoricalPerspective**

 

Wewere organized in 1991 and spent several years developing the AEM monitoringsystem and protective sheaths to adapt to conventional electrosurgicalinstruments. During this period, we conducted product trials and applied forpatents with the United States Patent Office and international patent agencies.Patents were issued to us in 1994, 1996, 1997, 1998 and 2002.

 

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Aswe evolved, it became clear to us that our AEM technology needed to beintegrated into the standard laparoscopic instrument design. As the developmentprogram proceeded, it also became apparent that the merging of electrical andmechanical engineering skills in the instrument development process for ourpatented, integrated electrosurgical instruments was a complex and difficulttask. As a result, instruments with integrated AEM technology were notcompleted for several years. Prior to offering a full range of laparoscopicelectrosurgical instrumentation, it was difficult for hospitals to commit tothe AEM solution, as we did not have adequate comparable surgical instrumentoptions to meet surgeons’ demands. As of fiscal year 2005, a sufficiently broadproduct line was available to provide hospital operating rooms with AEMinstruments in most of the designs common for laparoscopic surgery.

 

Thelaunch of an expanded line of AEM instruments was accomplished over the pastthree years. We are now turning our focus to developing next generationversions of our AEM instruments to better meet market demands, particularly thedemand for improved ergonomics and simplified user functionalities. Thisstrategy coincides with the independent endorsements of our AEM technology andthe recommendations from the malpractice insurance and medicolegal communities.

 

**Outlook**

 

*InstalledBase of AEM Monitoring Equipment*:  We believe that sales of our installed baseof AEM monitors will increase sales as the inherent risks associated withmonopolar laparoscopic electrosurgery become more widely acknowledged and as wefocus on increasing our sales efficiency. We expect that the replacement salesof electrosurgical instruments and accessories will also increase as additionalhospitals adopt AEM technology. We anticipate that the efforts to improve thequality of sales representatives carrying the AEM product line, along withincreased marketing efforts and the introduction of next generation products,may provide the basis for increased sales and profitable operations. However,these measures, or any others that we may adopt, may not result in eitherincreased sales or profitable operations. Furthermore, most of our nextgeneration products are in the early stages of development.

 

Webelieve that the unique performance of the AEM technology and our breadth ofindependent endorsements provide an opportunity for continued market sharegrowth. In our view, market awareness and awareness of the clinical credibilityof the AEM technology, as well as awareness of our endorsements, arecontinually improving, and we expect this awareness to benefit our salesefforts for the remainder of fiscal year 2009. Our objectives in the remainderof fiscal year 2009 are to maintain expense controls while optimizing salesexecution in the field, to expand market awareness of the AEM technology and tomaximize the number of additional hospital accounts switching to AEMinstruments while retaining existing hospital customers. In addition,acceptance of AEM products depends on surgeons’ preference for our instruments,which depends on factors such as ergonomics and ease of use in addition to thetechnological advantage of AEM products. If surgeons prefer other instrumentsto our instruments, our business results will suffer.

 

*Possibilityof Operating Losses*:  We have,except for the nine months ended December 31, 2008 and fiscal years 2004and 2003 when we achieved profitable operations, incurred losses since ourinception and have an accumulated deficit of $16,314,713 at December 31,2008. Operations have been financed primarily through issuances of our commonstock. We have made strides toward improving our operating results but due tothe ongoing need to develop, optimize and train our direct sales managers andthe independent sales representative network, the need to support thedevelopment of refinements to our product line, and the need to increasesustained sales to a level adequate to cover fixed and variable operatingcosts, we may continue to operate at a net loss. Sustained losses, or ourinability to generate sufficient cash flow from operations to fund ourobligations, may result in a need to raise additional capital.

 

*SalesGrowth*:  We expect to generate increasedsales in the U.S. from sales to new hospital customers and from expanded salesin existing hospitals as our network of direct and independent salesrepresentatives becomes more efficient. We believe that the visibility andcredibility of the independent clinical endorsements for AEM technology willcontribute to new hospital accounts and increase sales in fiscal year 2009. Wealso expect that supplier agreements with Novation and Premier, which togetherrepresent over 3,000 U.S. hospitals, will expose more hospitals to the benefitsof AEM technology and may stimulate new hospital accounts. We also expect toincrease market share through promotional programs of placing our AEM monitorsat no charge into hospitals that commit to standardize AEM instruments.However, all of these efforts to increase market share and grow sales willdepend in part on our ability to expand the efficiency and effective coveragerange of our direct and independent sales representatives.

 

Wealso have longer term initiatives in place to improve our prospects.  We expect that development of next generationversions of our AEM products will better position our products in themarketplace and improve our retention rate at hospitals that have changed toAEM technology, enabling us to grow our sales. We may also explore overseas marketsto assess opportunities for sales growth internationally. Finally, we intend toexplore opportunities to capitalize on our proven AEM technology via licensingarrangements and strategic alliances. These efforts to generate additionalsales and further the market penetration of our products are longer term innature and may not materialize. Even if we are able to successfully developnext generation products or identify potential international markets orstrategic partners, we may not be able to capitalize on these opportunities.

 

*GrossProfit and Gross Margins*:  Grossprofit and gross margins can be expected to fluctuate from quarter to quarteras a result of product sales mix and sales volume. Gross margins on productsmanufactured or assembled by us are expected to improve at higher levels ofproduction and sales.

 

*ManufacturingEquipment:*  We expect toincrease gross profit and gross margins by manufacturing our scissor insertsinternally. We began manufacturing our scissor inserts in the third quarter offiscal year 2008.

 

*Salesand Marketing Expenses*: We continue our efforts to expand domesticand international distribution capability, and we believe that sales andmarketing expenses will decrease as a percentage of net sales with increasingsales volume.

 

*Researchand Development Expenses*: Research and development expenses areexpected to decrease modestly but will support development of refinements toour AEM product line, which will further expand the instrument options forsurgeons.

 

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**Results of Operations**

 

*For thethree months ended December 31, 2008 compared to the three months ended December 31,2007.*

 

*Netsales.* Net sales for the quarter ended December 31, 2008, were $3,270,854compared to $3,130,752 for the quarter ended December 31, 2007, anincrease of 4%. The increase is attributable to the addition of new hospitalaccounts, partially offset by business lost from hospitals that previouslychanged to AEM technology. We opened five new hospital accounts for AEMtechnology in the three months ended December 31, 2008 versus nine newhospital accounts for AEM technology in the three months ended December 31,2007. We have changed and added new sales managers and independent salesrepresentatives in an effort to capitalize on identified market opportunities.It will take a number of months before new sales managers and new independentsales representatives generate new hospital accounts, but we expect that thecombination of these new additions will provide the focus that is needed toachieve market gains.

 

*Grossprofit*. Gross profit for the quarter ended December 31, 2008 of$2,079,362 represented an increase of 3% from gross profit of $2,027,567 forthe quarter ended December 31, 2007. Gross profit as a percentage of sales(gross margins) decreased from 65% for the quarter ended December 31, 2007to 64% for the quarter ended December 31, 2008. The gross profit margindecrease for the quarter ended December 31, 2008 was primarily due toincreased sales of lower gross profit margin products that was partially offsetby a higher gross profit margin for our internally manufactured disposablescissor inserts. In the quarter ended December 31, 2008, gross profitmargin was 0.8% higher as a result of a decrease in warranty claims.

 

*Sales and marketing expenses*. Sales and marketingexpenses of $1,191,079 for the quarter ended December 31, 2008 representeda decrease of 9% from sales and marketing expenses of $1,304,732 for thequarter ended December 31, 2007. The decrease was a result of decreasedcommissions for independent sales representatives and decreased independentcontractor and trade shows expenses. The decrease in such cost was partiallyoffset by increased compensation for additional sales employees.

 

*General and administrative expenses*. General and administrativeexpenses of $354,908 for the quarter ended December 31, 2008 representedan increase of 7% from general and administrative expenses of $330,777 for thequarter ended December 31, 2007. The increase was the result of anincrease to compensation.

 

*Research and development expenses*. Research and developmentexpenses of $286,551 for the quarter ended December 31, 2008 represented adecrease of 12% compared to $325,028 for the quarter ended December 31,2007. The decrease was a result of decreased compensation and outside services.

 

*Netincome.*Net income was $232,910 for the quarter ended December 31,2008 compared to net income of $59,036 for the quarter ended December 31,2007. Net income increase was a result of increased sales income and reducedoperating expenses.

 

Theresults of operations for the three months ended December 31, 2008 shouldnot be taken as an indication of the results of operations for all or any partof the balance of the fiscal year.

 

*For thenine months ended December 31, 2008 compared to the nine months ended December 31,2007.*

 

*Netsales.* Net sales for the nine months ended December 31, 2008, were$9,711,029 compared to $8,882,413 for the nine months ended December 31,2007, an increase of 9%. The increase is attributable to the addition of newhospital accounts, partially offset by business lost from hospitals thatpreviously changed to AEM technology. We opened thirty-four new hospitalaccounts for AEM technology in the nine months ended December 31, 2008versus thirty new hospital accounts for AEM technology in the nine months endedDecember 31, 2007. We have changed and added new sales managers andindependent sales representatives in an effort to capitalize on identifiedmarket opportunities. It will take a number of months before new sales managersand new independent sales representatives generate new hospital accounts, butwe expect that the combination of these new additions will provide the focusthat is needed to achieve market gains.

 

*Grossprofit*. Gross profit for the nine months ended December 31, 2008 of$5,996,121 represented an increase of 7% from gross profit of $5,581,822 forthe nine months ended December 31, 2007. Gross profit as a percentage ofsales (gross margins) decreased from 63% for the nine months ended December 31,2007 to 62% for the nine months ended December 31, 2008. The gross profitmargin decrease for the nine months ended December 31, 2008 was primarilydue to increased sales of lower gross profit margin products. The decrease waspartially offset by a higher gross profit margin for our internallymanufactured disposable scissor inserts.

 

*Sales and marketing expenses*. Sales and marketingexpenses of $3,887,030 for the nine months ended December 31, 2008represented an increase of 4% from sales and marketing expenses of $3,755,460for the nine months ended December 31, 2007. The increase was a result ofincreased compensation for additional sales employees and increases in travelexpenses and outside services. The increase in such cost was partially offsetby decreased commissions for independent sales representatives and trade shows.

 

*General and administrative expenses*. General and administrativeexpenses of $1,079,861 for the nine months ended December 31, 2008represented a 3% increase from general and administrative expenses of$1,053,022 for the nine months ended December 31, 2007. The increase wasprimarily the result of an increase to compensation. The increase in such costwas partially offset by reduced investor relations costs.

 

*Research and development expenses*. Research and developmentexpenses of $855,764 for the nine months ended December 31, 2008represented a decrease of 13% compared to $988,659 for the nine months ended December 31,2007. The decrease was a result of decreased compensation, outside services andinventory usage.

 

*Netincome.*Net income was $143,893 for the nine months ended December 31,2008 compared to a net loss of $228,486 for the nine months ended December 31,2007. Net income increase was a result of increased sales income that waspartially reduced by increased operating expenses.

 

Theresults of operations for the nine months ended December 31, 2008 shouldnot be taken as an indication of the results of operations for all or any partof the balance of the fiscal year.

 

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**Liquidity and Capital Resources**

 

Todate, operating funds have been provided primarily by issuances of our commonstock and warrants to purchase our common stock, which together totaled$19,523,110 through December 31, 2008, and, to a lesser degree, by fundsprovided by sales of our products.

 

OnNovember 10, 2006, we entered into a credit facility agreement withSilicon Valley Bank. The terms of the credit facility include a line of creditfor $2,000,000 for three years at an interest rate calculated at prime rateplus 1.25%, subject to increase upon a default. In connection with the creditfacility, we issued warrants to Silicon Valley Bank to purchase 28,000 sharesof our common stock at a per share price of $2.75. Our borrowing under the creditfacility is limited by our eligible receivables and inventory at the time ofborrowing. As of December 31, 2008, we had borrowed $198,942 from thecredit facility and, under our eligible receivables and inventory limit, had anadditional $1,507,068 available to borrow.

 

Ouroperations provided $609,665 of cash in the nine months ended December 31,2008 on net sales of $9,711,029. Cash was provided principally by sales and ourreduced cost structure as it relates to engineering projects. The amounts of cashprovided by and used in operations for the nine months ended December 31,2008 are not indicative of the expected cash to be generated from or used inoperations in fiscal year 2009. During the nine months ended December 31,2008, we invested $184,250 in the acquisition of property and equipment. As of December 31,2008, we had $72,380 in cash and cash equivalents available to fund futureoperations and have borrowed $198,942 from our credit facility. Working capitalwas $2,147,508 at December 31, 2008 compared to $2,483,993 at March 31,2008. Current liabilities were $1,557,432 at December 31, 2008, comparedto $1,409,750 at March 31, 2008. The increase in current liabilities at December 31,2008 was caused principally by a shift in debt from long-term debt to currentliability line of credit.

 

Ifwe are not successful in obtaining profitability and positive cash flow,additional capital may be required to maintain ongoing operations. We haveexplored and are continuing to explore options to provide additional financingto fund future operations as well as other possible courses of action. Suchactions include, but are not limited to, securing further lines of credit,sales of debt or equity securities (which may result in dilution to existingshareholders), licensing of technology, strategic alliances and other similaractions. There can be no assurance that we will be able to obtain additionalfunding (if needed), on acceptable terms or at all, through a sale of ourcommon stock, loans from financial institutions or other third parties, or anyof the actions discussed above. If we cannot sustain profitable operations, andadditional capital is unavailable, lack of liquidity could have a materialadverse effect on our business viability, financial position, results ofoperations and cash flows.

 

Wecurrently lease our facilities at 6797 Winchester Circle, Boulder, Coloradounder noncancelable lease agreements through August 14, 2009. The minimumfuture lease payment by fiscal year as of December 31, 2008 is as follows:

 
| **Fiscal Year**                | ** ** | **Amount** | ** ** |
|--------------------------------|------------|------------|------------|
| 2009 (three  months remaining) |       | $          | 62,423     |   |
| 2010                           |       | 94,804     |       |
| Total                          |       | $          | 157,227    |   |

 

Our minimum future equipment lease payments withGeneral Electric Capital Corporation as of December 31, 2008, by fiscalyear, are as follows:

 
| **Fiscal  Year**              | ** ** | **Amount** | ** **    |
|-------------------------------|------------|------------|---------------|
| 2009 (three months remaining) |       | $          | 25,469        |   |
| 2010                          |       | 101,873    |          |
| 2011                          |       | 101,873    |          |
| 2012                          |       | 101,873    |          |
| 2013                          |       | 101,873    |          |
| 2014                          |       | 8,488      |          |
| Total                         |       | $          |  441,449 |   |

 

Ourfiscal year 2009 operating plan is focused on increasing new hospital accounts,retaining existing hospital customers, growing sales, increasing gross profitsand conserving cash. We are investing in research and development efforts todevelop next generation versions of the AEM product line. We have invested inmanufacturing property and equipment to manufacture disposable scissors insertsinternally and reduce our cost of sales. We cannot predict with certainty theexpected sales, gross profit, net income or loss and usage of cash and cashequivalents for fiscal year 2009. However, we believe that our cash resourcesand credit facility will be sufficient to fund our operations for at least thenext twelve months. If we are unable to manage our business operations in linewith budget expectations, it could have a material adverse effect on our businessviability, financial position, results of operations and cash flows. If we arenot successful in achieving profitability and positive cash flow, additionalcapital may be required to maintain ongoing operations.

 

OnDecember 5, 2008, the OTC Bulletin Board (“OTCBB”) initiated quotes of ourstock with a trading symbol of “ECIA.OB.” The Company will continue to be aSecurities and Exchange Commission (“SEC”) reporting company and believes thatit is current in all of its required SEC and regulatory filings. We do not paya listing fee to the OTCBB.

 

**Income Taxes**

 

Asof March 31, 2008, net operating loss carryforwards totaling approximately$16,400,000 are available to reduce taxable income in the future. The netoperating loss carryforwards expire, if not previously utilized, at variousdates beginning in the fiscal year ending March 31, 2009. We have not paidincome taxes since our inception. The Tax Reform Act of 1986 and other incometax regulations 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. We have established a valuationallowance for the entire amount of our deferred tax asset since inception dueto our history of losses. Should we achieve

 

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sufficient,sustained income in the future, we may conclude that some or all of the valuationallowance should be reversed. If some or all of the valuation allowance werereversed, then, to the extent of the reversal, a tax benefit would berecognized which would result in an increase to income.

 

## **Critical Accounting Policies and Estimates**

## ** **

Ourdiscussion and analysis of our financial condition and results of operationsare based upon our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, sales andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate our estimates, including those related to baddebts, inventories, sales returns, warranty, contingencies and litigation. Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. Actualresults may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies affect themore significant judgments and estimates used in the preparation of ourfinancial statements.

 

Wemaintain allowances for doubtful accounts for estimated losses resulting fromthe inability of our customers to make required payments. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances would be required, whichwould increase our expenses during the periods in which any such allowanceswere made. The amount recorded as a provision for bad debts in each period isbased upon our assessment of the likelihood that we will be paid on ouroutstanding receivables, based on customer-specific as well as generalconsiderations. To the extent that our estimates prove to be too high, and weultimately collect a receivable previously determined to be impaired, we mayrecord a reversal of the provision in the period of such determination.

 

Weprovide for the estimated cost of product warranties at the time sales arerecognized. While we engage in extensive product quality programs andprocesses, including actively monitoring and evaluating the quality of ourcomponent suppliers, we have experienced some costs related to warranties. Thewarranty accrual is based on historical experience and is adjusted based oncurrent experience. Should actual warranty experience differ from ourestimates, revisions to the estimated warranty liability would be required.

 

Wereduce inventory for estimated obsolete or unmarketable inventory equal to thedifference between the cost of inventory and the estimated market value basedon assumptions about future demand and market conditions. If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required. Any write-downs of inventory wouldreduce our reported net income during the period in which such write-downs wereapplied. To the extent that our estimates prove to be too high, and we ultimatelyutilize or sell inventory previously determined to be impaired, we may record areversal of the provision in the period of such determination.

 

Werecognize deferred income tax assets and liabilities for the expected futureincome tax consequences, based on enacted tax laws, of temporary differencesbetween the financial reporting and tax bases of assets and liabilities.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. Should we achievesufficient, sustained income in the future, we may conclude that all or some ofthe valuation allowance should be reversed.

 

Propertyand equipment are stated at cost, with depreciation computed over the estimateduseful lives of the assets, generally three to seven years. Prior to fiscalyear 2008, we utilized the double-declining method of depreciation for propertyand equipment due to the expected usage of the property and equipment overtime. This method is expected to continue throughout the life of thisequipment. Manufacturing and production equipment acquired, but not placed inservice, in fiscal year 2007 and manufacturing and production equipment acquiredafter fiscal year 2007 is of a different technology for which the straight-linemethod is more appropriate. Therefore, we used the straight-line method ofdepreciation for this and other property and equipment starting April 1,2007. This difference in depreciation methods utilized for manufacturing andproduction equipment is based on the technological differences of the equipmentand does not constitute a change in accounting principle. Leaseholdimprovements are depreciated over the shorter of the remaining lease term orthe estimated useful life of the asset. Maintenance and repairs are expensed asincurred and major additions, replacements and improvements are capitalized.

 

Weamortize our patent costs over their estimated useful lives, which is typicallythe remaining statutory life. From time to time, we may be required to adjustthese useful lives of our patents based on advances in technology, competitoractions, and the like. We review the recorded amounts of patents at each periodend to determine if their carrying amount is still recoverable based on ourexpectations regarding sales of related products. Such an assessment, in thefuture, may result in a conclusion that the assets are impaired, with acorresponding charge against earnings.

 

Wecurrently estimate forfeitures for stock-based compensation expense related toemployee stock options at 7% and evaluate the forfeiture rate quarterly. Otherassumptions that are used in calculating stock-based compensation expenseinclude risk-free interest rate, expected life, expected volatility andexpected dividend.

 

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**ITEM 4        ****-****        CONTROLS AND PROCEDURES**

 

(a) We have carried out an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer andPrincipal Accounting and Financial Officer, of the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities and Exchange Act of 1934 (the “Exchange Act”)).Based upon that evaluation, the Chief Executive Officer and the PrincipalAccounting and Financial Officer concluded that, as of December 31, 2008,our disclosure controls and procedures were effective in ensuring thatinformation required to be disclosed by us under the Exchange Act was recorded,processed, summarized and reported within the time periods specified under theExchange Act rules and forms.

 

(b) During the quarter ended December 31, 2008, there were no changes in ourinternal control over financial reporting or in other factors that havematerially affected, or are reasonably likely to materially affect, ourinternal 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.**                **OTHERINFORMATION**

 

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

 

                                The followingexhibits are filed with this report on Form 10-Q or are incorporated byreference:

 

3.1              Articles ofIncorporation of the Company, as amended (incorporated by reference fromRegistration Statement #333-4118-D dated June 25, 1996).

 

3.2              Bylaws of theCompany (incorporated by reference from Current Report on Form 8-K dated October 30,2007).

 

4.1              Form ofcertificate for shares of Common Stock (incorporated by reference fromRegistration Statement #333-4118-D dated June 25, 1996).

 

31.1        Certification of Chief Executive Officer under Rule 13a-14(a) ofthe Exchange Act (filed herewith).

 

31.2        Certification of Principal Financial and AccountingOfficer under Rule 13a-14(a) of the Exchange Act (filed herewith).

 

32.1        Certification of Periodic Reports pursuant to Section 906of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

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**SIGNATURE**

 

Pursuant to the requirements of the Exchange Act, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

Encision Inc.

 

| February 13,  2009 |   | /s/  Marcia McHaffie                     |   |
|-------------------------|--------|------------------------------------------|--------|
| Date                    |   | Marcia  McHaffie                         |   |
|                    |   | Controller                               |   |
|                    |   | Principal  Accounting Officer & |   |
|                    |   | Principal  Financial Officer             |   |

 

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