**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 THE QUARTER ENDED June 30, 2002**

** **

**COMMISSION FILE 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 telephonenumber, including area code)

 

**None**

(Former name, formeraddress, and

former fiscal year ifchanged since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirement for the past 90 days.

 

Yes  ý                   No o

 

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of July 31, 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 |
|     |                  |   |
| Part II. | Other Information     |
|     |                  |   |
|     | Item 6.               | Exhibits and  Reports on Form 8-K |
|     |                  |   |
|     | Signatures            |

 

2

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**PART I - FINANCIAL INFORMATION**

**Item1: FINANCIAL STATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

** **
|                                                                                                                                                                                 |   | **June 30,  2002** |      | **March 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|---------------------|--------|
| ASSETS                                                                                                                                                                               |   |               |      |                |   |
| Current Assets:                                                                                                                                                                      |   |               |      |                |   |
| Cash and cash  equivalents                                                                                                                                                           |   | $                  | 1,542,255 |                | $      | 2,890,364 |   |
| Marketable  securities                                                                                                                                                               |   | 1,100,965          |      | 251,445             |   |
| Accounts  receivable, net of allowance for doubtful accounts of $77,654 and $76,641,  respectively                                                                                   |   | 941,167            |      | 834,577             |   |
| Inventories                                                                                                                                                                          |   | 1,344,743          |      | 1,193,181           |   |
| Prepaid expenses  and deposits                                                                                                                                                       |   | 83,785             |      | 76,932              |   |
| Total current  assets                                                                                                                                                                |   | 5,012,915          |      | 5,246,499           |   |
|                                                                                                                                                                                 |   |               |      |                |   |
| Property and  Equipment, at cost:                                                                                                                                                    |   |               |      |                |   |
| Machinery and  equipment                                                                                                                                                             |   | 3,305,471          |      | 3,283,341           |   |
| Furniture and  fixtures                                                                                                                                                              |   | 208,934            |      | 208,934             |   |
| Leasehold  improvements                                                                                                                                                              |   | 466,505            |      | 462,882             |   |
|                                                                                                                                                                                 |   | 3,980,910          |      | 3,955,157           |   |
| Less-Accumulated  depreciation and amortization                                                                                                                                      |   | 3,348,405          |      | 3,297,582           |   |
|                                                                                                                                                                                 |   | 632,505            |      | 657,575             |   |
|                                                                                                                                                                                 |   |               |      |                |   |
| Other assets,  net of accumulated amortization of $36,331 and $34,746, respectively                                                                                                  |   | 94,515             |      | 96,100              |   |
| Total assets                                                                                                                                                                         |   | $                  | 5,739,935 |                | $      | 6,000,174 |   |
|                                                                                                                                                                                 |   |               |      |                |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                            |   |               |      |                |   |
| Current  Liabilities:                                                                                                                                                                |   |               |      |                |   |
| Acceptances  payable to a bank                                                                                                                                                       |   | $                  | 36,911    |                | $      | 43,226 |   |
| Current portion  of note payable                                                                                                                                                     |   | 9,739              |      | 23,989              |   |
| Accounts payable                                                                                                                                                                     |   | 582,548            |      | 286,730             |   |
| Accrued expenses                                                                                                                                                                     |   | 948,799            |      | 1,103,156           |   |
| Total current  liabilities                                                                                                                                                           |   | 1,577,997          |      | 1,457,101           |   |
|                                                                                                                                                                                 |   |               |      |                |   |
| Potential  obligations to non-qualified option holders                                                                                                                               |   | 222,150            |      | 421,110             |   |
|                                                                                                                                                                                 |   |               |      |                |   |
| Stockholders’  Equity:                                                                                                                                                          |   |               |      |                |   |
| Common stock,  $.01 par value — Authorized — 50,000,000 shares  Issued and outstanding — 27,198,712 shares at June 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                                                                                                                                                                 |   | (54,842,719        | )         | (54,535,591         | )      |
| Total stockholders’  equity                                                                                                                                                     |   | 3,939,788          |      | 4,121,963           |   |
| Total  liabilities and stockholders’ equity                                                                                                                                     |   | $                  | 5,739,935 |                | $      | 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   June 30,** |      |
|-----------------------------------------------------------------------|--------|------------------------------------|-----------|
|                                                                  |   | **2002**                           |      | **2001** |   |
| Net sales                                                             |   | $                                  | 1,734,459 |   | $ | 1,731,880 |   |
| Cost of sales                                                         |   | 1,272,486                          |      | 1,144,992 |   |
|                                                                  |   |                               |      |   |   |
| Gross profit                                                          |   | 461,973                            |      | 586,888 |   |
|                                                                  |   |                               |      |   |   |
| Selling, general  and administrative expenses (1)                     |   | 788,058                            |      | 644,816 |   |
| Research and  development expenses(1)                                 |   | 94,540                             |      | 33,140 |   |
| Stock-based  compensation                                             |   | (94,507                            | )         | — |   |
| Loss from  operations                                                 |   | (326,118                           | )         | (91,068 | ) |
|                                                                  |   |                               |      |   |   |
| Interest income                                                       |   | 12,147                             |      | 43,929 |   |
| Interest expense                                                      |   | (578                               | )         | (2,182 | ) |
| Equity in losses  of 3DV Systems Ltd                                  |   | —                             |      | (500,000 | ) |
| Other income,  net                                                    |   | 7,421                              |      | 1,645 |   |
|                                                                  |   |                               |      |   |   |
| Net loss before  cumulative effect of change in accounting principle  |   | (307,128                           | )         | (547,676 | ) |
|                                                                  |   |                               |      |   |   |
| Cumulative  effect of change in accounting principle (Note 2)         |   | —                             |      | 327,169 |   |
|                                                                  |   |                               |      |   |   |
| Net loss after  cumulative effect of change in accounting principle   |   | $                                  | (307,128  | ) | $ | (874,845 | ) |
|                                                                  |   |                               |      |   |   |
| Basic and  diluted net loss per common share                          |   | $                                  | (0.01     | ) | $ | (0.03 | ) |
|                                                                  |   |                               |      |   |   |
| Shares used in computing  basic and diluted net loss per common share |   | 27,185,845                         |      | 26,636,627 |   |

 

----

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

 
| Research and  development expenses            |   | $      | (174,361 | )       | $      | — |   |
|-----------------------------------------------|--------|--------|----------|---------|--------|--------|--------|
| Selling, general  and administrative expenses |   | 79,854 |     | —  |   |
| Total                                         |   | $      | (94,507  | )  | $      | — |   |

 

See accompanying notes toconsolidated financial statements.

 

4

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**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY**

**(Unaudited)**

 

 
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                           |        |   |     |
|--------------------------------------------------------|--------|----------------------|--------|---------------------------------|---------|--------------------------|--------|---------------------------------------|--------|--------------------------------|-------------|--------|----------|
|                                                   |   | **Common  Stock**    |   | **Additional  Paid-in-Capital** |    | **Accumulated  Deficit** |   | **Total  Stockholders’  Equity** |   | **Total  Comprehensive  Loss** |        |
| **Number  of Shares**                                  |   | **$ .01  Par Value** |
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                           |        |   |     |
| 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                                               |   | —               |   | —                          |    | —                   |   | (307,128                              | )      | (307,128                       | )           | $      | (307,128 | ) |
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                           |        |   |     |
| Total  comprehensive loss                              |   |                 |   |                            |    |                     |   |                                  |   |                           |        | $      | (307,128 | ) |
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                           |        |   |     |
| Balance June 30,  2002                                 |   | 27,198,712           |   | $                               | 271,986 |                     | $      | 58,510,521                            |   | $                              | (54,842,719 | )      | $        | 3,939,788 |   |   |   |

 

See accompanyingnotes to consolidated financial statements.

 

5

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                               |   | **Three Months Ended  June 30, 2002** |      | **Three Months  Ended  June 30, 2001** |   |
|----------------------------------------------------------------------------------------------------|--------|---------------------------------------|-----------|----------------------------------------|--------|
| Cash flows from operating activities:                                                              |   |                                  |      |                                   |   |
| Net loss                                                                                           |   | $                                     | (307,128  | )                                      | $      | (874,845 | ) |
| Adjustments to  reconcile net loss to net cash used for operating activities:                      |   |                                  |      |                                   |   |
| Depreciation and  amortization                                                                     |   | 52,408                                |      | 56,833                                 |   |
| Equity in losses  of 3DV Systems, Ltd.                                                             |   | —                                |      | 500,000                                |   |
| Loss on disposal  of property and equipment                                                        |   | —                                |      | —                                 |   |
| Stock  compensation to non-employees                                                               |   | (94,507                               | )         | 327,169                                |   |
| Changes in  assets and liabilities:                                                                |   |                                  |      |                                   |   |
| Accounts  receivable                                                                               |   | (106,590                              | )         | (28,624                                | )      |
| Inventories                                                                                        |   | (151,562                              | )         | (163,252                               | )      |
| Prepaid expenses  and deposits                                                                     |   | (6,853                                | )         | (32,323                                | )      |
| Accounts payable                                                                                   |   | 295,818                               |      | 239,519                                |   |
| Accrued expenses                                                                                   |   | (154,357                              | )         | (213,408                               | )      |
|                                                                                               |   |                                  |      |                                   |   |
| Net cash used  for operating activities                                                            |   | (472,771                              | )         | (188,931                               | )      |
| Cash flows  provided by (used for) investing activities                                            |   |                                  |      |                                   |   |
| (Increase)  Decrease in marketable securities                                                      |   | (849,520                              | )         | 835,391                                |   |
| Purchase of  property and equipment, net                                                           |   | (25,754                               | )         | (39,852                                | )      |
|                                                                                               |   |                                  |      |                                   |   |
| Net cash (used  for) provided by investing activities                                              |   | (875,274                              | )         | 795,539                                |   |
|                                                                                               |   |                                  |      |                                   |   |
| Cash flows  provided by (used for) financing activities:                                           |   |                                  |      |                                   |   |
| Payments on note  payable for leasehold improvements                                               |   | (14,250                               | )         | (12,646                                | )      |
| (Payments for)  proceeds from acceptances payable to a bank                                        |   | (6,315                                | )         | 40,303                                 |   |
| Proceeds from  the sale of common stock, net                                                       |   | —                                |      | 600,000                                |   |
| Exercise of  stock options                                                                         |   | 20,501                                |      | 2,375                                  |   |
| Net cash (used  for) provided by financing activities                                              |   | (64                                   | )         | 630,032                                |   |
|                                                                                               |   |                                  |      |                                   |   |
| Net (decrease)  increase in cash and cash equivalents                                              |   | (1,348,109                            | )         | 1,236,640                              |   |
| Cash and cash  equivalents, beginning of period                                                    |   | 2,890,364                             |      | 2,568,724                              |   |
| Cash and cash  equivalents, end of period                                                          |   | $                                     | 1,542,255 |                                   | $      | 3,805,364 |   |
|                                                                                               |   |                                  |      |                                   |   |
| Supplemental  Disclosure of Cash Flow Information:                                                 |   |                                  |      |                                   |   |
| Cash paid during  the period for interest                                                          |   | $                                     | 578       |                                   | $      | 2,182 |   |
|                                                                                               |   |                                  |      |                                   |   |
| 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 the  period |   | $                                     | (174,361  | )                                      | $      | — |   |

 

See accompanyingnotes to consolidated 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 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 presented notmisleading.  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.                                       *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**.****                                     ***CashEquivalents*: 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.                                       *MarketableSecurities*: Marketable securities are carried at market value, whichapproximates amortized cost.  TheCompany has classified its investments in marketable securities asavailable-for-sale securities.  At June30, 2002, the Company’s marketable securities consisted of commercial paperwith a maturity of 262 days.

 

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

 
|            |   | **June 30,  2002** |      | **March 31,  2002** |   |
|-----------------|--------|--------------------|-----------|---------------------|--------|
|            |   |               |      | **(audited)**       |   |
| Raw materials   |   | $                  | 715,855   |                | $      | 612,827 |   |
| Work-in-process |   | 186,156            |      | 190,686             |   |
| Finished goods  |   | 442,732            |      | 389,668             |   |
|            |   | $                  | 1,344,743 |                | $      | 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:

 

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

 

Leasehold improvements are amortized over the shorterof their estimated useful lives or the 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.

 

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, 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 ownstock, including common stock options and warrants, to be designated as anequity instrument, 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 June 30, 2002 to purchase 1,363,032shares of the Company’s common stock should be designated as a liability.

 

Duringthe three months ended June 30, 2002, a holder of non-qualified optionsexercised options for 45,072 shares with a value of $60,545.  As a result of this exercise, this value wastransferred from the potential obligations to non-qualified option holders toadditional paid-in-capital.  Inaddition, that holder of non-qualified options received two new options for anaggregate of 64,570 shares, of which one option for 32,285 shares was exercisedin the three months ended June 30, 2002, and one option for 32,285 sharesremained outstanding as of June 30, 2002. The value of the option exercised was determined to be $43,907, the fairmarket value at the date of grant.  TheCompany recorded an expense in Selling, General and Administrative expensesrelated to this grant.  The Company alsorecorded an expense in Selling, General and Administrative expenses of $35,946,the fair market value, using the Black-Scholes method, of the othernon-qualified option that remained outstanding at June 30, 2002.

 

TheCompany valued the other non-qualified options outstanding at June 30, 2002using the Black-Scholes method.  Thevalue of those options declined by $174,361 in the three months ended June 30,2002.  The Company recorded this declineas a reduction in operating expenses in the accompanying statement ofoperations for this period.

 

Underthe transition rules of EITF 00-19, effective June 30, 2001, the Companyrecorded the fair value, based upon the Black-Scholes model, of non-qualifiedoptions to non-employees to purchase 1,335,747 shares of its common stock as aliability, with the required adjustment included as a cumulative adjustment inits results of operations for the three months ended June 30, 2001.

 

9

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**3.     Investmentsin Israel**

 

*3DV Systems Ltd.*

 

The Company accounts forits investment in 3DV Systems Ltd. (“3DV”) using the equity method ofaccounting.  As of March 31, 2002, theCompany owned approximately 24% of the outstanding shares of 3DV, and wouldhold approximately 18% of the shares of 3DV, if all employee options and ConvertibleNotes were converted to common shares.

 

In March 2002, 3DVexecuted a sixth round of financing with investors other than the Company,including two employee-directors of the Company.  This round of financing was for $4,000,000, payable in two installmentsin March 2002 and September 2002.  As ofJune 30, 2002, 3DV had received approximately $1,000,000 of that round.

 

In the three months endedJune 30, 2001, 3DV incurred losses of approximately $2,177,000.  The Company’s investment in 3DV totaled $500,000at March 31, 2001, and accordingly, the Company recognized equity in losses of3DV equal to the total value of its investment in the three months ended June30, 2001.  In the three months endedJune 30, 2002, 3DV incurred losses of approximately $1,241,000.  The Company’s investment in 3DV totaled $0at March 31, 2002, and accordingly, the Company did not recognize any portionof the losses of 3DV for the three months ended June 30, 2002.

 

 

10

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**4.****             ****        SegmentInformation**

 

The Company has threereportable segments – Medical, Industrial and Corporate.  The medical segment designs, manufacturesand sells EndoSheaths and sells endoscopes to users in the health careindustry.  The industrial segmentdesigns, manufactures and sells borescopes to a variety of users, primarily inthe aircraft maintenance industry.  Inaddition, the industrial segment manufactures and repairs endoscopes for themedical segment.  The corporate segmentconsists of certain administrative expenses beneficial to the Company as awhole and the management oversight of the Company’s investment in 3DV,Vision-Sciences Ltd. (the Company’s Israeli subsidiary) and the Company’ssupport of the University of Georgia 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 June 30, 2002 was$0.  Data regarding management’s view ofthe Company’s segments are provided in the following tables.

 
| **Three  months ended June 30,**                     |   | **Medical** |      | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total** |   |
|------------------------------------------------------|--------|-------------|-----------|----------------|--------|---------------|--------|-----------------|--------|-----------|--------|
| **2002**                                             |   |        |      |           |   |          |   |            |   |      |   |
| Sales to  external customers                         |   | $           | 1,008,006 |           | $      | 726,453       |   | $               | — |      | $      | — |   | $ | 1,734,459 |   |
| Intersegment  sales                                  |   | —      |      | 202,873        |   | —        |   | (202,873        | )      | —    |   |
| Operating income  (loss)                             |   | (242,989    | )         | 4,834          |   | (87,963       | )      | —          |   | (326,118  | )      |
| Interest income  (expense)                           |   | —      |      | (578           | )      | 12,147        |   | —          |   | 11,569    |   |
| Depreciation and  amortization                       |   | 44,216      |      | 8,192          |   | —        |   | —          |   | 52,408    |   |
| Other significant  non-cash items:                   |   |        |      |           |   |          |   |            |   |      |   |
| Stock-based  compensation                            |   | —      |      | —         |   | (94,507       | )      | —          |   | (94,507   | )      |
| Expenditures for  fixed assets                       |   | 14,860      |      | 10,894         |   | —        |   | —          |   | 25,754    |   |
| Total assets                                         |   | 1,879,284   |      | 1,290,133      |   | 2,735,194     |   | (164,676        | )      | 5,739,935 |   |
|                                                 |   |        |      |           |   |          |   |            |   |      |   |
| **2001**                                             |   |        |      |           |   |          |   |            |   |      |   |
| Sales to  external customers                         |   | $           | 728,981   |           | $      | 1,002,899     |   | $               | — |      | $      | — |   | $ | 1,731,880 |   |
| Intersegment  sales                                  |   | —      |      | 114,097        |   | —        |   | (114,097        | )      | —    |   |
| Operating income  (loss)                             |   | (141,434    | )         | 180,926        |   | (130,560      | )      | —          |   | (91,068   | )      |
| Interest income  (expense)                           |   | —      |      | (2,182         | )      | 43,929        |   | —          |   | 41,747    |   |
| Depreciation and  amortization                       |   | 48,370      |      | 8,463          |   | —        |   | —          |   | 56,833    |   |
| 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  | )      |
| Expenditures for  fixed assets                       |   | 39,852      |      | —         |   | —        |   | —          |   | 39,852    |   |
| Total assets                                         |   | 1,975,416   |      | 1,375,225      |   | 4,309,493     |   | (357,006        | )      | 7,303,128 |   |

 

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## **Item2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF**

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

 

Critical Accounting Policies and Estimates

 

The Company’sdiscussion and analysis of its financial condition and results of operationsare based upon the Company’s Consolidated Financial Statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States.  See the Notes to theConsolidated Financial Statements included elsewhere herein.  Certain of the Company’s accounting policiesrequire the application of judgment in selecting the appropriate assumptionsfor calculating financial estimates.  Bytheir nature these judgments are subject to an inherent degree of uncertainty.  The Company periodically evaluates thejudgments and estimates used for its critical accounting policies to ensurethat such judgments and estimates are reasonable for its interim and year-endreporting requirements.  These judgmentsand estimates are based upon the Company’s historical experience, currenttrends and information available from other sources, as appropriate.  If different conditions result from thoseassumptions used in the Company’s judgments, the results could be materiallydifferent from the Company’s estimates. The Company’s critical accounting policies include the following:

 

### *RevenueRecognition*

 

The Company recognizes revenue in accordance with SEC Staff AccountingBulletin No. 101, *Revenue Recognition in Financial Statements*(SAB 101), asamended by SAB 101A and 101B.  SAB 101requires that four basic criteria must be met before revenue can be recognized:(1) persuasive evidence that an arrangement exists; (2) delivery has occurredor services 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 the Company records the estimatedfuture tax effects 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.  The Company follows very specific anddetailed guidelines regarding the recoverability of any tax assets recorded onthe balance sheet and provides any necessary allowances as required.

 

# ***Fair Value***

 

Financial instruments, including derivatives and non-qualified optionsto purchase Company stock, require disclosure of an estimate of their fairvalues.  Fair values are based on listedmarket prices, where possible.  TheCompany accounts for certain non-qualified options granted to non-employees topurchase Company 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 carries 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.

## ** **

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#### *Equity Investments*

 

The Company owns a 24% interest in 3DV Systems Ltd. (3DV), which isaccounted for using the equity method of accounting.  Under the equity method the Company periodically recognizes itsproportionate share of 3DV’s income or loss as an item of income or expensewith a corresponding increase or decrease in its investment.  Generally, the investment balance would notbe reduced below zero.  To date, theCompany’s proportionate share of losses has exceeded its cumulative investmentsin 3DV.  As a result, the Company hasdiscontinued recording its proportionate share of 3DV’s losses.  Operating results or future marketconditions could impair the recoverability of the Company’s current orpotential future investments.

 

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, theimpact of competitive products and pricing, changing economic conditions, andother risk factors detailed in the Company’s most recent annual report andother filings with the Securities and Exchange Commission.

 

Results of Operations

 

Net sales for the three months ended June 30, 2002 (“Q1 03”) were$1,734,459, an increase of $2,579, or 0%, compared to the three-month periodended June 30, 2001 (“Q1 02”).  DuringQ1 03, sales of the medical segment increased by $279,025, or 38%, and sales ofthe industrial segment decreased by $276,446, or 28%, compared to Q1 02.

 

The increase in medical sales was due primarily to higher demand forthe Company’s EndoSheathsÒfrom the Ear-Nose-Throat (“ENT”) market of approximately $202,000, or 43%,compared to Q1 02.  Sales of the ENTEndoSheaths increased by 24% from domestic customers, and by 76% frominternational distributors.  This higherdemand was due primarily to the continued program of lower unit prices fordomestic customers, and incentives for establishing new accounts that theCompany put in place in the three months ended March 31, 2002.  In addition, demand from the internationalmarket for the ENT EndoSheath has continued to be strong, especially incountries where fears of variant Creutzfeld-Jacob Disease, the human form ofMad Cow Disease, persist.  Sales of ENTendoscopes increased by approximately $84,000, or 113%, compared to Q1 02.  The increase in sales of these endoscopes wasdue primarily to higher demand from domestic customers resulting from improvedpositioning of the product in this market.

 

The total number of ENT EndoSheath units shipped in Q1 03 increased by67% compared to Q1 02.  Unit shipmentsto domestic customers increased by 44%, while unit shipments to internationaldistributors increased by 87%.  TheCompany shipped approximately 86,100 ENT EndoSheaths in Q1 03, an increase of34,600, compared to shipments of approximately 51,500 in Q1 02.  Shipments to international distributorscomprised approximately 61% of total ENT EndoSheath unit shipments in Q1 03,compared to approximately 54% in Q1 02.

 

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Partially offsetting these sales increases was a reduction in sales ofEndoSheaths to the gastrointestinal (“GI”) market, where a lack of reimbursementfor the EndoSheath by insurance companies to health care providerscontinues.  Sales of other productscomprised the remaining change.

 

The lower sales of industrial products in Q1 03, compared to Q1 02,were due primarily to lower demand during this period for the Company’sproducts by the aircraft engine and aircraft maintenance markets.  Historically, this segment derivedapproximately 65% of its sales from these markets. The Company believes thelower demand in Q1 03 for the products of this segment is directly related tothe events of September 11, 2001, and the resulting reduction in the number ofcommercial flights.  The Company expectsdemand for products sold by the industrial segment to these markets to remainweak for at least the first half of the fiscal year ending March 31, 2003.  The industrial segment was successful inobtaining orders from the defense market in Q1 03, and plans to continue toseek orders in that and other markets.

 

Gross profit in Q1 03 decreased to $461,973, or 27% of net sales,compared to $586,888, or 34% of net sales in Q1 02.  Gross profit increased by approximately $51,000 in the medicalsegment, due primarily to the higher volume of ENT EndoSheaths that resulted inhigher absorption of manufacturing costs, offset partially by lower prices forENT EndoSheaths and higher standard costs for GI EndoSheaths.  Gross profit decreased by approximately$176,000 in the industrial segment, due primarily to lower sales volume and productmix.

 

Selling, general and administrative (“SG&A”) expenses in Q1 03increased by $143,242, or 22% compared to Q1 02.  SG&A expenses amounted to 45% and 37% of net sales in Q1 03and Q1 02, respectively.  SG&Aexpenses increased in the medical segment by approximately $104,000, dueprimarily to higher costs for personnel and product promotion.  SG&A expenses were flat in theindustrial segment in Q1 03, compared to Q1 02.  SG&A expenses increased by approximately $39,000 in thecorporate segment due primarily to higher costs for fringe benefits andprofessional fees.

 

R&D expenses increased by $61,400 in Q1 03,compared to Q1 02, and were 5% of sales in Q1 03, compared to 2% in Q1 02.  The primary causes for this increase werehigher costs for personnel, outside services related to CMOS patentapplications and costs related to the Company’s new Slide-OnÔbronchoscope EndoSheath, which was approved by the Food and Drug Administrationin May 2002.  The Company expects costsfor R&D will continue to be higher in FY 03, compared to FY 02, as it increasesits efforts to develop new products utilizing the technology inherent in itsEndoSheaths.

 

Stock-based compensation costs were a credit of$94,507, due primarily to a reduction in the fair value of non-qualifiedoptions.  This cost is computed by determiningthe change in the fair value of stock options granted to non-employees of theCompany.  The Company uses theBlack-Scholes method to calculate the fair value.  This method uses stock price volatility, the closing price of theCompany’s common stock as traded on the Nasdaq SmallCap Market and otherfactors to determine the fair value of non-qualified options.  The largest component in the calculation offair value is the closing price of the Company’s common stock on the NasdaqSmallCap Market, which was $1.12 on June 28, 2002, compared to $1.35 on March29, 2002.

 

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The net loss per share for Q1 03 was $.01, compared to a net loss of$.03 per share for Q1 02.

 

Liquidity and Capital Resources

 

At June 30, 2002, theCompany’s principal sources of liquidity included $2.6 million in cash,cash equivalents and marketable securities and working capital of $3.4million.  In addition, as of June 30,2002 the Company had a demand line of credit with a bank under which theCompany could borrow up to $250,000 in cash, net of any outstanding letters ofcredit and banker’s acceptances.  AtJune 30, 2002, the Company had acceptances payable totaling approximately$37,000.  The Company had pledged$250,000 to secure that bank line of credit.

 

The Company also has anagreement with another bank, which includes a revolving line of credit underwhich the Company may borrow up to $1,000,000, net of up to $250,000 of anyoutstanding letters of credit and banker’s acceptances. In addition, theCompany may borrow up to 75% of the cost of new equipment to a maximum amountof $250,000.  Borrowings under theseloan arrangements must be fully cash collateralized.  The agreement also stipulates that when the Company achieves positivecash flow, as defined in the agreement, the Company will be eligible tonegotiate changes to these loan arrangements that may include changing theborrowing base for revolving loans, and the release of the pledged cashcollateral.  The Company expects itscurrent balance of cash, cash equivalents and marketable securities issufficient to fund its operations at least for the next twelve months.

 

The Company’s cash and cash equivalents decreased by approximately$1,348,000 in the three months ended June 30, 2002, due primarily to cash usedfor operations of approximately $473,000 and cash used for investing activitiesof approximately $875,000.

 

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 approximately$233,000 as of June 30, 2002.  TheCompany expects to make other progress payments for the new equipment duringthe three months ending September 30, 2002 of approximately $24,000.  The new ENT EndoSheath forming machine wasplaced in service in the fourth quarter of the fiscal year ended March 31,2002.  The Company expects the new ENTbonding machine will be placed in service during the quarter ending September30, 2002.

 

The Company expects total spending for property and equipment will notexceed $350,000 for the fiscal year ending March 31, 2003.  In addition, as reported in the Company’sForm 10-K for the fiscal year ended March 31, 2002, the Company will continueto evaluate its investment in 3DV, and may make further investments if itbelieves it is in the best interests of the Company’s shareholders.

 

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The Companyconducts it operations in certain facilities leased from non-relatedparties.  These leases expire on variousdates through August 2005.  In addition,the Company has operating leases for certain office equipment leased fromnon-related parties.  These leasesexpire on various dates through May 2006. 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  ending March 31,** |   |    |    |
|---------------------------------|--------|---------|---------|
| 2003                            |   | $       | 313,000 |   |
| 2004                            |   | 239,000 |    |
| 2005                            |   | 157,000 |    |
| 2006                            |   | 72,000  |    |
| 2007                            |   | 2,000   |    |
| Total                           |   | $       | 783,000 |   |

 

The Company has incurred losses since its inception, and losses areexpected to continue at least during the fiscal year ending March 31, 2003 (“FY03”).  The Company has funded the lossesprincipally with the proceeds from public and private equity financings.  Although the Company does not anticipate theneed for additional financing in FY 03, management has decided that newfinancing may be desirable.  However,there can be no assurance that additional funding will be available, oravailable on reasonable terms.

 

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## **Item3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES 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 fixed income, available-for-sale securities of various issuers, typesand maturities.  The Company has notused derivative 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 June 30, 2002, the Company’s liabilities relating to JapaneseYen were approximately $87,000.

 

**PART II - OTHER INFORMATION**

 

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

 

(a)                                  Exhibits

99.1 Statement Pursuantto 18 U.S.C. §1350

 

(b)                                 Reportson Form 8-K

 

On July 9, 2002,the Company filed a Current Report on Form 8-K, to report the decision by theCompany’s Board of Directors to terminate Arthur Andersen LLP as its principalaccountants and to engage BDO Seidman, LLP as its principal accountants,subject to client acceptance procedures of BDO Seidman, LLP.  On August 2, 2002, the Company filed aCurrent Report on Form 8-K, to report the formal engagement of BDO Seidman, LLPas its principal accountants.

 

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##### **SIGNATURES**

 

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

 
| VISION-SCIENCES,  INC. |
|------------------------|
|                   |   |
| Date:  August 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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