**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20459**

 

**FORM 10-Q**

 

**QUARTERLY REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THEQUARTER ENDED December 31, 2001**

 

**COMMISSIONFILE NUMBER 0-20970**

 

**VISION-SCIENCES, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                                        |   | **13-3430173**                        |
|-------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                     |   | (IRS Employer  Identification Number) |
|                                                                                |   |                                  |
| **9  Strathmore Road, Natick, MA**                                                  |   | **01760**                             |
| (Address of principal  executive offices)                                           |   | (Zip Code)                            |
|                                                                                |   |                                  |
| **(508)  650-9971**                                                                 |
| (Registrant’s telephone  number, including area code)                          |
|                                                                                |
| **None**                                                                            |
| (Former name, former  address, and former fiscal year if changed since last report) |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirement for the past90 days.

 

Yes  ý                 No  o

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as ofDecember 31, 2001.

 

| **Common  Stock, par value of $.01** |   | **27,105,355**     |
|--------------------------------------|--------|--------------------|
| (Title of Class)                     |   | (Number of Shares) |

** **

 

**VISION-SCIENCES, INC.**

**TABLE OF CONTENTS**

 
| Part I.  | Financial Information                                                                                                         |
|----------|-------------------------------------------------------------------------------------------------------------------------------|
|     |                                                                                                                          |
|     | Item 1. Financial  Statements                                                                                                 |
|     |                                                                                                                          |
|     |              Consolidated Balance  Sheets                         |
|     |                                                                                                                          |
|     |              Consolidated  Statements of Operations               |
|     |                                                                                                                          |
|     |              Consolidated  Statement of Stockholders’ Equity |
|     |                                                                                                                          |
|     |              Consolidated  Statements of Cash Flows               |
|     |                                                                                                                          |
|     |              Notes to  Consolidated Financial Statements          |
|     |                                                                                                                          |
|     | Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations                          |
|     |                                                                                                                          |
|     | Item  3. Quantitative and Qualitative Disclosures about Market Risk                                                           |
|     |                                                                                                                          |
| Part II. | Other Information                                                                                                             |
|     |                                                                                                                          |
|     | Item 6. Exhibits  and Reports on Form 8-K                                                                                     |
|     |                                                                                                                          |
|     | Signature                                                                                                                     |
|     |                                                                                                                          |

 

2

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**PARTI - FINANCIAL INFORMATION**

**Item1: FINANCIAL STATEMENTS**

 

**VISION-SCIENCES, INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

** **
|                                                                                                                                                                              |   | **December  31, 2001** |      | **March 31, 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-----------|-------------------------|--------|
| ASSETS                                                                                                                                                                            |   |                        |      | **(audited)**           |   |
| Current Assets:                                                                                                                                                                   |   |                        |      |                    |   |
| Cash and cash  equivalents                                                                                                                                                        |   | $                           | 3,263,555 |                    | $      | 2,568,724 |   |
| Marketable  securities                                                                                                                                                            |   | 253,193                     |      | 1,243,068               |   |
| Accounts  receivable, net of allowance for doubtful accounts of $81,000 and $98,000,  respectively                                                                                |   | 967,163                     |      | 1,148,092               |   |
| Inventories                                                                                                                                                                       |   | 1,243,421                   |      | 1,006,016               |   |
| Prepaid expenses  and deposits                                                                                                                                                    |   | 100,045                     |      | 66,339                  |   |
| Total current  assets                                                                                                                                                             |   | 5,827,377                   |      | 6,032,239               |   |
|                                                                                                                                                                              |   |                        |      |                    |   |
| Property and  Equipment, at cost:                                                                                                                                                 |   |                        |      |                    |   |
| Machinery and  equipment                                                                                                                                                          |   | 3,121,545                   |      | 2,984,511               |   |
| Furniture and  fixtures                                                                                                                                                           |   | 208,934                     |      | 208,934                 |   |
| Leasehold  improvements                                                                                                                                                           |   | 458,817                     |      | 450,396                 |   |
|                                                                                                                                                                              |   | 3,789,296                   |      | 3,643,841               |   |
| Less-Accumulated  depreciation and amortization                                                                                                                                   |   | 3,248,446                   |      | 3,083,860               |   |
|                                                                                                                                                                              |   | 540,850                     |      | 559,981                 |   |
|                                                                                                                                                                              |   |                        |      |                    |   |
| Equity  investment in 3DV Systems, Ltd. (Note 3)                                                                                                                                  |   | —                      |      | 500,000                 |   |
| Other assets,  net of accumulated amortization of $33,000 and $28,000, respectively                                                                                               |   | 97,685                      |      | 102,441                 |   |
| Total assets                                                                                                                                                                      |   | $                           | 6,465,912 |                    | $      | 7,194,661 |   |
|                                                                                                                                                                              |   |                        |      |                    |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                         |   |                        |      |                    |   |
| Current  Liabilities:                                                                                                                                                             |   |                        |      |                    |   |
| Acceptances  payable to a bank                                                                                                                                                    |   | $                           | 49,878    |                    | $      | 38,713 |   |
| Current portion  of note payable                                                                                                                                                  |   | 37,820                      |      | 52,931                  |   |
| Accounts payable                                                                                                                                                                  |   | 337,847                     |      | 287,458                 |   |
| Accrued expenses                                                                                                                                                                  |   | 1,021,213                   |      | 1,377,455               |   |
| Total current  liabilities                                                                                                                                                        |   | 1,446,758                   |      | 1,756,557               |   |
|                                                                                                                                                                              |   |                        |      |                    |   |
| Note payable,  net of current portion                                                                                                                                             |   | —                      |      | 23,989                  |   |
|                                                                                                                                                                              |   |                        |      |                    |   |
| Potential  obligations to non-qualified option holders                                                                                                                            |   | 149,913                     |      | 188,515                 |   |
| Stockholders’  Equity:                                                                                                                                                       |   |                        |      |                    |   |
| Common stock,  $.01 par value—Authorized—50,000,000 shares Issued and outstanding—27,105,355  shares at December 31, 2001 and 26,520,831 shares at March 31, 2001. |   | 271,052                     |      | 265,207                 |   |
| Additional  paid-in capital                                                                                                                                                       |   | 58,386,502                  |      | 57,601,457              |   |
| Accumulated  deficit                                                                                                                                                              |   | (53,788,313                 | )         | (52,641,064             | )      |
| Total  stockholders’ equity                                                                                                                                                  |   | 4,869,241                   |      | 5,225,600               |   |
| Total  liabilities and stockholders’ equity                                                                                                                                  |   | $                           | 6,465,912 |                    | $      | 7,194,661 |   |

 

See accompanying notes toconsolidated financial statements.

 

3

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**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
|                                                                  |   | **Three  Months Ended   December 31,** |      | **Nine  Months Ended   December 31,** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------|-----------|---------------------------------------|--------|
|                                                                  |   | **2001**                               |      | **2000**                              |   | **2001** |   | **2000** |   |
| Net sales                                                             |   | $                                      | 1,629,055 |                                  | $      | 1,946,289 |   | $ | 5,081,214 |   | $ | 5,232,914 |   |
| Cost of sales                                                         |   | 1,167,699                              |      | 1,284,636                             |   | 3,372,214 |   | 3,558,277 |   |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Gross profit                                                          |   | 461,356                                |      | 661,653                               |   | 1,709,000 |   | 1,674,637 |   |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Selling, general  and administrative expenses                         |   | 830,550                                |      | 802,951                               |   | 2,170,788 |   | 2,302,532 |   |
| Research and  development expenses(1)                                 |   | 72,468                                 |      | 288,748                               |   | 135,369 |   | 436,999 |   |
| Stock-based  compensation                                             |   | (75,025                                | )         | 11,102                                |   | (177,256 | ) | 257,169 |   |
| Loss from  operations                                                 |   | (366,637                               | )         | (441,148                              | )      | (419,901 | ) | (1,322,063 | ) |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Interest income                                                       |   | 24,099                                 |      | 18,452                                |   | 103,210 |   | 61,196 |   |
| Interest expense                                                      |   | (1,404                                 | )         | (2,915                                | )      | (5,385 | ) | (3,965 | ) |
| Equity in losses  of 3DV Systems Ltd.                                 |   | —                                 |      | —                                |   | (500,000 | ) | (222,553 | ) |
| Other income  (expense), net                                          |   | (1,620                                 | )         | (2,329                                | )      | 1,996 |   | (686 | ) |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Net loss before  cumulative effect of change in accounting principle  |   | (345,562                               | )         | (427,940                              | )      | (820,080 | ) | (1,488,071 | ) |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Cumulative  effect of change in accounting principle (Note 2)         |   | —                                 |      | —                                |   | 327,169 |   | — |   |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Net loss after  cumulative effect of change in accounting principle   |   | $                                      | (345,562  | )                                     | $      | (427,940 | ) | $ | (1,147,249 | ) | $ | (1,488,071 | ) |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Basic and  diluted net loss per common share                          |   | $                                      | (0.01     | )                                     | $      | (0.02 | ) | $ | (0.04 | ) | $ | (0.07 | ) |
|                                                                  |   |                                   |      |                                  |   |   |   |   |   |
| Shares used in  computing basic and diluted net loss per common share |   | 27,105,355                             |      | 21,115,611                            |   | 26,950,249 |   | 20,992,136 |   |

 

----

 

(1)   Excludesnon-cash stock-based compensation, as follows:

 
| Research and development expenses. |   | $ | (75,025) |   | $ | 11,102 |   | $ | (177,256) |   | $ | 257,169 |   |
|------------------------------------|--------|---|----------|--------|---|--------|--------|---|-----------|--------|---|---------|--------|

 

See accompanying notes toconsolidated financial statements.

 

4

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**VISION-SCIENCES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**(Unaudited)**

 
|                                                              |   | **Common  Stock** |   |          |    |                |   | **Total**       |   | **Total**              |        |
|-------------------------------------------------------------------|--------|-------------------|--------|---------------|---------|---------------------|--------|-----------------|--------|------------------------|-------------|
|                                                              |   | **Number of**     |   | **$.01**      |    | **Additional**      |   | **Accumulated** |   | **Stockholders’** |        | **Comprehensive** |   |
|                                                              |   | **Shares**        |   | **Par Value** |    | **Paid-in-Capital** |   | **Deficit**     |   | **Equity**             |        | **Loss** |   |
| Balance, March  31, 2001 (audited)                                |   | 26,520,831        |   | $             | 265,207 |                | $      | 57,601,457      |   | $                      | (52,641,064 | ) | $ | 5,225,600 |   |   |   |
| Reclass of  potential obligations to non-qualified option holders |   | —            |   | —        |    | 188,515             |   | —          |   | 188,515                |        |   |   |
| Exercise of  stock options                                        |   | 2,000             |   | 20            |    | 2,355               |   | —          |   | 2,375                  |        |   |   |
| Sale of common  stock, net                                        |   | 582,524           |   | 5,825         |    | 594,175             |   | —          |   | 600,000                |        |   |   |
| Net loss                                                          |   | —            |   | —        |    | —              |   | (1,147,249      | )      | (1,147,249             | )           | $ | (1,147,249 | ) |
|                                                              |   |              |   |          |    |                |   |            |   |                   |        |   |   |
| Total  comprehensive loss                                         |   |              |   |          |    |                |   |            |   |                   |        | $ | (1,147,249 | )  |
|                                                              |   |              |   |          |    |                |   |            |   |                   |        |   |   |
| Balance December  31, 2001                                        |   | 27,105,355        |   | $             | 271,052 |                | $      | 58,386,502      |   | $                      | (53,788,313 | ) | $ | 4,869,241 |   |   |   |

 

See accompanying notes toconsolidated financial statements.

 

5

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**VISION-SCIENCES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                          |   | **Nine  Months Ended** |       | **Nine  Months Ended** |   |
|-------------------------------------------------------------------------------|--------|------------------------|------------|------------------------|--------|
|                                                                          |   | **December 31, 2001**  |       | **December 31, 2000**  |   |
| Cash flows from  operating activities:                                        |   |                   |       |                   |   |
| Net loss                                                                      |   | $                      | (1,147,249 | )                      | $      | (1,488,071 | ) |
| Adjustments to  reconcile net loss to net cash used for operating activities: |   |                   |       |                   |   |
| Depreciation and  amortization                                                |   | 169,342                |       | 190,696                |   |
| Equity in losses  of 3DV Systems, Ltd.                                        |   | 500,000                |       | 222,553                |   |
| Loss on disposal  of property and equipment                                   |   | —                 |       | 2,773                  |   |
| Stock  compensation to non-employees                                          |   | 149,913                |       | 309,309                |   |
| Changes in  assets and liabilities:                                           |   |                   |       |                   |   |
| Accounts  receivable                                                          |   | 180,929                |       | 21,784                 |   |
| Inventories                                                                   |   | (237,405               | )          | 124,294                |   |
| Prepaid expenses  and deposits                                                |   | (33,706                | )          | (126,983               | )      |
| Accounts payable                                                              |   | 50,389                 |       | 133,505                |   |
| Accrued expenses                                                              |   | (356,242               | )          | (147,109               | )      |
|                                                                          |   |                   |       |                   |   |
| Net cash used  for operating activities                                       |   | (724,029               | )          | (757,249               | )      |
|                                                                          |   |                   |       |                   |   |
| Cash flows  provided by (used for) investing activities                       |   |                   |       |                   |   |
| Decrease in  marketable securities                                            |   | 989,875                |       | —                 |   |
| Purchase of  property and equipment, net                                      |   | (145,455               | )          | (127,327               | )      |
|                                                                          |   |                   |       |                   |   |
| Net cash  provided by (used for) investing activities                         |   | 844,420                |       | (127,327               | )      |
|                                                                          |   |                   |       |                   |   |
| Cash flows  provided by (used for) financing activities:                      |   |                   |       |                   |   |
| Foreign exchange  losses                                                      |   | —                 |       | (1,062                 | )      |
| Proceeds from  note payable to stockholders                                   |   | —                 |       | 154,197                |   |
| Payments on note  payable for leasehold improvements                          |   | (39,100                | )          | (15,806                | )      |
| Proceeds from  acceptances payable to a bank                                  |   | 11,165                 |       | 14,364                 |   |
| Proceeds from  the sale of common stock, net                                  |   | 600,000                |       | 3,453,150              |   |
| Exercise of  stock options                                                    |   | 2,375                  |       | 323                    |   |
|                                                                          |   |                   |       |                   |   |
| Net cash  provided by financing activities                                    |   | 574,440                |       | 3,605,166              |   |
| Net increase in  cash and cash equivalents                                    |   | 694,831                |       | 2,720,590              |   |
| Cash and cash equivalents,  beginning of period                               |   | 2,568,724              |       | 1,581,381              |   |
| Cash and cash  equivalents, end of period                                     |   | $                      | 3,263,555  |                   | $      | 4,301,971 |   |
|                                                                          |   |                   |       |                   |   |
| Supplemental  Disclosure of Non-Cash Investing Activities:                    |   |                   |       |                   |   |
| Leasehold  improvements acquired in exchange for note payable .               |   | $                      | —     |                   | $      | 105,000 |   |
| Supplemental  Disclosure of Cash Flow Information:                            |   |                   |       |                   |   |
| Cash paid during  the period for interest                                     |   | $                      | 5,385      |                   | $      | 1,050 |   |

 

See accompanying notes toconsolidated financial statements.

 

6

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**VISION-SCIENCES, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1**.             **Basis of Presentation**

 

The unaudited consolidated financial statementsincluded herein have been prepared by the Company in accordance with generallyaccepted accounting principles, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission and include, in theopinion of management, all adjustments (consisting only of normal and recurringadjustments) that the Company considers necessary for a fair presentation ofsuch information.  Certain informationand footnote disclosures normally included in financial statements have beencondensed or omitted pursuant to such rules and regulations.  The Company believes, however, that itsdisclosures are adequate to make the information presented not misleading.  These consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and notes thereto included in the Company’s latest annual report tostockholders.  The results for theinterim periods presented are not necessarily indicative of results to beexpected for the full fiscal year.

 

**2**.             **Summary of Significant AccountingPolicies**

 

The accompanying consolidated financial statementsreflect the application of certain  accountingpolicies described below:

 

a.                                       *Principlesof Consolidation*: The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly-owned subsidiaries.  All material intercompany accounts andtransactions have been eliminated in consolidation.

 

b**.****                                     ***Cash*Equivalents:Cash equivalents are carried at market value, which approximates amortized cost*.** *Cash equivalents are short-term,highly liquid investments with original maturities of less than three months.

 

c.                                       *Marketable*Securities:Marketable securities are carried at market value, which approximates amortizedcost.  The Company has classified itsinvestments in marketable securities as available-for-sale securities.  At December 31, 2001, the Company’smarketable securities consisted of commercial paper with a maturity of 302days.

 

d.                                      *Inventories*:  Inventories are stated at the lower of costor market using the first-in, first-out (FIFO) method and consist of thefollowing:

 
|            |   | **December  31,** |      | **March 31,** |   |
|-----------------|--------|-------------------|-----------|---------------|--------|
|            |   | **2001**          |      | **2001**      |   |
|            |   |              |      | **(audited)** |   |
| Raw materials   |   | $                 | 449,888   |          | $      | 118,194 |   |
| Work-in-process |   | 146,030           |      | 177,804       |   |
| Finished goods  |   | 647,503           |      | 710,018       |   |
|            |   | $                 | 1,243,421 |          | $      | 1,006,016 |   |

 

Work-in-process and finished goods inventories consistof material, labor, and  manufacturingoverhead.

 

7

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e.                                       *Depreciationand Amortization*: The Company provides for depreciation and  amortization using the straight-line methodin amounts that allocate the cost of the assets to operations over their estimated useful lives as follows:

 
| **Asset Classification** |   | **Estimated  Useful Life** |   |
|--------------------------|--------|----------------------------|--------|
| Machinery and  Equipment |   | 3-5 Years                  |   |
| Furniture and  Fixtures  |   | 5 Years                    |   |

 

Leasehold improvementsare amortized over the shorter of their estimated useful lives or the lives ofthe leases.

 

f.                                         *Basic andDiluted Net Loss Per Common Share*: Basic and diluted net loss percommon share is based on the weighted average number of common sharesoutstanding.  Shares of common stockissuable pursuant to outstanding stock options have not been considered, astheir effect would be antidilutive.

 

g.                                      *RevenueRecognition*: The Company recognizes revenue upon product shipment.

 

h.                                      *ForeignCurrency Transactions*: In accordance with SFAS No. 52, *ForeignCurrency Translation,* the Company charges foreign currency exchangegains or losses, in connection with its purchases of products from vendors inJapan, to operations, and charges foreign exchange translation gains and lossesto retained earnings.

 

i.                                          *Income Taxes*:The Company accounts for income taxes under the liability method in accordancewith SFAS No. 109, *Accounting for Income Taxes*.  Under SFAS No. 109, deferred tax assets orliabilities are computed based upon the differences between the financialstatement and income tax bases of assets and liabilities as measured by theenacted tax rates.

 

The Company has recorded a valuation allowance equalto its net deferred tax asset due to the uncertainty of realizing the benefitof this asset.

 

8

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j*.*                                          *Accountingfor Derivatives*: In September 2000, the Emerging Issues Task Forceissued EITF 00-19, *Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock*, which requires freestandingcontracts that are settled in a company’s own stock, including common stockoptions and warrants, to be designated as an equity instrument, an asset or aliability.  Under the provisions of EITF00-19, a contract designated as an asset or a liability must be carried at fairvalue, with any changes in fair value recorded in the results ofoperations.  A contract designated as anequity instrument must be included within equity, and no fair value adjustmentsare required.  In accordance with EITF00-19, the Company has determined that outstanding options as of December 31,2001 to purchase 1,335,747 shares of the Company’s common stock should bedesignated as a liability.

 

Under the transitionrules of EITF 00-19, effective June 30, 2001, the Company recorded theseoptions as a liability at fair value with the required adjustment included as acumulative adjustment in its results of operations for the three months endedJune 30, 2001.  Pursuant to EITF 00-19,as of June 30, 2001, the Company recorded an option liability totalingapproximately $327,000, which was included under “Potential obligations tonon-qualified option holders” in the Company’s balance sheet.  For the three months ended December 31,2001, the fair value of these outstanding options declined to approximately$150,000.  Accordingly, the Companyrecorded a credit in its results of operations of approximately $75,000 for thethree months ended December 31, 2001.

* *

*k.**                                      Recent Accounting Pronouncements*:In June 2001, the Financial AccountingStandards Board (FASB) issued SFAS No. 143, *Accounting for Asset RetirementObligations*.  SFAS No. 143 requires all entities torecognize the fair value of liabilities for an asset retirement in the periodin which it is incurred if reasonable estimates of fair value can be made.  This statement is effective for allfinancial statements issued for fiscal years beginning after June 15, 2002.

 

In August 2001, the FASBissued SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*.  Thisstatement applies to the accounting for long-lived assets, including reportingthe effects of the disposal of a segment of a business.  This statement is effective for allfinancial statements issued for fiscal years beginning after December 15,2001.  Management does not expect thatthese statements will have a material impact on the Company’s financialstatements.

 

9

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**3.             Investments in Israel**

 

*3DV Systems Ltd.*

 

The Company accounts for its investment in 3DV SystemsLtd. (“3DV”) using the equity method of accounting.  Due to the Company’s former commitment to finance the workingcapital needs of 3DV, the Company absorbed 100% of the losses of 3DV up throughDecember 23, 1999.  On that date, 3DVcompleted a second round of financing which resulted in an amendment to theAugust 6, 1998 Agreement between 3DV and the Company.  The effect of that amendment was to eliminate the Company’soption to purchase the remaining shares of 3DV under certain conditions, and toexempt the Company from guaranteeing the working capital requirements of3DV.  Subsequent to December 23, 1999,the Company continued to account for its investment in 3DV using the equitymethod of accounting.  However, afterDecember 23, 1999, the Company included only its proportional share of 3DV’slosses, not 100% of 3DV’s losses.

 

In April and May 2000, 3DV executed a third round offinancing with investors other than the Company.  In March 2001, 3DV executed a fourth round of financing with allits investors.  As part of this round,the Company invested $500,000 in Series A Convertible Subordinated Notes (the“Notes”) of 3DV.  The Notes arenon-interest bearing, and are convertible into shares of 3DV at the higher of$22.63 per share or the price paid for common shares of 3DV in any subsequentfinancing that occurs on or before March 31, 2002.  As a result, the Company owned approximately 25% and 24%,respectively, of the outstanding shares of 3DV as of June 30, 2000 and 2001.

 

In September 2001, 3DV executed a fifth round offinancing with investors other than the Company, including twoemployee-directors of the Company.  Theterms of this financing are substantially the same as the fourth round.  The amount raised was $2,000,000, payable intwo equal installments in September 2001 and December 2001.  Subsequent to the installment of December2001, the Company held approximately 24% of the outstanding shares of 3DV, andwould hold approximately 18% of the shares of 3DV, if all employee options andNotes were converted to common shares.

 

In the three months ended June 30, 2000, 3DV incurredlosses of approximately $2,412,000.  TheCompany’s investment in 3DV totaled $222,553 at March 31, 2000, andaccordingly, the Company recognized equity in losses of 3DV of the total valueof that investment in the three months ended June 30, 2000.  The Company recognized no losses in the three-monthperiods ended September 30, 2000, December 31, 2000 and March 31, 2001.

 

In the three months ended June 30, 2001, 3DV incurredlosses of approximately $2,177,000.  TheCompany’s investment in 3DV totaled $500,000 at March 31, 2001, andaccordingly, the Company recognized equity in losses of 3DV of the total valueof that investment in the three months ended June 30, 2001. The Companyrecognized no losses in the three-month periods ended September 30, 2001 andDecember 31, 2001.

 

10

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**4.             Segment Information**

 

The Company has three reportable segments — Medical,Industrial and Corporate.  The medicalsegment designs, manufactures and sells EndoSheaths and sells endoscopes tousers in the health care industry.  Theindustrial segment designs, manufactures and sells borescopes to a variety ofusers, primarily in the aircraft maintenance industry.  In addition, the industrial segmentmanufactures and repairs endoscopes for the medical segment.  The corporate segment consists of certainadministrative expenses beneficial to the Company as a whole and the managementoversight of the Company’s investment in 3DV, Vision-Sciences Ltd. (theCompany’s Israeli subsidiary) and the Company’s support of the University ofGeorgia Hepatitis Project, Proposal No. 022297-01 (the “Egypt Project”).

 

The accounting policies of the segments are describedin the summary of significant accounting policies.  The Company evaluates segment performance based upon operatingincome.  Identifiable assets are thoseused directly in the operations of each segment.  Corporate assets include cash, marketable securities, the assetsof Vision-Sciences, Ltd. and the investment in 3DV.  The carrying value of the investment in 3DV at December 31, 2001was $0.  Data regarding management’sview of the Company’s segments are provided in the following tables.

 
| **Three months ended December 31,**                                |   | **Medical** |      | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total**  |   |
|--------------------------------------------------------------------|--------|-------------|-----------|----------------|--------|---------------|--------|-----------------|--------|------------|--------|
| **2001**                                                           |   |        |      |           |   |          |   |            |   |       |   |
| Sales to external customers                                        |   | $           | 877,001   |           | $      | 752,054       |   | $               | — |       | $      | — | $ | 1,629,055 |   |
| Intersegment sales                                                 |   | —      |      | 152,265        |   | —        |   | (152,265)       |   | —     |   |
| Operating income  (loss)                                           |   | (370,561    | )         | 77,049         |   | (73,125       | )      | —          |   | (366,637   | )      |
| Interest income  (expense)                                         |   | —      |      | (1,404         | )      | 24,099        |   | —          |   | 22,695     |   |
| Depreciation and  amortization                                     |   | 42,974      |      | 8,407          |   | —        |   | —          |   | 51,381     |   |
| Other  significant non-cash items:                                 |   |        |      |           |   |          |   |            |   |       |   |
| Stock-based  compensation                                          |   | —      |      | —         |   | (75,025       | )      | —          |   | (75,025    | )      |
| Expenditures for  fixed assets                                     |   | 42,377      |      | 2,448          |   | —        |   | —          |   | 44,825     |   |
|                                                               |   |        |      |           |   |          |   |            |   |       |   |
| **2000**                                                           |   |        |      |           |   |          |   |            |   |       |   |
| Sales to  external customers                                       |   | $           | 1,020,334 |           | $      | 925,955       |   | $               | — |       | $      | — | $ | 1,946,289 |   |
| Intersegment  sales                                                |   | —      |      | 128,770        |   | —        |   | (128,770        | )      | —     |   |
| Operating income  (loss)                                           |   | (96,996     | )         | 72,087         |   | (416,239      | )      | —          |   | (441,148   | )      |
| Interest income  (expense)                                         |   | —      |      | (2,915         | )      | 18,452        |   | —          |   | 15,537     |   |
| Depreciation and  amortization                                     |   | 48,179      |      | 10,470         |   | —        |   | —          |   | 58,649     |   |
| Other  significant non-cash items:                                 |   |        |      |           |   |          |   |            |   |       |   |
| Stock-based  compensation                                          |   | —      |      | —         |   | 11,102        |   | —          |   | 11,102     |   |
| Expenditures for  fixed assets                                     |   | 95,032      |      | —         |   | —        |   | —          |   | 95,032     |   |
| **Nine months ended December 31,**                                 |   | **Medical** |      | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total**  |   |
| **2001**                                                           |   |        |      |           |   |          |   |            |   |       |   |
| Sales to external customers                                        |   | $           | 2,490,168 |           | $      | 2,591,046     |   | $               | — |       | $      | — |   | $ | 5,081,214 |   |
| Intersegment sales                                                 |   | —      |      | 410,646        |   | —        |   | (410,646)       |   | —     |   |
| Operating income  (loss)                                           |   | (530,643    | )         | 390,390        |   | (279,648      | )      | —          |   | (419,901   | )      |
| Interest income  (expense)                                         |   | —      |      | (5,385         | )      | 103,210       |   | —          |   | 97,825     |   |
| Depreciation and  amortization                                     |   | 144,036     |      | 25,306         |   | —        |   | —          |   | 169,342    |   |
| Other  significant non-cash items: Equity in losses of 3DV Systems |   | —      |      | —         |   | (500,000      | )      | —          |   | (500,000   | )      |
| Cumulative  effect of change inaccounting principle                |   | —      |      | —         |   | 327,169       |   | —          |   | 327,169    |   |
| Stock-based  compensation                                          |   | —      |      | —         |   | (177,256      | )      | —          |   | (177,256   | )      |
| Total assets                                                       |   | 1,937,417   |      | 1,894,975      |   | 3,608,722     |   | (975,202        | )      | 6,465,912  |   |
| Expenditures for  fixed assets                                     |   | 142,266     |      | 3,189          |   | —        |   | —          |   | 145,455    |   |
|                                                               |   |        |      |           |   |          |   |            |   |       |   |
| **2000**                                                           |   |        |      |           |   |          |   |            |   |       |   |
| Sales to external  customers                                       |   | $           | 2,707,103 |           | $      | 2,525,811     |   | $               | — |       | $      | — |   | $ | 5,232,914 |   |
| Intersegment  sales                                                |   | —      |      | 387,098        |   | —        |   | (387,098        | )      | —     |   |
| Operating income  (loss)                                           |   | (360,041    | )         | 48,273         |   | (1,010,295    | )      | —          |   | (1,322,063 | )      |
| Interest income  (expense)                                         |   | —      |      | (3,965         | )      | 61,196        |   | —          |   | 57,231     |   |
| Depreciation and  amortization                                     |   | 170,218     |      | 20,469         |   | 9             |   | —          |   | 190,696    |   |
| Other  significant non-cash items:                                 |   |        |      |           |   |          |   |            |   |       |   |
| Equity in losses  of 3DV Systems                                   |   | —      |      | —         |   | (222,553      | )      | —          |   | (222,553   | )      |
| Leasehold  improvement acquired in exchange for note payable       |   | —      |      | 105,000        |   | —        |   | —          |   | 105,000    |   |
| Total assets                                                       |   | 2,394,989   |      | 1,165,335      |   | 4,398,423     |   | (533,017        | )      | 7,425,730  |   |
| Expenditures for  fixed assets                                     |   | 103,777     |      | 37,945         |   | (14,395       | )      | —          |   | 127,327    |   |
|                                                                    |        |             |           |                |        |               |        |                 |        |            |        |  |  |  |  |  |  |  |  |  |

 

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**Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

**FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

Results of Operations

 

Except for the historical information herein, the matters discussed inthis Form 10-Q include forward-looking statements that may involve a number ofrisks and uncertainties.  Future resultsmay vary significantly based upon a number of important factors including, butnot limited to, the Company’s history of losses, lack of third-partyreimbursement for its products, state and federal regulatory restrictions,reliance upon certain suppliers, dependence upon proprietary rights, risks inmarket acceptance of new products and services and continuing demand for same,the impact of competitive products and pricing, changing economic conditions,and other risk factors detailed in the Company’s most recent annual report andother filings with the Securities and Exchange Commission.

 

Net sales for the three months ended December 31, 2001 (“Q3 02”) were$1,629,055, a decrease of $317,234, or 16%, compared to the three-month periodended December 31, 2000 (“Q3 01”). During this period, sales of medical products decreased by $143,333, or14%, and sales of industrial products decreased by $173,901, or 19%.

 

The decrease in medical sales was due primarily to lower demand for theCompany’s EndoSheathsÒ from the gastrointestinal(“GI”) market of approximately $95,000. This lower demand is due primarily to the continued lack ofreimbursement for the EndoSheath by insurance companies to health careproviders.  In addition, sales ofEndoSheaths to the Ear-Nose-Throat (“ENT”) market declined by $23,000, dueprimarily to lower prices and a higher percentage of sales to internationaldistributors, compared to domestic customers. Sales of endoscopes to the ENT market declined by $32,000 due to lowerdemand from both domestic and international markets.  Sales of other products comprised the remaining change.

 

The number of ENT EndoSheath units shipped in Q3 02 increased by 16%,compared to Q3 01.  However, loweraverage selling prices per unit resulted in a sales decrease of 5%.  The lower average selling price was due totwo factors, lower prices instituted by the Company in June 2001 to make theENT EndoSheath more affordable to customers and to a higher percentage of unitsshipped to international distributors. Shipments to international distributors have a lower average sellingprice than do shipments to domestic end users.

 

The Company shipped approximately 59,200 ENT EndoSheaths in Q3 02, anincrease of 8,200, or 16%, compared to shipments of approximately 51,000 in Q3 01.  Shipments to international distributorscomprised approximately 59% of total ENT EndoSheath unit shipments in Q3 02,compared to approximately 49% in Q3 01. International demand for the Company’s ENT EndoSheath continues to behigh, especially in Europe and Australia.

 

During Q3 02, although the Company acquired approximately 40 newdomestic ENT customers, unit shipments to all domestic customers decreased byapproximately 6%, compared to Q3 01, primarily due to overall lowerdemand.  The Company cannot quantify howmuch of the lower demand was due to the events of September 11, 2001.  However, the Company did experience areduction of approximately 45% in the number of new customers in September andOctober.  In addition, the Companybelieves cost pressures continue to plague the market for its products, ashealth care providers are not reimbursed for using the products.

 

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The lower sales of industrial products in Q3 02, compared to Q3 01,were due primarily to lower demand during this period for the Company’sproducts by the aircraft engine and aircraft maintenance markets.  This segment derives approximately 65% ofits sales from these markets.  TheCompany believes the lower demand in Q3 02 for the products of this segment isdirectly related to the events of September 11, 2001, and the resultingreduction in the number of commercial flights. The Company expects demand for products sold by the industrial segmentto these markets to remain weak for at least the next two fiscal quarters.

 

Net sales for the nine months ended December 31, 2001 (“2001”) were$5,081,214, a decrease of  $151,700, or3% compared to the nine-month period ended December 31, 2000 (“2000”).  During this period, sales of the medicalsegment decreased by $216,935, or 8%, and sales of the industrial segmentincreased by $65,235, or 3%.

 

The decrease in medical sales was due to lower demand for the Company’sendoscopes and EndoSheaths for the GI market of approximately $336,000.  This was partially offset by higher demandfor the Company’s endoscopes and EndoSheaths for the ENT market ofapproximately $79,000, for the pulmonary market of approximately $16,000, andaccessories of approximately $24,000.

 

The number of ENT EndoSheath units shipped in 2001 was greater by 18%than in 2000.  However, lower averageselling prices per unit resulted in a slight sales decrease of $4,000.  The lower average selling price was due totwo factors, lower prices instituted by the Company in June 2001 to make theENT EndoSheath more affordable to customers and an increase in the percentageof units shipped to international distributors. Shipments to internationaldistributors have a lower average selling price than do shipments to domesticend users.  The Company shippedapproximately 173,100 ENT EndoSheaths in 2001, an increase of 26,400, or 18%,compared to shipments of approximately 146,700 in 2000.  Shipments to international distributorscomprised approximately 56% of total ENT EndoSheath unit shipments in 2001,compared to approximately 48% in 2000. International demand for the Company’s ENT EndoSheath continues to behigh, especially in Europe and Australia.

 

During 2001, although the Company acquired approximately 113 newdomestic ENT customers, unit shipments to all domestic customers decreased inthe period by approximately 1%, compared to 2000, due to lower demand in Q302.  The Company expects the lower unitprices will encourage more usage of the ENT EndoSheath, both in domestic andinternational markets.  The Company isinstituting a new sales incentive plan for its outside sales representativesduring the fourth fiscal quarter of 2002 in order to increase unit sales andenlarge the domestic customer base. However, there can be no assurance that these plans will result in anincrease in the number of units shipped.

 

Gross profit in Q3 02 decreased to $461,356, or 28% of net sales,compared to $661,653, or 34% of net sales in Q3 01.  Gross profit decreased in the medical segment, due primarily tothe lower prices for ENT EndoSheaths. Gross profit decreased in the industrial segment, due primarily to lowersales volume and product mix.

 

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Gross profit in 2001 increased to $1,709,000, or 34% of net sales,compared to $1,674,637, or 32% of net sales in 2000.  Gross profit decreased in the medical segment, due primarily tothe lower prices for ENT EndoSheaths. Gross profit increased in the industrial segment, due primarily to afavorable product mix resulting in higher manufacturing efficiencies, improvedusage of materials and lower overhead spending.

 

Selling, general and administrative (“SG&A”) expenses in Q3 02increased by $27,599, or 3% compared to Q3 01. SG&A expenses amounted to 51% and 41% of net sales in Q3 02 and Q301, respectively. SG&A expenses increased in the medical segment byapproximately $88,000, due primarily to higher legal fees related to filing ofpatents.  SG&A expenses declined inthe industrial segment by approximately $47,000 due primarily to lower costsfor commissions and product promotion. SG&A expenses decreased in the corporate segment by approximately$14,000 due to lower charges for investor relations.

 

SG&A expenses decreased by $131,744 in 2001, compared to 2000.  SG&A expenses amounted to 43% of salesin 2001, compared to 44% of sales in 2000. SG&A expenses decreased in the medical and industrial segments by$45,000 and $81,000, respectively, and by $6,000 in the corporate segment.  The primary causes for the decrease in themedical segment were lower costs for commissions and public relations.  In the industrial segment the decrease inSG&A expenses was due primarily to lower facility costs, resulting from amove to more efficient office space in September 2000, and lower spending forproduct promotion.  The corporatesegment incurred higher expenses for payrolls and consulting fees related toCMOS patents, while reducing costs for investor relations and legal fees.

 

Research and development (“R&D”) expenses decreased by $216,280 inQ3 02 compared to Q3 01, and were 4% of sales in Q3 02, compared to 15% ofsales in Q3 01.  The lower expenses forR&D were due primarily to a favorable comparison to Q3 01, which incurred acharge of approximately $244,000 for the Egypt Project.

 

R&D expenses decreased by $301,630 for 2001, compared to 2000, andwere 3% of sales in 2001, compared to 8% in 2000.  The primary causes for this decrease were charges of $270,000related to the Egypt Project in 2000 which did not recur in 2001, lower costsin the medical segment of approximately $12,000 and a reduction of approximately$20,000 for costs related to the Company’s subsidiary in Israel.

 

Stock-based compensation costs declined by $86,127 in Q3 02, comparedto Q3 01, and by $434,425 in 2001, compared to 2000.  This charge is computed to determine the fair value of stock optionsgranted to non-employees of the Company. The Company uses the Black-Scholes method to calculate the fairvalue.  This method uses stock pricevolatility, the closing price of the Company’s common stock as traded on theNasdaq SmallCap Market and other factors to determine the fair value ofnon-qualified options.  For Q3 02 and2001, the change in the Company’s closing stock price was the largest cause forthe reduction in this cost.

 

The Company did not record equity in losses of 3DV Systems in Q3 02 norin Q3 01.  For 2001 the Company recordedequity in the losses of 3DV of $500,000, compare to $222,553 in 2000.  See Note 3 above.

 

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The net loss per share for Q3 02 was $.01, compared to a net loss of$.02 per share for Q3 01.  For 2001, theloss per share was $.04, compared to $.07 for 2000.

 

Liquidity and Capital Resources

 

As of December 31, 2001, the Company had $3.5 million in cash, cashequivalents and marketable securities, and working capital of  $4.4 million.  The Company also had a cash collateralized demand line of creditwith a bank for borrowings of up to $250,000. At December 31, 2001, there was approximately $200,000 available underthis line for use in support of general working capital needs and the issuanceof commercial and standby letters of credit. The Company expects its current balance of cash, cash equivalents andmarketable securities is sufficient to fund its operations at least for thenext twelve months.

 

The Company’s cash and cash equivalents increased by $695,000 in thenine months ended December 31, 2001, due primarily to cash provided byfinancing activities of $574,000, and cash provided by investing of$844,000.  These were partially offsetby cash used in operations of $724,000.

 

In the fiscal year ended March 31, 2001, the Company entered into acontract for approximately $203,000, subsequently increased by approximately$54,000, for the design and manufacture of new equipment for manufacturing itsENT EndoSheaths, and has made payments to the supplier of $141,000 as ofDecember 31, 2001.  The Company expectsto make other progress payments for the new equipment during the first sixmonths of calendar 2002 of approximately $116,000.  The Company expects total spending for property and equipmentwill not exceed $350,000 for all of FY 02. The Company expects the new ENT EndoSheath forming machine will be inplace in January 2002, and the ENT EndoSheath assembly machine will be in placein June 2002.  In addition, as reportedin the Company’s Form 10-K for the fiscal year ended March 31, 2001, theCompany will continue to evaluate its investment in 3DV, and may make furtherinvestments if it believes it is in the best interests of the Company’sshareholders.

 

The Company conducts it operations in certain facilities leased fromnon-related parties.  These leasesexpire on various dates through August 2005. Approximate future minimum lease commitments under these leases,including payments of a note payable in conjunction with certain leaseholdimprovements capitalized in fiscal year 2001, are as follows:

 
| **Year ended  March 31,** |   |    |    |
|---------------------------|--------|---------|---------|
| 2002                      |   | $       | 80,000  |   |
| 2003                      |   | 298,000 |    |
| 2004                      |   | 224,000 |    |
| 2005                      |   | 145,000 |    |
| 2006                      |   | 60,000  |    |
| Total                     |   | $       | 807,000 |   |

 

The Company has incurred losses since its inception, and losses areexpected to continue at least during FY 02. The Company has funded the losses principally with the proceeds frompublic and private equity financings. Although the Company does not anticipate the need for additionalfinancing in FY 02, management has decided that new financing may bedesirable.  However, there can be noassurance that additional funding will be available, or available on reasonableterms.

 

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**Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company, in the normal course of business, is subject to the risksassociated with fluctuations in interest rates and changes in foreign currencyexchange rates.

 

*Interest and Market Risk*

 

The Company maintains a portfolio of marketable, primarily fixedincome, available-for-sale securities of various issuers, types andmaturities.  The Company has not usedderivative financial instruments in its investment portfolio.  The Company attempts to limit its exposureto interest rate and credit risk by placing its investments with high-qualityfinancial institutions and has established investment guidelines relative todiversification and maturities designed to maintain safety and liquidity.

 

Investments in both fixed-rate and floating-rate interest earninginstruments carry a degree of interest rate risk.  Fixed-rate securities may have their fair market value adverselyimpacted due to a rise in interest rates, while floating-rate securities mayproduce less income than expected if interest rates decline.  Due in part to these factors, the Company’sfuture investment income may fall short of expectations due to changes ininterest rates, or the Company may suffer losses in principal if forced to sellsecurities which have seen a decline in market value due to changes in interestrates.

 

*Foreign Currency Exchange*

 

The Company faces exposure, due to purchases of raw materials fromJapanese suppliers, to adverse movements in the value of the Japanese Yen.  This exposure may change over time, andcould have a materially adverse effect on the Company’s financial results.  The Company may attempt to limit thisexposure by purchasing forward contracts, as required.  Most of the Company’s liabilities aresettled within 90 days of receipt of materials.  At December 31, 2001, the Company’s liabilities relating to JapaneseYen were approximately $57,000.

 

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**PARTII - OTHER INFORMATION**

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)         Exhibits

None.

 

(b)        Reports on Form 8-K

None.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                    |   |   | Vision-Sciences, Inc.                                                                                                                |
|-------------------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------|
|                    |   |   |                                                                                                                                 |
| Date: February 14, 2002 |   |   | By:                                                                                                                                  |
|                    |   |   |                                                                                                                                 |
|                    |   |   | /s/ Gerald B. Lichtenberger                                                                                                          |   |
|                    |   |   | Dr. Gerald B. Lichtenberger, Ph. D.                                                                                                  |
|                    |   |   | Vice President of Business Development                                                                                               |
|                    |   |   |                                                                                                                                 |
|                    |   |   | /s/ James A. Tracy                                                                                                                   |   |
|                    |   |   | James A. Tracy                                                                                                                       |
|                    |   |   | Vice President Finance, Chief Financial Officer and  Controller (Principal Financial Officer and Principal Accounting  Officer) |

 

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