** **

**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 September 30, 2002**

** **

**COMMISSIONFILE NUMBER 0-20970**

** **

| **VISION-SCIENCES, INC.**                                |
|----------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)  |
|                                                     |   |   |
| **Delaware**                                             |   | **13-3430173** |
| (State or other  jurisdiction of                         |   | (IRS Employer |
| incorporation or  organization)                          |   | Identification Number) |
|                                                     |   |   |
| **9  Strathmore Road, Natick, MA**                       |   | **01760** |
| (Address of principal  executive offices)                |   | (Zip Code) |
|                                                     |   |   |
| Registrant’s telephone  number, including area code |   | **(508)  650-9971** |
|                                                     |   |   |
| **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 thenumber of shares outstanding of each of the issuer’s classes of common stock,as of September 30, 2002.

 

| **Common  Stock, par value of $.01** |   | **27,198,712**     |
|--------------------------------------|--------|--------------------|
| (Title of Class)                     |   | (Number of Shares) |

 

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**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                                 |   |
|     |                  |                                                                                        |   |
|     | Item 4.               | Controls and  Procedures                                                                    |   |
|     |                  |                                                                                        |   |
| Part II. | Other Information     |                                                                                        |
|     |                  |                                                                                        |   |
|     | Item  4.              | Submission  of Matters to a Vote of Stockholders                                            |   |
|     |                  |                                                                                        |   |
|     | Signatures            |                                                                                        |   |
|     |                  |                                                                                        |   |
|     | Certifications        |                                                                                        |   |
|     |                  |                                                                                        |   |
|     | Exhibits              |                                                                                        |   |
|          |                       |                                                                                             |        |  |  |

 

2

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**PART I - FINANCIAL INFORMATION**

**Item1: FINANCIAL STATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**
|                                                                                                                                                                                     |   | **September 30,**

**2002** |      | **March 31,**

**2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|-----------|-------------------------|--------|
| **ASSETS**                                                                                                                                                                               |   |                        |      |                    |   |
| Current Assets:                                                                                                                                                                          |   |                        |      |                    |   |
| Cash and cash  equivalents                                                                                                                                                               |   | $                           | 224,647   |                    | $      | 2,890,364 |   |
| Marketable  securities                                                                                                                                                                   |   | 2,130,113                   |      | 251,445                 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $78,280 and $76,641,  respectively                                                                                       |   | 620,000                     |      | 834,577                 |   |
| Inventories                                                                                                                                                                              |   | 1,350,042                   |      | 1,193,181               |   |
| Prepaid expenses  and deposits                                                                                                                                                           |   | 81,077                      |      | 76,932                  |   |
| Total current  assets                                                                                                                                                                    |   | 4,405,879                   |      | 5,246,499               |   |
|                                                                                                                                                                                     |   |                        |      |                    |   |
| Property and Equipment, at cost:                                                                                                                                                         |   |                        |      |                    |   |
| Machinery and  equipment                                                                                                                                                                 |   | 3,367,773                   |      | 3,283,341               |   |
| Furniture and  fixtures                                                                                                                                                                  |   | 208,934                     |      | 208,934                 |   |
| Leasehold  improvements                                                                                                                                                                  |   | 466,505                     |      | 462,882                 |   |
|                                                                                                                                                                                     |   | 4,043,212                   |      | 3,955,157               |   |
| Less-Accumulated  depreciation and amortization                                                                                                                                          |   | 3,402,494                   |      | 3,297,582               |   |
|                                                                                                                                                                                     |   | 640,718                     |      | 657,575                 |   |
|                                                                                                                                                                                     |   |                        |      |                    |   |
| Other assets,  net of accumulated amortization of $37,917 and $34,746, respectively                                                                                                      |   | 92,929                      |      | 96,100                  |   |
| Total assets                                                                                                                                                                             |   | $                           | 5,139,526 |                    | $      | 6,000,174 |   |
|                                                                                                                                                                                     |   |                        |      |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                            |   |                        |      |                    |   |
| Current Liabilities:                                                                                                                                                                     |   |                        |      |                    |   |
| Acceptances  payable to a bank                                                                                                                                                           |   | $                           | 63,421    |                    | $      | 43,226 |   |
| Current portion  of note payable                                                                                                                                                         |   | —                      |      | 23,989                  |   |
| Accounts payable                                                                                                                                                                         |   | 426,445                     |      | 286,730                 |   |
| Accrued expenses                                                                                                                                                                         |   | 943,219                     |      | 1,103,156               |   |
| Total current  liabilities                                                                                                                                                               |   | 1,433,085                   |      | 1,457,101               |   |
|                                                                                                                                                                                     |   |                        |      |                    |   |
| Potential obligations to non-qualified option  holders                                                                                                                                   |   | 130,574                     |      | 421,110                 |   |
| Stockholders’ Equity:                                                                                                                                                               |   |                        |      |                    |   |
| Common stock,  $.01 par value—  Authorized—50,000,000 shares   Issued and outstanding—27,198,712 shares at   September 30, 2002 and 27,105,355 shares   at March 31, 2002 |   | 271,986                     |      | 271,052                 |   |
| Additional  paid-in capital                                                                                                                                                              |   | 58,510,521                  |      | 58,386,502              |   |
| Accumulated  deficit                                                                                                                                                                     |   | (55,206,640                 | )         | (54,535,591             | )      |
| Total  stockholders’ equity                                                                                                                                                         |   | 3,575,867                   |      | 4,121,963               |   |
| Total  liabilities and stockholders’ equity                                                                                                                                         |   | $                           | 5,139,526 |                    | $      | 6,000,174 |   |
|                                                                                                                                                                                          |        |                             |           |                         |        |  |  |  |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** (Unaudited)**

** **
|                                                                           |   | **Three  Months Ended** |      | **Six Months  Ended** |   |
|--------------------------------------------------------------------------------|--------|-------------------------|-----------|-----------------------|--------|
|                                                                           |   | **September  30,**      |      | **September  30,**    |   |
|                                                                           |   | **2002**                |      | **2001**              |   | **2002** |   | **2001** |   |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Net sales                                                                      |   | $                       | 1,512,124 |                  | $      | 1,720,279 |   | $ | 3,246,583 |   | $ | 3,452,159 |   |
| Cost of sales                                                                  |   | 1,091,678               |      | 1,059,524             |   | 2,364,164 |   | 2,204,516 |   |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Gross profit                                                                   |   | 420,446                 |      | 660,755               |   | 882,419 |   | 1,247,643 |   |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Selling, general  and administrative expenses  (1)                        |   | 795,095                 |      | 651,988               |   | 1,583,154 |   | 1,296,804 |   |
| Research and  development expenses (1)                                         |   | 95,922                  |      | 73,194                |   | 190,462 |   | 106,334 |   |
| Stock-based  compensation                                                      |   | (91,576                 | )         | (102,231              | )      | (186,083 | ) | (102,231 | ) |
| Income (loss)  from operations                                                 |   | (378,995                | )         | 37,804                |   | (705,114 | ) | (53,264 | ) |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Interest income                                                                |   | 12,087                  |      | 35,182                |   | 24,234 |   | 79,111 |   |
| Interest expense                                                               |   | (146                    | )         | (1,799                | )      | (724 | ) | (3,981 | ) |
| Equity in losses  of 3DV Systems Ltd                                           |   | —                  |      | —                |   | — |   | (500,000 | ) |
| Other income                                                                   |   | 3,133                   |      | 1,972                 |   | 10,555 |   | 3,616 |   |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Net income  (loss) before cumulative effect of change in accounting principle  |   | (363,921                | )         | 73,159                |   | (671,049 | ) | (474,518 | ) |
| Cumulative  effect of change in accounting principle (Note 2)                  |   | —                  |      | —                |   | — |   | 327,169 |   |
| Net income  (loss) after cumulative effect of change in accounting principle   |   | $                       | (363,921  | )                     | $      | 73,159 |   | $ | (671,049 | ) | $ | (801,687 | ) |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Basic and  diluted net income (loss) per common share                          |   | $                       | (0.01     | )                     | $      | 0.00 |   | $ | (0.02 | ) | $ | (0.03 | ) |
|                                                                           |   |                    |      |                  |   |   |   |   |   |
| Shares used in  computing basic and diluted net income (loss) per common share |   | 27,198,712              |      | 27,105,355            |   | 27,192,314 |   | 26,872,272 |   |

----

(1)  Excludes non-cash stock-based compensation,as follows:
| Research and  development expenses            |   | $      | (84,111 | )      | $      | (102,231 | )      | $      | (258,472 | ) | $ | (102,231 | ) |
|-----------------------------------------------|--------|--------|---------|--------|--------|----------|--------|--------|----------|---|---|----------|---|
| Selling, general  and administrative expenses |   | (7,465 | )       | — |   | 72,389   |   | — |     |
| Total                                         |   | $      | (91,576 | )      | $      | (102,231 | )      | $      | (186,083 | ) | $ | (102,231 | ) |

 

 

 

See accompanyingnotes to consolidated financial statements.

 

4

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**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

** (Unaudited)**

 

 

 

 

 
|                                                   |   | **Common  Stock**     |   |                |    |                            |   |                     |   |                                 |        |
|--------------------------------------------------------|--------|-----------------------|--------|---------------------|---------|---------------------------------|--------|--------------------------|--------|--------------------------------------|-------------|
|                                                   |   | **Number of  Shares** |   | **$.01 Par  Value** |    | **Additional  Paid-in-Capital** |   | **Accumulated  Deficit** |   | **Total  Stockholders’ Equity** |        | **Total  Comprehensive Loss** |   |
|                                                   |   |                  |   |                |    |                            |   |                     |   |                                 |        |   |   |
| Balance, March  31, 2002                               |   | 27,105,355            |   | $                   | 271,052 |                            | $      | 58,386,502               |   | $                                    | (54,535,591 | ) | $ | 4,121,963 |   |   |   |
| Exercise of  incentive stock options                   |   | 16,000                |   | 160                 |    | 19,567                          |   | —                   |   | 19,727                               |        |   |   |
| Exercise of  non-qualified stock options               |   | 77,357                |   | 774                 |    | —                          |   | —                   |   | 774                                  |        |   |   |
| Fair value of  stock options exercised by non-employee |   |                  |   |                |    | 104,452                         |   |                     |   | 104,452                              |        |   |   |
| Net loss                                               |   | —                |   | —              |    | —                          |   | (671,049                 | )      | (671,049                             | )           | $ | (671,049 | ) |
| Total  comprehensive loss                              |   |                  |   |                |    |                            |   |                     |   |                                 |        | $ | (671,049 | ) |
| Balance  September 30, 2002                            |   | 27,198,712            |   | $                   | 271,986 |                            | $      | 58,510,521               |   | $                                    | (55,206,640 | ) | $ | 3,575,867 |   |   |   |

 

 

See accompanyingnotes to consolidated financial statements.

 

5

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** (Unaudited)**

 

 
|                                                                                           |   | **Six Months Ended**
**September 30, 2002** |     | **Six Months Ended**

**September 30, 2001** |   |
|------------------------------------------------------------------------------------------------|--------|---------------------------------------------|----------|----------------------------------------------|--------|
| Cash flows from operating activities:                                                          |   |                                        |     |                                         |   |
| Net loss                                                                                       |   | $                                           | (671,049 | )                                            | $      | (801,687 | ) |
| Adjustments to  reconcile net loss to net cash used for operating activities:                  |   |                                        |     |                                         |   |
| Depreciation and  amortization                                                                 |   | 108,083                                     |     | 117,959                                      |   |
| Equity in losses  of 3DV Systems, Ltd.                                                         |   | —                                      |     | 500,000                                      |   |
| Stock  compensation to non-employees                                                           |   | (186,083                                    | )        | 224,938                                      |   |
| Changes in  assets and liabilities:                                                            |   |                                        |     |                                         |   |
| Accounts  receivable                                                                           |   | 214,577                                     |     | 218,037                                      |   |
| Inventories                                                                                    |   | (156,861                                    | )        | (295,069                                     | )      |
| Prepaid expenses  and deposits                                                                 |   | (4,145                                      | )        | (17,949                                      | )      |
| Accounts payable                                                                               |   | 139,715                                     |     | 154,270                                      |   |
| Accrued expenses                                                                               |   | (159,937                                    | )        | (298,301                                     | )      |
| Net cash used  for operating activities                                                        |   | (715,700                                    | )        | (197,802                                     | )      |
| Cash flows  provided by (used for) investing activities                                        |   |                                        |     |                                         |   |
| Decrease  (increase) in marketable securities                                                  |   | (1,878,668                                  | )        | 441,216                                      |   |
| Purchase of  property and equipment, net                                                       |   | (88,055                                     | )        | (100,629                                     | )      |
| Net cash  provided by (used for) investing activities                                          |   | (1,966,723                                  | )        | 340,587                                      |   |
|                                                                                           |   |                                        |     |                                         |   |
| Cash flows  provided by (used for) financing activities:                                       |   |                                        |     |                                         |   |
| Payments on note  payable for leasehold improvements                                           |   | (23,989                                     | )        | (25,676                                      | )      |
| Proceeds from  acceptances payable to a bank                                                   |   | 20,195                                      |     | 13,492                                       |   |
| Proceeds from  the sale of common stock, net                                                   |   | —                                      |     | 600,000                                      |   |
| Exercise of  stock options                                                                     |   | 20,500                                      |     | 2,375                                        |   |
| Net cash  provided by financing activities                                                     |   | 16,706                                      |     | 590,191                                      |   |
| Net increase  (decrease) in cash and cash equivalents                                          |   | (2,665,717                                  | )        | 732,976                                      |   |
| Cash and cash equivalents, beginning of period                                                 |   | 2,890,364                                   |     | 2,568,724                                    |   |
| Cash and cash equivalents, end of period                                                       |   | $                                           | 224,647  |                                         | $      | 3,301,700 |   |
|                                                                                           |   |                                        |     |                                         |   |
| Supplemental  Disclosure of Cash Flow Information:                                             |   |                                        |     |                                         |   |
| Cash paid during  the period for interest                                                      |   | $                                           | 724      |                                         | $      | 3,981 |   |
|                                                                                           |   |                                        |     |                                         |   |
| Supplemental  Disclosure of Non-cash items from Financing Activities:                          |   |                                        |     |                                         |   |
| Exercise of  non-qualified options transferred to equity during the period                     |   | $                                           | 104,452  |                                         | $      | — |   |
| Fair market  value of non-qualified options granted in the period                              |   | $                                           | 79,854   |                                         | $      | — |   |
| Change in the  fair market value of non-qualified options existing at the beginning of  period |   | $                                           | (265,937 | )                                            | $      | (102,231 | ) |

 

 

See accompanyingnotes to consolidated financial statements.

 

6

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**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

 

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

 

                                                The consolidated financial statementsincluded herein have been prepared by the Company in accordance with accountingprinciples generally accepted in the United States of America, without audit,pursuant to the rules and regulations of the Securities and Exchange Commissionand include, in the opinion of management, all adjustments (consisting only ofnormal and recurring adjustments) that the Company considers necessary for afair presentation of such information. Certain information and footnote disclosures normally included infinancial statements have been condensed or omitted pursuant to such rules andregulations.  The Company believes,however, that its disclosures are adequate to make the information presentednot misleading.  These consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in the Company’slatest annual report to stockholders. The results for the interim periods presented are not necessarilyindicative of results to be expected for the full fiscal year.

 

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

 

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

 

a.                                       *Principles of 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, whichapproximates amortized cost*.** *Cashequivalents are short-term, highly liquid investments with original maturitiesof less than three months.

 

c.                                       *Marketable Securities*: Marketable securities are carried at market value,which approximates amortized cost.  TheCompany has classified its investments in marketable securities asavailable-for-sale securities.  AtSeptember 30, 2002, the Company’s marketable securities consisted of commercialpaper and a certificate of deposit with a weighted average maturity of 181days.

 

d.                                      *Inventories*:  Inventoriesare stated at the lower of cost or market using the first-in, 

first-out (FIFO) method and consist of the following:
|            |   | **September 30,**

**2002** |      | **March 31,**

**2002** |   |
|-----------------|--------|-----------------------------|-----------|-------------------------|--------|
|            |   |                        |      | **(audited)**           |   |
| Raw materials   |   | $                           | 740,190   |                    | $      | 612,827 |   |
| Work-in-process |   | 154,903                     |      | 190,686                 |   |
| Finished goods  |   | 454,949                     |      | 389,668                 |   |
|            |   | $                           | 1,350,042 |                    | $      | 1,193,181 |   |

 

 

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

 

7

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                                                e.             *Depreciationand Amortization*: The Company provides for depreciation andamortization using the straight-line method in amounts that allocate the costof the assets to operations over their estimated useful lives as follows:

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

 

 

                                                                Leaseholdimprovements are amortized over the shorter of their estimated useful lives orthe lives of the 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 following must occur before the Company recognizesrevenue: (1) persuasive evidence of an arrangement exists, (2) delivery hasoccurred or services have been rendered, (3) the price is fixed ordeterminable, and (4) collectibility is reasonably assured.

 

                                                h.             *ForeignCurrency Transactions*: In accordance with Statement of FinancialAccounting Standard (“SFAS”) No. 52, *Foreign Currency Translation,* the Companycharges foreign currency exchange gains or losses, in connection with itspurchases of products from vendors in Japan, to operations, and charges foreignexchange translation gains and losses to 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.

 

                                                                TheCompany has recorded a valuation allowance equal to its net deferred tax assetdue to the uncertainty of realizing the benefit of this asset.

 

8

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**2**.             **Summary of Significant AccountingPolicies (Continued)**

 

j*.*                                          *Accountingfor Derivatives*: In September 2000, theEmerging Issues Task Force issued EITF 00-19, *Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock*,which requires freestanding contracts that are settled in a company’s own stock,including common stock options and warrants, to be designated as an equityinstrument, an asset or a liability. Under the provisions of EITF 00-19, a contract designated as an asset ora liability must be carried at fair value, with any changes in fair valuerecorded in the results of operations. A contract designated as an equity instrument must be included withinequity, and no fair value adjustments are required.  In accordance with EITF 00-19, the Company has determined thatoutstanding options to non-employees as of September 30, 2002 to purchase1,363,032 shares of the Company’s common stock should be designated as aliability.

TheCompany valued the non-qualified options outstanding at September 30, 2002using the Black-Scholes method.  Thevalue of those options declined by $91,576 and by $265,937, respectively, inthe three and six months ended September 30, 2002.  The Company recorded these declines as reductions in operatingexpenses in the accompanying consolidated statement of operations for theseperiods.

**3.****             ****Investments in Israel**

 

*3DVSystems Ltd.*

 

The Company accounts for its investment in 3DV SystemsLtd. (“3DV”) using the equity method of accounting.  As of March 31, 2002, the Company owned approximately 24% of theoutstanding shares of 3DV, and would hold approximately 18% of the shares of3DV, if all employee options and Convertible Notes were converted to commonshares.

 

In March 2002, 3DV executed a sixth round of financingwith investors other than the Company, including two employee-directors of theCompany.  This round of financing wasfor $4,000,000, payable in two installments in March 2002 and September2002.  As of September 30, 2002, 3DV hadreceived approximately $2,500,000 of that round.  These employee-directors have offered, and the Company isconsidering accepting, a no-cost option to acquire the interest of the twoemployee-directors.  This option wouldbe exercisable for ten years, solely by the Company, and for payment of onlythe principal amount of their investment.

 

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 equal to the totalvalue of its investment in the three months ended June 30, 2001.  In the three and six months ended September30, 2002, 3DV incurred losses of approximately $1,479,000 and $4,034,000,respectively.  The Company’s investmentin 3DV totaled $0 at March 31, 2002, and accordingly, the Company did notrecognize any portion of the losses of 3DV for the three and six-month periodsended September 30, 2002.

 

9

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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 applicable 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”).

 

All segments follow the accounting policies 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 September 30, 2002was $0.  Data regarding management’sview of the Company’s segments are provided in the following tables.

 

10

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| **Three  months ended September 30,** |   | **Medical** |    | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total** |    |
|---------------------------------------|--------|-------------|---------|----------------|--------|---------------|--------|-----------------|--------|-----------|---------|
| **2002**                              |   |        |    |           |   |          |   |            |   |      |    |
| Sales to  external customers          |   | $           | 848,025 |           | $      | 664,099       |   | $               | — |      | $       | — |   | $ | 1,512,124 |   |
| Intersegment  sales                   |   | —      |    | 151,041        |   | —        |   | (151,041        | )      | —    |    |
| Operating income  (loss)              |   | (268,372    | )       | (14,863        | )      | (95,760       | )      | —          |   | (378,995  | )       |
| Interest income  (expense)            |   | —      |    | (146           | )      | 12,087        |   | —          |   | 11,941    |    |
| Depreciation and  amortization        |   | 45,804      |    | 9,870          |   | —        |   | —          |   | 55,674    |    |
| Other significant  non-cash items:    |   |        |    |           |   |          |   |            |   |      |    |
| Stock-based  compensation             |   | —      |    | —         |   | (91,576       | )      | —          |   | (91,576   | )       |
| Expenditures for  fixed assets        |   | 42,999      |    | 19,302         |   | —        |   | —          |   | 62,301    |    |
|                                  |   |        |    |           |   |          |   |            |   |      |    |
| **2001**                              |   |        |    |           |   |          |   |            |   |      |    |
| Sales to  external customers          |   | $           | 884,186 |           | $      | 836,093       |   | $               | — |      | $       | — |   | $ | 1,720,279 |   |
| Intersegment  sales                   |   | —      |    | 144,283        |   | —        |   | (144,283        | )      | —    |    |
| Operating income  (loss)              |   | (18,648     | )       | 132,415        |   | (75,963       | )      | —          |   | 37,804    |    |
| Interest income  (expense)            |   | —      |    | (1,799         | )      | 35,182        |   | —          |   | 33,383    |    |
| Depreciation and  amortization        |   | 52,691      |    | 8,436          |   | —        |   | —          |   | 61,127    |    |
| Other  significant non-cash items:    |   |        |    |           |   |          |   |            |   |      |    |
| Stock-based  compensation             |   | —      |    | —         |   | (102,231      | )      | —          |   | (102,231  | )  |
| Expenditures for  fixed assets        |   | 60,036      |    | 741            |   | —        |   | —          |   | 60,777    |    |

 

 
| **Six months  ended September 30,**                  |   | **Medical** |      | **Industrial** |   | **Corporate** |   | **Adjustments** |    | **Total** |   |
|------------------------------------------------------|--------|-------------|-----------|----------------|--------|---------------|--------|-----------------|---------|-----------|--------|
| **2002**                                             |   |        |      |           |   |          |   |            |    |      |   |
| Sales to  external customers                         |   | $           | 1,856,031 |           | $      | 1,390,552     |   | $               | —  |      | $      | — |   | $ | 3,246,583 |   |
| Intersegment  sales                                  |   | —      |      | 353,914        |   |          |   | (353,914        | )  | —    |   |
| Operating income  (loss)                             |   | (511,362    | )         | (10,029        | )      | (183,723      | )      | —          |    | (705,114  | )      |
| Interest income  (expense)                           |   | —      |      | (724           | )      | 24,234        |   | —          |    | 23,510    |   |
| Depreciation and  amortization                       |   | 90,021      |      | 18,062         |   | —        |   | —          |    | 108,083   |   |
| Other  significant non-cash items:                   |   |        |      |           |   |          |   |            |    |      |   |
| Stock-based  compensation                            |   | —      |      | —         |   | (186,083      | )      | —          |    | (186,083  | )      |
| Total assets                                         |   | 1,807,078   |      | 1,142,370      |   | 2,446,734     |   | (256,656        | )       | 5,139,526 |   |
| Expenditures for  fixed assets                       |   | 57,860      |      | 30,195         |   | —        |   | —          |    | 88,055    |   |
|                                                 |   |        |      |           |   |          |   |            |    |      |   |
| **2001**                                             |   |        |      |           |   |          |   |            |    |      |   |
| Sales to  external customers                         |   | $           | 1,613,167 |           | $      | 1,838,992     |   | $               | —  |      | $      | — |   | $ | 3,452,159 |   |
| Intersegment  sales                                  |   | —      |      | 258,380        |   | —        |   | (258,380        | )  | —    |   |
| Operating income  (loss)                             |   | (160,082    | )         | 313,341        |   | (206,523      | )      | —          |    | (53,264   | )      |
| Interest income  (expense)                           |   | —      |      | (3,981         | )      | 79,111        |   | —          |    | 75,130    |   |
| Depreciation and  amortization                       |   | 101,061     |      | 16,898         |   | —        |   | —          |    | 117,959   |   |
| Other  significant non-cash items:                   |   |        |      |           |   |          |   |            |    |      |   |
| Equity in losses  of 3DV Systems                     |   | —      |      | —         |   | (500,000      | )      | —          |    | (500,000  | )      |
| Cumulative  effect of change in accounting principle |   | —      |      | —         |   | (327,169      | )      | —          |    | (327,169  | )      |
| Stock-based  compensation                            |   | —      |      | —         |   | (102,231      | )      | —          |    | (102,231  | )      |
| Total assets                                         |   | 1,838,461   |      | 1,244,522      |   | 4,200,004     |   | (218,915        | )       | 7,064,072 |   |
| Expenditures for  fixed assets                       |   | 99,888      |      | 741            |   | —        |   | —          |    | 100,629   |   |

 

 

11

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## **Item2.  MANAGEMENT’S DISCUSSION AND ANALYSIS** OF

## **FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Critical Accounting Policies and Estimates

 

This discussionand analysis of our financial condition and results of operations is based uponour Consolidated Financial Statements, which have been prepared in accordancewith accounting principles generally accepted in the United States.  See the Notes to the Consolidated FinancialStatements included elsewhere herein. Certain of our accounting policies require the application of judgmentin selecting the appropriate assumptions for calculating financialestimates.  By their nature thesejudgments are subject to an inherent degree of uncertainty.  We periodically evaluate the judgments andestimates used for our critical accounting policies to ensure that suchjudgments and estimates are reasonable for our interim and year-end reportingrequirements.  These judgments andestimates are based upon our historical experience, current trends andinformation available from other sources, as appropriate.  If different conditions result from thoseassumptions used in our judgment, the results could be materially differentfrom our estimates.  Our criticalaccounting policies include the following:

 

### *RevenueRecognition*

 

We recognize revenue in accordance with SEC Staff Accounting BulletinNo. 101, *RevenueRecognition in Financial Statements*(SAB 101), as amended by SAB101A and 101B.  SAB 101 requires thatfour basic criteria must be met before revenue can be recognized: (1)persuasive evidence that an arrangement exists; (2) delivery has occurred orservices rendered; (3) the fee is fixed and determinable; and (4)collectibility is reasonably assured. Determination of criterion (4) is based on management’s judgmentregarding the collectibility of invoices for products and services delivered tocustomers.  Should changes in conditionscause management to determine this criterion is not met for certain futuretransactions, revenue recognized for any reporting period could be adverselyaffected.

 

# ***Income Taxes***

 

The income tax policy followed by us records the estimated future taxeffects of temporary differences between the tax bases of assets andliabilities and amounts reported in the accompanying consolidated balancesheets, as well as operating loss and tax credit carryforwards.  We follow very specific and detailedguidelines regarding the recoverability of any tax assets recorded on thebalance sheet and provide any necessary allowances as required.

 

# ***Fair Value***

 

Financial instruments, including derivatives and non-qualified optionsto purchase our common stock, require disclosure of an estimate of their fairvalues.  Fair values are based on listedmarket prices, where possible.  Weaccount for certain non-qualified options granted to non-employees to purchaseour common stock in accordance the Emerging Issues Task Force (“EITF”) 00-19, *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock*, and carry these contracts at fair value, withany changes in fair value recorded in the results of operations.  Fair values for certain non-qualifiedoptions are derived from pricing models that consider current market andcontractual prices for the underlying financial instruments or commodities, aswell as time value and yield curve or volatility factors underlying thepositions.  Pricing models and theirunderlying assumptions impact the amount and timing of unrealized gains andlosses recognized, and the use of different pricing models or assumptions couldproduce different financial results.

 

12

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#### *Equity Investments*

 

We own approximately 24% of the outstanding shares of 3DV Systems Ltd.(3DV), which we account for using the equity method of accounting.  Under the equity method we periodicallyrecognize our proportionate share of 3DV’s income or loss as an item of incomeor expense with a corresponding increase or decrease in our investment.  Generally, the investment balance would notbe reduced below zero.  To date, ourproportionate share of losses has exceeded our cumulative investments in3DV.  As a result, we have discontinuedrecording our proportionate share of 3DV’s losses.  Operating results or future market conditions could impair therecoverability of our current or potential future investments.

 

Results of Operations

 

This Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of The Private SecuritiesLitigation Reform Act of 1995.  Examplesof forward-looking statements include statements about expectations aboutfuture financial results, future products and future sales of new and existingproducts, future expenditures, and capital resources to meet anticipatedrequirements.  Without limiting the foregoing,the words “believes”, “anticipates”, “plans”, “expects”, and similarexpressions are intended to identify forward-looking statements.  These forward-looking statements involverisks and uncertainties, and our actual results may differ significantly fromthose discussed in the forward-looking statements. Factors that might causesuch a difference include, but are not limited to the availability of capitalresources, the availability of third-party reimbursement, governmentregulation, the availability of supplies, competition, technological difficulties,general economic conditions and other risks detailed in our most recent AnnualReport on Form 10-K and any subsequent periodic filings made with theSecurities and Exchange Commission.  Wedo not undertake an obligation to update our forward-looking statements toreflect future events or circumstances.

 

We operate in three reporting segments, medical, industrial andcorporate.  The medical segment suppliesendoscopes and EndoSheaths® to the Ear-Nose-Throat (“ENT”), gastrointestinal(“GI”) and pulmonary markets.  Theindustrial segment supplies borescopes to the aircraft engine manufacturing andrepair market and other industrial markets. In addition, the industrial segment manufactures and repairs endoscopesfor the medical segment.

 

Sales

 

Q2 03 Compared to Q2 02

 

Net sales for the three months ended September 30, 2002 (“Q2 03”) were$1,512,124, a decrease of $208,155, or 12%, compared to the three-month periodended September 30, 2001 (“Q2 02”). During this period, sales of the medical segment decreased by $36,161,or 4%, and sales of the industrial segment decreased by $171,994, or 21%.

 

Within the medical segment, sales to the ENT market decreased byapproximately $1,000, while sales to the GI and pulmonary markets decreased byapproximately $38,000.  Sales ofaccessories, repair services and other medical products increased byapproximately $3,000.

 

13

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#### *Medical Segment -ENT Market*

 

Sales of EndoSheaths and endoscopes to the domestic ENT marketincreased by approximately $39,000 and $50,000, respectively.  We believe this higher demand is due to ourcontinued efforts to promote the ENT EndoSheath and endoscope to the domesticmarket with promotional prices for first-time users.  We expect to continue this pricing policy for the next fiscalquarter ending December 31, 2002.

 

Sales of endoscopes to the international ENT market decreased byapproximately $97,000, while sales of EndoSheaths increased by $7,000.  Sales of endoscopes to our internationaldistributors is more variable than the domestic market due to a number offactors, such as local country promotions of competitor’s products andparticular needs of some international customers that do not repeatconsistently from year to year.

 

We shipped approximately 68,700 ENT EndoSheaths in Q2 03, an increaseof 6,300, or 10%, compared to shipments of approximately 62,400 in Q2 02.  However, lower average selling prices perunit resulted in a sales increase of 9%. The lower average selling price was due primarily to lower pricesinstituted by us to make the ENT EndoSheath more affordable to customers.  Shipments to international distributorscomprised approximately 51% of total ENT EndoSheath unit shipments in Q2 03,compared to approximately 54% in Q2 02. During Q2 03, we acquired approximately 48 new domestic ENT customers,and unit shipments to all domestic customers increased by 19%, compared to Q202, primarily due to higher demand generated by the lower prices, and by thedesire of hospitals to avoid the risk of cross-infection and the time-consumingtask of cleaning endoscopes.  Unitshipments in Q2 03 to international distributors increased by 3%, compared tothe same quarter last year.  Weexperienced increased demand of 12% from Europe, where fears of Mad-Cow Diseasepersist, but lower demand from our distributor in the Pacific Rim where unitsales declined in Q2 03, compared to Q2 02. The reason for this decline was related to that distributor loweringinventory levels inherited from the prior distributor.  We expect shipment levels to this newdistributor will return to levels of last year in the second half of fiscal2003.

 

#### *Medical Segment -GI and Pulmonary Markets*

 

Sales of endoscopes and EndoSheaths to the GI andpulmonary markets decreased by approximately $38,000.  We did not ship any endoscopes to the GI market in Q2 03.  We believe the continued lack ofreimbursement for the GI EndoSheath by insurance companies to health careproviders is the primary cause for this lower demand.  We do not expect demand for our GIEndoSheaths to increase, as health care providers cannot, in general, obtainreimbursement for the EndoSheath, thus discouraging its use. We have kept ourprices relatively low compared to the cost to manufacture, expecting thatdemand would increase for the GI EndoSheath, and result in lower costs tomanufacture.  As demand has notincreased, we intend to increase the price of the GI EndoSheath in November2002 to help us recover our costs to manufacture it.

 

In the pulmonary market, we spent our efforts onInstitutional Review Board (“IRB”) activities to test the market acceptance ofour new Slide-On bronchoscope EndoSheath. In the quarter ending December 31, 2002, we expect to review theseactivities and launch this product in the international and domesticmarkets.  We believe this systemaddresses design and use problems for bronchoscopy that competitor’s productsdo not address, but the perceived higher cost may prevent wide acceptance bythe market.

 

14

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#### *Industrial Segment*

 

The lower sales of the industrial segment’s products in Q2 03, comparedto Q2 02, were due primarily to lower demand during this period by the aircraftengine manufacturing and maintenance markets. We had expected demand for these products to be slow, due to the reducedair traffic.  We expect demand fromthese markets will remain low for at least the next two fiscal quarters.  The industrial segment continues to seekorders in the defense and other markets to offset this decline.

 

6 Months 03 Compared to 6 Months 02

 

Net sales for the six months ended September 30, 2002 (“6 months 03”)decreased by $205,576, or 6% compared to the six-month period ended September30, 2001 (“6 months 02”).  During thisperiod, sales of the medical segment increased by $242,864, or 15%, and salesof the industrial segment decreased by $448,440, or 24%.

 

Within the medical segment, sales to the ENT market increased byapproximately $286,000, while sales to the GI and pulmonary markets decreasedby approximately $41,000.  Sales ofaccessories, repair services and other medical products decreased byapproximately $2,000.

 

#### *Medical Segment —ENT Market*

 

Sales of EndoSheaths and endoscopes to the domestic ENT marketincreased by approximately $110,000 and $126,000, respectively.  We believe this higher demand is due to ourcontinued efforts to promote the ENT EndoSheath and endoscope in the domesticmarket with promotional prices for first-time users, instituted in June 2001.  Sales of endoscopes to the international ENTmarket decreased by approximately $89,000, while sales of EndoSheaths increasedby $139,000.

 

The number of ENT EndoSheath units shipped in 6 months 03 increased by36% in total, 30% to domestic customers and 41% to internationaldistributors.  We shipped approximately154,700 ENT EndoSheaths in 6 months 03, an increase of 40,800, compared toshipments of approximately 113,900 in 6 months 02.  However, lower average selling prices per unit resulted in asales increase of 25% in total, 18% from domestic customers and 37% frominternational distributors.  The loweraverage selling price was due to lower prices instituted by us in June 2001 tomake the ENT EndoSheath more affordable to customers.

 

Shipments to international distributors comprised approximately 56% oftotal ENT EndoSheath unit shipments in 6 months 03, compared to approximately54% in 6 months 02.  Internationaldemand for the Company’s ENT EndoSheath continues to be high, especially inEurope.  During 6 months 03, we acquiredapproximately 105 new domestic ENT customers. We expect the lower unit prices will encourage more usage of the ENTEndoSheath, both in domestic and international markets.  However, there can be no assurance that thehigher number of units shipped will more than offset the lower unit sellingprices.

 

15

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*MedicalSegment — GI and Pulmonary Markets*

 

The decline in sales to these markets was due primarily to lower unitsales of EndoSheaths to the GI market, again due to lack of reimbursement.  We did sell two bronchoscopes tointernational distributors, and we expect to sell more after an officialproduct launch, which is expected to occur in the quarter ending December 31,2002.

 

#### *Industrial Segment*

 

The industrial segment experienced lower sales in 6 months 03, comparedto 6 months 02, primarily due to lower demand by aircraft enginemanufacturers.  We had expected thisdemand to be lower for the first two fiscal quarters, and as of September 30,2002, we expect demand from these markets will remain at current levels atleast for the next two fiscal quarters.

 

Gross Profit

 

Gross profit in Q2 03 decreased to $420,446, or 28% of net sales,compared to $660,755, or 38% of net sales in Q2 02.  Gross profit decreased by approximately $72,000 in the medicalsegment, due primarily to the lower sales volume and higher manufacturing costsof endoscopes and EndoSheaths for the GI and pulmonary markets.  Gross profit decreased in the industrial segmentby approximately $168,000, due primarily to lower sales volume.

 

Gross profit in 6 months 03 decreased to $882,419, or 27% of net sales,compared to $1,247,643, or 36% of net sales in 6 months 02.  In the medical segment, gross profit wasapproximately $483,000, or 26% of sales, compared to approximately $505,000, or31%, in 2001.  The higher gross profitthat resulted from higher unit volume of endoscopes and EndoSheaths sold to theENT market was offset partially by the lower prices from these same markets.  In addition, the lower volume of endoscopesand EndoSheaths sold to the GI and pulmonary markets resulted in lower grossprofit.  Gross profit decreased in theindustrial segment by approximately $344,000, due primarily to lower salesvolume.

 

Operating Expenses

 

Selling, general and administrative (“SG&A”) expenses in Q2 03increased by $143,107, or 22% compared to Q2 02.  SG&A expenses amounted to 53% of net sales in Q2 03 and 38%in Q2 02.  The increase in thesecategories was primarily attributable to higher expenses in the medical segmentof approximately $129,000 resulting from higher costs for personnel, productpromotion and legal costs related to patents. In the industrial segment these costs decreased due to lower costs forcommissions and product promotion.  Inthe corporate segment, we incurred higher expenses for fringe benefits.

 

SG&A expenses increased by $286,350 in 6 months 03, compared to 6months 02.  SG&A expenses amountedto 49% of sales in 6 months 03, compared to 38% of sales in 6 months 02.  SG&A expenses increased in the medicaland corporate segments by approximately $232,000 and $74,000, respectively, anddecreased in the industrial segment by approximately $20,000.  The primary causes for the increase in themedical and corporate segments were higher costs for personnel, productpromotion and commissions.  In theindustrial segment the decrease in SG&A expenses was due primarily to lowercommissions.

 

16

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Research and development (“R&D”) expenses increased by $22,728 inQ2 03 compared to Q2 02, and were 6% of sales in Q2 03, compared to 4% of salesin Q2 02.  We increased the effortdevoted to R&D by adding personnel for specific products that we expectwill result in higher sales of EndoSheaths to the ENT market in our fiscal year2004.  Our strategy in new products has shifted from designing EndoSheathsprimarily to prevent cross-infection to designing EndoSheaths that will alsoallow health-care providers to perform procedures in their offices thatcurrently are only be performed in hospitals. We plan to launch the first of these products in the fourth quarter offiscal 2003.  We are planning toincrease this activity in the second half of fiscal 2003, resulting in higher expenses,compared to the first half of fiscal 2003. In the corporate segment, we reduced the resources expended onComplementary Metal Oxide Semiconductor image sensor patent applications, as weare in the prosecution phase for these applications.

 

R&D expenses increased by $84,128 in 6 months 03, compared to 6months 02, and were 6% of sales in 6 months 03, compared to 3% in 6 months02.  We increased the efforts devoted toR&D for our new bronchoscope EndoSheath and began the effort devoted to newproducts for the ENT market.

 

We recorded a reduction to expenses for the change in value ofnon-qualified stock options. Stock-based compensation costs declined by $91,576 in Q2 03, compared toa decline of $102,231 in Q2 02.  Thisline item is the result of valuing our non-qualified stock options using theBlack-Scholes method, which uses stock price volatility, the closing price ofour common stock as traded on the Nasdaq SmallCap and other factors todetermine the potential liability to option holders.  For Q2 03, the change in the closing stock price was the largestcause for the reduction in this potential liability.

 

We did not record equity in losses of 3DV Systems in Q2 03 nor in Q202.  For 6 months 02 we recorded equityin the losses of 3DV of $500,000.  SeeNote 3 in the Notes to Consolidated Financial Statements in this Form 10-Q.

 

The net loss per share for Q2 03 was $.01, compared to a breakevenincome of $.00 per share for Q2 02.  For6 months 03 the loss per share was $.02, compared to $.03 for 6 months 02.

 

Liquidity and Capital Resources

 

At September 30, 2002, our principal sources of liquidity included$2.35 million in cash, cash equivalents and marketable securities, which ispart of our working capital of $3.0 million. As of September 30, 2002 we had an agreement with a bank, which includesa revolving line of credit under which we may borrow up to $1,000,000, net ofup to $250,000 of any outstanding letters of credit and banker’sacceptances.  The bank agreement alsoprovided that we could borrow, under a term loan facility, up to 75% of thecost of new equipment to a maximum amount of $250,000.  The availability under the term loanfacility expired on September 30, 2002, but we expect we can have it reinstatedduring the second half of fiscal 2003. Borrowings under these loan arrangements must be fully cashcollateralized.

 

17

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The agreement also stipulates that when we achieve positive cash flow,as defined in the agreement, we will be eligible to negotiate changes to theseloan arrangements that may include changing the borrowing base for revolvingloans, and the release of the pledged cash collateral.  We expect our current balance of cash, cashequivalents and marketable securities is sufficient to fund our operations atleast for the next twelve months.

 

At September 30, 2002, we had acceptances payable totalingapproximately $63,000, secured by a certificate of deposit of $125,000.

 

Our cash and cash equivalents decreased by approximately $2,666,000 in6 months 03.  However, approximately$1,879,000 of this usage resulted from an increase in our marketablesecurities, as we increased the duration of our investments to obtain higheryields.  The net usage of cash, cashequivalents and marketable securities was approximately $787,000 for 6 months03, compared to a generation of approximately $292,000 for the same period lastyear.  The primary reasons for thehigher usage were the increased cost of operations and a non-repeating sale ofour common stock of $600,000 that occurred in June 2001.  These were partially offset by a lower needfor working capital totaling approximately $272,000.

 

In the fiscal year ended March 31, 2001, we entered into a contract forapproximately $203,000, subsequently increased by approximately $54,000, forthe design and manufacture of new equipment for manufacturing our ENTEndoSheaths.  We have made payments tothe supplier of approximately $233,000 as of September 30, 2002.  We expect to make the remaining progresspayments for the new equipment during the three months ending December 31, 2002of approximately $24,000.  The new ENTEndoSheath forming machine was placed in service in the fourth quarter of thefiscal year ended March 31, 2002.  Thenew ENT bonding machine was delivered in October 2002, and we expect to have itplaced in service during the quarter ending December 31, 2002.

 

We expect total spending for property and equipment will not exceed$350,000 for the fiscal year ending March 31, 2003.  In addition, as reported in our Form 10-K for the fiscal yearended March 31, 2002, we will continue to evaluate our investment in 3DV, andmay make further investments if we believe it is in the best interests of ourshareholders.

 

We conduct our operations in certain facilities leased from non-relatedparties.  These leases expire on variousdates through August 2005.  In addition,we have operating leases for certain office equipment leased from non-relatedparties.  These leases expire on variousdates through May 2006.  Approximatefuture minimum lease commitments under these leases, including payments of anote payable in conjunction with certain leasehold improvements capitalized infiscal year 2001, are as follows:

 
| **Year  ending March 31,** |   |    |    |   |
|----------------------------|--------|---------|---------|--------|
| 2003                       |   | $       | 313,000 |   |
| 2004                       |   | 239,000 |    |
| 2005                       |   | 157,000 |    |
| 2006                       |   | 72,000  |    |
| 2007                       |   | 2,000   |    |
| Total                      |   | $       | 783,000 |   |

 

18

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We have incurred losses since our inception, andlosses are expected to continue at least during the fiscal year ending March31, 2003.  We have funded the lossesprincipally with the proceeds from public and private equity financings.  Although we believe we have sufficient cashresources to fund our operations for the next twelve months, management hasdecided that new financing is desirable. However, there can be no assurance that additional funding will beavailable, or available on reasonable terms.

 

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## **Item3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

In the normal course of business, we are subject to the risksassociated with fluctuations in interest rates and changes in foreign currencyexchange rates.

 

#### *Interest and Market Risk*

 

We maintain a portfolio of marketable, primarily fixedincome, available-for-sale securities of various issuers, types andmaturities.  We have not used derivativefinancial instruments in our investment portfolio.  We attempt to limit our exposure to interest rate and credit riskby placing our investments with high-quality financial institutions and haveestablished investment guidelines relative to diversification and maturitiesdesigned 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, our futureinvestment income may fall short of expectations due to changes in interestrates, or we may suffer losses in principal if forced to sell securities whichhave seen a decline in market value due to changes in interest rates.

 

#### *Foreign Currency Exchange*

 

We face exposure, due to purchases of raw materials from Japanesesuppliers, to adverse movements in the value of the Japanese Yen.  This exposure may change over time, andcould have a materially adverse effect on our financial results.  We may attempt to limit this exposure bypurchasing forward contracts, as required. Most of our liabilities are settled within 90 days of receipt ofmaterials.  At September 30, 2002, ourliabilities relating to Japanese Yen were approximately $63,000.

 

## **Item 4.  CONTROLS AND PROCEDURES**

 

*a) Evaluation of Disclosure Controlsand Procedures.*

 

Based on an evaluation of our disclosure controls and procedures (asdefined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of1934) as of a date within 90 days of the filing date of this Quarterly Reporton Form 10-Q, the chief executive officer and chief financial officer haveconcluded that our disclosure controls and procedures are designed to ensurethat information required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and areoperating in an effective manner.

 

*b)Changes in internal controls.*

 

There were no significant changes in our internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof their most recent evaluation.

 

20

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**PART II - OTHER INFORMATION**

 

## **Item 4:  Submission of Matters to a Vote ofStockholders**

 

We held the 2002 AnnualGeneral Meeting of Shareholders (the “Annual Meeting”) on August 15, 2002.  At the Annual Meeting, the following actionswere taken:

 

1.               The stockholders re-elected Katsumi Oneda and FredSilverstein, M.D. as Class II Directors, to serve for a three-year term.  Holders of 15,190,424 shares of Common Stockvoted for and holders of 16,172 shares of Common Stock withheld voting for eachof Mr. Oneda and Dr. Silverstein.  Inaddition to Mr. Oneda and Dr. Silverstein, Dr. Gerald B. Lichtenberger, Ph.D.,Mr. Lewis C. Pell, Mr. William F. Doyle, Mr. Kenneth W. Anstey and Mr. John J.Wallace continue to serve on the Board of Directors.

 

**Item 6.  Exhibits and Reports on Form 8-K**

 
| (a)    |   | Exhibits                                            |
|--------|--------|-----------------------------------------------------|
|   |   | 99.1 Certification pursuant to 18 U.S.C. §1350 |
|   |   |                                                |
| (b)    |   | Reports on Form 8-K                                 |
|   |   | None.                                               |

 

 

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**SIGNATURES**

 

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

VISION-SCIENCES, INC.

 
|  Date:  November 14, 2002 | /s/ Katsumi Oneda                                                                                                                     |   |
|--------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|--------|
|                           | Katsumi Oneda                                                                                                                         |
|                           | President, CEO (Duly Authorized Officer)                                                                                              |
|                           |                                                                                                                                  |   |
|                           | /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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CERTIFICATIONS

I, Katsumi Oneda, certify that:

1.               I have reviewed this quarterly report on Form 10-Q ofVision-Sciences, Inc.;

 

2.               Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

a)              designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

c)              presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.               The registrant’s other certifying officers and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
|   |              | /s/ Katsumi Oneda       |   |
|--------|-------------------|-------------------------|--------|
| Dated: | November 14, 2002 | Katsumi Oneda           |
|   |              | Chief Executive Officer |

 

 

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CERTIFICATIONS

I, James A. Tracy, certify that:

1.               I have reviewed this quarterly report on Form 10-Q ofVision-Sciences, Inc.;

 

2.               Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.               Based on my knowledge, the financial statements, andother financial information included in this quarterly report, fairly presentin all material respects the financial condition, results of operations andcash flows of the registrant as of, and for, the periods presented in thisquarterly report;

 

4.               The registrant’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and wehave:

a)              designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

b)             evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

c)              presented in this quarterly report our conclusionsabout the effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.               The registrant’s other certifying officers and I havedisclosed, based on our most recent evaluation, to the registrant’s auditorsand the audit committee of registrant’s board of directors (or personsperforming the equivalent functions):

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)             any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.               The registrant’s other certifying officers and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
|   |              | /s/ James A. Tracy      |   |
|--------|-------------------|-------------------------|--------|
| Dated: | November 14, 2002 | James A. Tracy          |
|   |              | Chief Financial Officer |

 

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