**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20459**

 

**FORM 10-Q**

 

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

 

**FOR THEQUARTER ENDED December 31, 2002**

 

**COMMISSIONFILE NUMBER 0-20970**

 

**VISION-SCIENCES, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                      |   | **13-3430173**                         |
|-------------------------------------------------------------------|--------|----------------------------------------|
| (State or other  jurisdiction of   incorporation or organization) |   | (IRS Employer   Identification Number) |
|                                                              |   |                                   |
| **9  Strathmore Road, Natick, MA**                                |   | **01760**                              |
| (Address of principal  executive offices)                         |   | (Zip Code)                             |
|                                                              |   |                                   |
| Registrant’s telephone  number, including area code          |   | **(508)  650-9971**                    |

 

**None**

(Former name, formeraddress, andformer fiscal year if changed 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 by check mark whether the registrant is anaccelerated filer (as defined in Rule12b-2 of the Exchange Act).

 

| Yes  o |   | No  ý |
|-------------|--------|-----------------|

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of December 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**

 
|     |                  | **Page**                                                                                    |
|----------|-----------------------|---------------------------------------------------------------------------------------------|
| Part I.  | Financial Information |                                                                                        |
|     |                  |                                                                                        |   |
|     | Item 1.               | Financial Statements                                                                        |   |
|     |                  |                                                                                        |   |
|     |                  | Consolidated Balance Sheets                                                                 | 3 |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statements of Operations                                                      | 4 |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statement of Stockholders’ Equity                                        | 5 |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statements of Cash Flows                                                      | 6 |
|     |                  |                                                                                        |   |
|     |                  | Notes to  Consolidated Financial Statements                                                 | 7-12 |
|     |                  |                                                                                        |   |
|     | Item  2.              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 13-20 |
|     |                  |                                                                                        |   |
|     | Item  3.              | Quantitative  and Qualitative Disclosures about Market Risk                                 | 21 |
|     |                  |                                                                                        |   |
|     | Item  4.              | Controls  and Procedures                                                                    | 21 |
|     |                  |                                                                                        |   |
| Part II. | Other Information     |                                                                                        |
|     |                  |                                                                                        |   |
|     | Item 6.               | Exhibits and  Reports on Form 8-K                                                           | 22 |
|     |                  |                                                                                        |   |
|     | Signatures            | 23                                                                                          |
|     |                  |                                                                                        |   |
|     | Certifications        | 24-25                                                                                       |
|     |                  |                                                                                        |   |
|     | Exhibits              | 26                                                                                          |
|          |                       |                                                                                             |  |  |

 

2

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**PARTI - FINANCIAL INFORMATION**

**Item1: FINANCIAL STATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

 
|                                                                                                                                                                                  |   | **December  31,  2002** |      | **March 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|---------------------|--------|
| ASSETS                                                                                                                                                                                |   |                    |      |                |   |
| Current Assets:                                                                                                                                                                       |   |                    |      |                |   |
| Cash and cash  equivalents                                                                                                                                                            |   | $                       | 578,374   |                | $      | 2,890,364 |   |
| Marketable  securities                                                                                                                                                                |   | 1,136,780               |      | 251,445             |   |
| Accounts  receivable, net of allowance for doubtful accounts of $77,256 and $76,641,  respectively                                                                                    |   | 662,869                 |      | 834,577             |   |
| Inventories                                                                                                                                                                           |   | 1,276,370               |      | 1,193,181           |   |
| Prepaid expenses  and deposits                                                                                                                                                        |   | 95,147                  |      | 76,932              |   |
| Total current  assets                                                                                                                                                                 |   | 3,749,540               |      | 5,246,499           |   |
|                                                                                                                                                                                  |   |                    |      |                |   |
| Property and  Equipment, at cost:                                                                                                                                                     |   |                    |      |                |   |
| Machinery and  equipment                                                                                                                                                              |   | 3,385,478               |      | 3,283,341           |   |
| Furniture and  fixtures                                                                                                                                                               |   | 208,934                 |      | 208,934             |   |
| Leasehold  improvements                                                                                                                                                               |   | 466,505                 |      | 462,882             |   |
|                                                                                                                                                                                  |   | 4,060,917               |      | 3,955,157           |   |
| Less-Accumulated  depreciation and amortization                                                                                                                                       |   | 3,458,123               |      | 3,297,582           |   |
|                                                                                                                                                                                  |   | 602,794                 |      | 657,575             |   |
|                                                                                                                                                                                  |   |                    |      |                |   |
| Other assets,  net of accumulated amortization of $39,502 and $34,746, respectively                                                                                                   |   | 91,344                  |      | 96,100              |   |
| Total assets                                                                                                                                                                          |   | $                       | 4,443,678 |                | $      | 6,000,174 |   |
|                                                                                                                                                                                  |   |                    |      |                |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                             |   |                    |      |                |   |
| Current  Liabilities:                                                                                                                                                                 |   |                    |      |                |   |
| Acceptances  payable to a bank                                                                                                                                                        |   | $                       | 19,555    |                | $      | 43,226 |   |
| Current portion  of note payable                                                                                                                                                      |   | —                  |      | 23,989              |   |
| Accounts payable                                                                                                                                                                      |   | 350,688                 |      | 286,730             |   |
| Accrued expenses                                                                                                                                                                      |   | 902,958                 |      | 1,103,156           |   |
| Total current  liabilities                                                                                                                                                            |   | 1,273,201               |      | 1,457,101           |   |
|                                                                                                                                                                                  |   |                    |      |                |   |
| Potential  obligations to non-qualified option holders                                                                                                                                |   | 120,504                 |      | 421,110             |   |
| Stockholders’  Equity:                                                                                                                                                           |   |                    |      |                |   |
| Common stock,  $.01 par value—   Authorized—50,000,000 shares   Issued and outstanding—27,198,712 shares at December 31, 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                                                                                                                                                                  |   | (55,732,534             | )         | (54,535,591         | )      |
| Total  stockholders’ equity                                                                                                                                                      |   | 3,049,973               |      | 4,121,963           |   |
| Total  liabilities and stockholders’ equity                                                                                                                                      |   | $                       | 4,443,678 |                | $      | 6,000,174 |   |

 

See accompanying notes toconsolidated financial statements.

 

3

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** (Unaudited)**

** **
|                                                                  |   | **Three  Months Ended  December 31,** |      | **Nine  Months Ended  December 31,** |   |
|-----------------------------------------------------------------------|--------|---------------------------------------|-----------|--------------------------------------|--------|
|                                                                  |   | **2002**                              |      | **2001**                             |   | **2002** |   | **2001** |   |
| Net sales                                                             |   | $                                     | 1,636,788 |                                 | $      | 1,629,055 |   | $ | 4,883,371 |   | $ | 5,081,214 |   |
| Cost of sales                                                         |   | 1,289,857                             |      | 1,167,699                            |   | 3,654,020 |   | 3,372,214 |   |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Gross profit                                                          |   | 346,931                               |      | 461,356                              |   | 1,229,351 |   | 1,709,000 |   |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Selling, general  and administrative expenses(1)                      |   | 766,308                               |      | 830,550                              |   | 2,349,463 |   | 2,170,788 |   |
| Research and  development expenses(1)                                 |   | 128,897                               |      | 72,468                               |   | 319,359 |   | 135,369 |   |
| Stock-based  compensation                                             |   | (10,070                               | )         | (75,025                              | )      | (196,153 | ) | (177,256 | ) |
| Loss from  operations                                                 |   | (538,204                              | )         | (366,637                             | )      | (1,243,318 | ) | (419,901 | ) |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Interest income                                                       |   | 8,944                                 |      | 24,099                               |   | 33,178 |   | 103,210 |   |
| Interest expense                                                      |   | —                                |      | (1,404                               | )      | (724 | ) | (5,385 | ) |
| Equity in losses  of 3DV Systems Ltd.                                 |   | —                                |      | —                               |   | — |   | (500,000 | ) |
| Other income                                                          |   | 3,366                                 |      | (1,620                               | )      | 13,921 |   | 1,996 |   |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Net loss before  cumulative effect of change in accounting principle  |   | (525,894                              | )         | (345,562                             | )      | (1,196,943 | ) | (820,080 | ) |
| Cumulative  effect of change in accounting principle (Note 2)         |   | —                                |      | —                               |   | — |   | 327,169 |   |
| Net loss after  cumulative effect of change in accounting principle   |   | $                                     | (525,894  | )                                    | $      | (345,562 | ) | $ | (1,196,943 | ) | $ | (1,147,249 | ) |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Basic and  diluted net loss per common share                          |   | $                                     | (0.02     | )                                    | $      | (0.01 | ) | $ | (0.04 | ) | $ | (0.04 | ) |
|                                                                  |   |                                  |      |                                 |   |   |   |   |   |
| Shares used in  computing basic and diluted net loss per common share |   | 27,198,712                            |      | 27,105,355                           |   | 27,194,454 |   | 26,950,249 |   |

 

----

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

 
| Research and  development expenses            |   | $   | (10,054 | )      | $      | (75,025 | )      | $      | (268,526 | ) | $ | (177,256 | ) |
|-----------------------------------------------|--------|-----|---------|--------|--------|---------|--------|--------|----------|---|---|----------|---|
| Selling, general  and administrative expenses |   | (16 | )       | — |   | 72,373  |   | — |     |
| Total                                         |   | $   | (10,070 | )      | $      | (75,025 | )      | $      | (196,153 | ) | $ | (177,256 | ) |

 

See accompanying notes toconsolidated financial statements.

 

4

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

**CONSOLIDATED STATEMENT 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                                               |   | —               |   | —                          |    | —                   |   | (1,196,943                            | )      | (1,196,943                      | )           | $ | (1,196,943 | ) |
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                            |        |   |   |   |
| Total  comprehensive loss                              |   |                 |   |                            |    |                     |   |                                  |   |                            |        | $ | (1,196,943 | ) |
|                                                   |   |                 |   |                            |    |                     |   |                                  |   |                            |        |   |   |
| Balance December  31, 2002                             |   | 27,198,712           |   | $                               | 271,986 |                     | $      | 58,510,521                            |   | $                               | (55,732,534 | ) | $ | 3,049,973 |   |   |   |

 

See accompanying notes toconsolidated financial statements.

 

5

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** (Unaudited)**

 
|                                                                                                   |   | **Nine  Months Ended    December 31, 2002** |       | **Nine  Months Ended    December 31, 2001** |   |
|--------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|------------|--------------------------------------------------|--------|
| Cash flows from  operating activities:                                                                 |   |                                             |       |                                             |   |
| Net loss                                                                                               |   | $                                                | (1,196,943 | )                                                | $      | (1,147,249 | ) |
| Adjustments to  reconcile net loss to net cash used for operating activities:                          |   |                                             |       |                                             |   |
| Depreciation and  amortization                                                                         |   | 165,297                                          |       | 169,342                                          |   |
| Equity in losses  of 3DV Systems, Ltd.                                                                 |   | —                                           |       | 500,000                                          |   |
| Stock compensation  to non-employees                                                                   |   | (196,153                                         | )          | 149,913                                          |   |
| Changes in  assets and liabilities:                                                                    |   |                                             |       |                                             |   |
| Accounts  receivable                                                                                   |   | 171,708                                          |       | 180,929                                          |   |
| Inventories                                                                                            |   | (83,189                                          | )          | (237,405                                         | )      |
| Prepaid expenses  and deposits                                                                         |   | (18,215                                          | )          | (33,706                                          | )      |
| Accounts payable                                                                                       |   | 63,958                                           |       | 50,389                                           |   |
| Accrued expenses                                                                                       |   | (200,198                                         | )          | (356,242                                         | )      |
|                                                                                                   |   |                                             |       |                                             |   |
| Net cash used  for operating activities                                                                |   | (1,293,735                                       | )          | (724,029                                         | )      |
|                                                                                                   |   |                                             |       |                                             |   |
| Cash flows provided by  (used for) investing activities   Decrease (increase) in marketable securities |   | (885,335                                         | )          | 989,875                                          |   |
| Purchase of  property and equipment, net                                                               |   | (105,760                                         | )          | (145,455                                         | )      |
|                                                                                                   |   |                                             |       |                                             |   |
| Net cash (used  for) provided by investing activities                                                  |   | (991,095                                         | )          | 844,420                                          |   |
|                                                                                                   |   |                                             |       |                                             |   |
| Cash flows  provided by (used for) financing activities:                                               |   |                                             |       |                                             |   |
| Payments on note  payable for leasehold improvements                                                   |   | (23,989                                          | )          | (39,100                                          | )      |
| Proceeds from  acceptances payable to a bank                                                           |   | (23,671                                          | )          | 11,165                                           |   |
| Proceeds from  the sale of common stock, net                                                           |   | —                                           |       | 600,000                                          |   |
| Exercise of  stock options                                                                             |   | 20,500                                           |       | 2,375                                            |   |
|                                                                                                   |   |                                             |       |                                             |   |
| Net cash (used  for) provided by financing activities                                                  |   | (27,160                                          | )          | 574,440                                          |   |
|                                                                                                   |   |                                             |       |                                             |   |
| Net increase  (decrease) in cash and cash equivalents                                                  |   | (2,311,990                                       | )          | 694,831                                          |   |
| Cash and cash  equivalents, beginning of period                                                        |   | 2,890,364                                        |       | 2,568,724                                        |   |
| Cash and cash  equivalents, end of period                                                              |   | $                                                | 578,374    |                                             | $      | 3,263,555 |   |
|                                                                                                   |   |                                             |       |                                             |   |
| Supplemental  disclosure of cash flow information:                                                     |   |                                             |       |                                             |   |
| Cash paid during  the period for interest                                                              |   | $                                                | 724        |                                             | $      | 5,385 |   |
|                                                                                                   |   |                                             |       |                                             |   |
| 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     |   | $                                                | (276,008   | )                                                | $      | (177,256 | ) |

 

See accompanying notes toconsolidated financial statements.

 

6

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

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

The consolidated financial statements included hereinhave been prepared by the Company in accordance with accounting principlesgenerally accepted in the United States of America, without audit, pursuant tothe rules and regulations of the Securities and Exchange Commission andinclude, 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.

 

At December 31, 2002,our principal sources of liquidity included $1.715 million in cash, cashequivalents and marketable securities, which is part of our working capital of$2.5 million.  We expect our currentbalance of cash, cash equivalents and marketable securities is not sufficientto fund our operations for the next twelve months.  Accordingly, management is pursuing the possibilities of raisingadditional cash by selling equity securities.

 

**2**.                                      **Summary of Significant Accounting Policies**

 

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.  AtDecember 31, 2002, the Company’s marketable securities consisted of commercialpaper and a certificate of deposit with a weighted average maturity of 240days.

 

7

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d.                                      *Inventories*:  Inventoriesare stated at the lower of cost or market using the first-in, first-out (FIFO)method and consist of the following:

 
|            |   | **December  31,  2002** |      | **March 31,  2002** |   |
|-----------------|--------|-------------------------|-----------|---------------------|--------|
|            |   |                    |      | **(audited)**       |   |
| Raw materials   |   | $                       | 688,104   |                | $      | 612,827 |   |
| Work-in-process |   | 195,679                 |      | 190,686             |   |
| Finished goods  |   | 392,587                 |      | 389,668             |   |
|            |   | $                       | 1,276,370 |                | $      | 1,193,181 |   |

 

Work-in-process andfinished goods inventories consist of material, labor, and manufacturingoverhead.

 

e.                                       *Depreciation and 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 improvementsare amortized over the shorter of their estimated useful lives or the lives ofthe leases.

 

f.                                         *Basic and Diluted Net Loss Per Common Share*: Basic and diluted net loss per common share is basedon the weighted average number of common shares outstanding.  Shares of common stock issuable pursuant tooutstanding stock options have not been considered, as their effect would beantidilutive.

 

g.                                      *Revenue Recognition*: The following must occur before the Companyrecognizes revenue: (1) persuasive evidence of an arrangement exists, (2)delivery has occurred or services have been rendered, (3) the price is fixed ordeterminable, and (4) collectibility is reasonably assured.

 

h.                                      *Foreign Currency Transactions*: In accordance with Statement of Financial AccountingStandard (“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.

 

8

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i.                                          *Income Taxes*: The Company accounts for income taxes under theliability method in accordance with 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.

 

j.                                          *Accounting for Derivatives*: In September 2000, the Emerging Issues Task Force(“EITF”) issued EITF 00-19, *Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock*, whichrequires 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.

 

Underthe transition rules of EITF 00-19, the Company recorded the optionsoutstanding at June 30, 2001 as a liability at fair value with a requiredadjustment of $327,169 in its results of operations.

 

Inaccordance with EITF 00-19, the Company has determined that outstanding optionsto non-employees as of December 31, 2002 to purchase 1,363,032 shares of theCompany’s common stock should be designated as a liability.

 

TheCompany valued the non-qualified options outstanding at December 31, 2002 usingthe Black-Scholes method.  The value ofthose options declined by $10,070 and by $276,008, respectively, in the threeand nine months ended December 31, 2002. The Company recorded these declines as reductions in operating expensesin the accompanying consolidated statements of operations for these periods.

** **

**3.****                                     ****Investment in 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 andConvertible Notes were converted to common shares.

 

9

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In 2002, 3DV executed asixth round of financing with investors other than the Company, including twoemployee-directors of the Company. These employee-directors have offered, and the Company is consideringaccepting, a no-cost option to acquire their entire interest in 3DV.  This option would be exercisable for tenyears, solely by the Company, and for payment of only the principal amount oftheir investment.  As of December 31,2002, the Company owned approximately 21% of the outstanding shares of 3DV, andwould hold approximately 17% of the shares of 3DV, if all employee options andConvertible Notes were converted to common shares.

 

In the three months endedJune 30, 2001, 3DV incurred losses of approximately $2,177,000.  The Company’s investment in 3DV totaled$500,000 at March 31, 2001, and accordingly, the Company recognized equity inlosses of 3DV equal to the total value of its investment in the three monthsended June 30, 2001.  In the three andnine months ended December 31, 2002, 3DV continued to incur losses.  Because the Company had fully recognized asa loss its total investment in 3DV at March 31, 2002, the Company did notrecognize any portion of the losses of 3DV for the three and nine-month periodsended December 31, 2002.

 

**4.****                                     ****Segment Information**

 

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 applicable 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 December 31, 2002was $0.  Data regarding management’sview of the Company’s segments are provided in the following tables.

 

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| **Three  months ended December 31,** |   | **Medical** |    | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total** |   |
|--------------------------------------|--------|-------------|---------|----------------|--------|---------------|--------|-----------------|--------|-----------|--------|
| **2002**                             |   |        |    |           |   |          |   |            |   |      |   |
| Sales to  external customers         |   | $           | 970,219 |           | $      | 666,569       |   | $               | — |      | $      | — |   | $ | 1,636,788 |   |
| Intersegment  sales                  |   | —      |    | 158,784        |   | —        |   | (158,784        | )      | —    |   |
| Operating loss                       |   | (302,818    | )       | (66,777        | )      | (168,609      | )      | —          |   | (538,204  | )      |
| Interest income  (expense)           |   | —      |    | —         |   | 8,944         |   | —          |   | 8,944     |   |
| Depreciation and  amortization       |   | 46,507      |    | 10,708         |   | —        |   | —          |   | 57,215    |   |
| Other  significant non-cash items:   |   |        |    |           |   |          |   |            |   |      |   |
| Stock-based  compensation            |   | —      |    | —         |   | (10,070       | )      | —          |   | (10,070   | )      |
| Expenditures for  fixed assets       |   | 17,473      |    | 232            |   | —        |   | —          |   | 17,705    |   |
|                                 |   |        |    |           |   |          |   |            |   |      |   |
| **2001**                             |   |        |    |           |   |          |   |            |   |      |   |
| Sales to  external customers         |   | $           | 877,001 |           | $      | 752,054       |   | $               | — |      | $      | — |   | $ | 1,629,055 |   |
| Intersegment  sales                  |   | —      |    | 152,265        |   | —        |   | (152,265        | )      | —    |   |
| Operating income  (loss)             |   | (370,561    | )       | 77,049         |   | (73,125       | )      | —          |   | (366,637  | )      |
| Interest income  (expense)           |   | —      |    | (1,404         | )      | 24,099        |   | —          |   | 22,695    |   |
| Depreciation and  amortization       |   | 42,974      |    | 8,407          |   | —        |   | —          |   | 51,381    |   |
| Other  significant non-cash items:   |   |        |    |           |   |          |   |            |   |      |   |
| Stock-based  compensation            |   | —      |    | —         |   | (75,025       | )      | —          |   | (75,025   | )      |
| Expenditures for  fixed assets       |   | 42,377      |    | 2,448          |   | —        |   | —          |   | 44,825    |   |

 
| **Nine months ended December 31,**                   |   | **Medical** |      | **Industrial** |   | **Corporate** |   | **Adjustments** |   | **Total**  |   |
|------------------------------------------------------|--------|-------------|-----------|----------------|--------|---------------|--------|-----------------|--------|------------|--------|
| **2002**                                             |   |        |      |           |   |          |   |            |   |       |   |
| Sales to  external customers                         |   | $           | 2,826,250 |           | $      | 2,057,121     |   | $               | — |       | $      | — |   | $ | 4,883,371 |   |
| Intersegment  sales                                  |   | —      |      | 512,698        |   | —        |   | (512,698        | )      | —     |   |
| Operating loss                                       |   | (814,180    | )         | (76,806        | )      | (352,332      | )      | —          |   | (1,243,318 | )      |
| Interest income  (expense)                           |   | —      |      | (724           | )      | 33,178        |   | —          |   | 32,454     |   |
| Depreciation and  amortization                       |   | 136,527     |      | 28,770         |   | —        |   | —          |   | 165,297    |   |
| Other  significant non-cash items:                   |   |        |      |           |   |          |   |            |   |       |   |
| Stock-based  compensation                            |   | —      |      | —         |   | (196,153      | )      | —          |   | (196,153   | )      |
| Total assets                                         |   | 1,779,393   |      | 1,111,780      |   | 1,807,128     |   | (254,623        | )      | 4,443,678  |   |
| Expenditures for  fixed assets                       |   | 75,333      |      | 30,427         |   | —        |   | —          |   | 105,760    |   |
|                                                 |   |        |      |           |   |          |   |            |   |       |   |
| **2001**                                             |   |        |      |           |   |          |   |            |   |       |   |
| Sales to  external customers                         |   | $           | 2,490,168 |           | $      | 2,591,046     |   | $               | — |       | $      | — |   | $ | 5,081,214 |   |
| Intersegment  sales                                  |   | —      |      | 410,646        |   |          |   | (410,646        | )      | —     |   |
| Operating income  (loss)                             |   | (530,643    | )         | 390,390        |   | (279,648      | )      | —          |   | (419,901   | )      |
| Interest income  (expense)                           |   | —      |      | (5,385         | )      | 103,210       |   | —          |   | 97,825     |   |
| Depreciation and  amortization                       |   | 144,036     |      | 25,306         |   | —        |   | —          |   | 169,342    |   |
| Other  significant non-cash items:                   |   |        |      |           |   |          |   |            |   |       |   |
| Equity in losses  of 3DV Systems                     |   | —      |      | —         |   | (500,000      | )      | —          |   | (500,000   | )      |
| Cumulative effect  of change in accounting principle |   | —      |      | —         |   | 327,169       |   | —          |   | 327,169    |   |
| Stock-based  compensation                            |   | —      |      | —         |   | (177,256      | )      | —          |   | (177,256   | )      |
| Total assets                                         |   | 1,937,417   |      | 1,894,975      |   | 3,608,722     |   | (975,202        | )      | 6,465,912  |   |
| Expenditures for  fixed assets                       |   | 142,265     |      | 3,190          |   | —        |   | —          |   | 145,455    |   |

 

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**5.****                                     ****New Accounting Pronouncements**

 

In June 2002, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 146 *Accountingfor Costs Associated with Exit or Disposal Activities*. Thisstatement superseded EITF No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity*. Under this statement, a liability or a cost associated with a disposal or exitactivity is recognized at fair value when the liability is incurred rather thanat the date of an entity’s commitment to an exit plan as required under EITF94-3.  The provision of this statement is effective for exit or disposalactivities that are initiated after December 31, 2002, with early adoptionpermitted.  The Company does not anticipate the adoption of this statementto have a material impact on its financial statements.

 

In November 2002, theEITF reached consensus on Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables*. Revenue arrangements with multiple deliverables include arrangements whichprovide for the delivery or performance of multiple products, services and/orrights to use assets where performance may occur at different points in time orover different periods of time.  EITFIssue No. 00-21 will become effective for the Company beginning October 1,2003.  The Company has not completed the evaluation of the impact of thisEITF.

 

The Company accounts forits stock option plans under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. No stock-based employee compensation cost isreflected in net loss, as the options granted under those plans had an exerciseprice equal to, or greater than, the market value of the underlying commonstock on the date of the grant. In accordance with FASB Statement No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*, beginningin the quarter ending March 31, 2003, the Company will adopt the disclosurerequirements of FASB No. 148.

 

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## **Item 2.** MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

 

Critical Accounting Policies and Estimates

 

This discussion and analysis of our financial condition and results ofoperations is based upon our Consolidated Financial Statements, which have beenprepared in accordance with accounting principles generally accepted in the UnitedStates.  See the Notes to theConsolidated Financial Statements included elsewhere herein.  Certain of our accounting policies requirethe application of judgment in selecting the appropriate assumptions forcalculating financial estimates.  Bytheir nature these judgments are subject to an inherent degree ofuncertainty.  We periodically evaluatethe judgments and estimates used for our critical accounting policies to ensurethat such judgments and estimates are reasonable for our interim and year-endreporting requirements.  These judgmentsand estimates 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 or servicesrendered; (3) the fee is fixed and determinable; and (4) collectibility isreasonably assured.  Determination ofcriterion (4) is based on management’s judgment regarding the collectibility ofinvoices for products and services delivered to customers.  Should changes in conditions causemanagement to determine this criterion is not met for certain futuretransactions, revenue recognized for any reporting period could be adverselyaffected.

 

# ***Potential Obligations to Non-qualified Option Holders***

 

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 EITF 00-19, *Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock*,and carry these contracts at fair value, with any changes in fair valuerecorded in the results of operations. Fair values for certain non-qualified options are derived from pricingmodels that consider current market and contractual prices for the underlyingfinancial instruments or commodities, as well as time value and yield curve orvolatility factors underlying the positions. Pricing models and their underlying assumptions impact the amount andtiming of unrealized gains and losses recognized, and the use of differentpricing models or assumptions could produce different financial results.  The Company uses the Black-Scholes methodfor determining the value of the potential obligation to non-qualified optionholders.

 

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Results of Operations

 

This Quarterly Report on Form 10-Q contains forward-lookingstatements within the meaning of The Private Securities Litigation Reform Actof 1995.  Examples of forward-lookingstatements include statements about expectations about future financialresults, future products and future sales of new and existing products, futureexpenditures, and capital resources to meet anticipated requirements.  Without limiting the foregoing, the words“believes”, “anticipates”, “plans”, “expects”, and similar expressions are intendedto identify forward-looking statements. These forward-looking statements involve risks and uncertainties, andour actual results may differ significantly from those discussed in theforward-looking statements. Factors that might cause such a difference include,but are not limited to the availability of capital resources, the availabilityof third-party reimbursement, government regulation, the availability ofsupplies, competition, technological difficulties, general economic conditionsand other risks detailed in our most recent Annual Report on Form 10-K and anysubsequent periodic filings made with the Securities and ExchangeCommission.  We do not undertake anobligation to update our forward-looking statements to reflect future events orcircumstances.

 

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

 

Q3 03 Compared to Q3 02

 

Net sales for the three months ended December 31, 2002 (“Q3 03”) were $1,636,788,an increase of $7,733, or 0%, compared to the three-month period ended December31, 2001 (“Q3 02”).  During this period,sales of the medical segment increased by $93,218, or 11%, and sales of theindustrial segment decreased by $85,485, or 11%.

 

Within the medical segment, sales to the ENT market increased byapproximately $116,000, while sales to the GI and pulmonary markets decreasedby approximately $30,000.  Sales ofaccessories, repair services and other medical products increased by approximately$7,000.

 

#### *Medical Segment -ENT Market*

 

Sales of EndoSheaths to the ENT market increased by approximately$120,000, or 25%.  Sales of ENTEndoSheaths increased by $65,000, or 24%, to the domestic market, and by$55,000, or 27%, to the international market. Demand increased in the domestic market from both hospitals and clinicsand from physician’s offices.  Webelieve the higher demand was due to users recognizing that the ENT EndoSheathprovides both efficiency and infection control and to our promotional pricingdesigned to increase the number of users of our products.  Unit sales to the hospital and clinic marketincreased by

 

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approximately 34% in Q3 03, compared to Q3 02.  This increase resulted from both a highernumber of users and an increased usage per customer.  In the physician market, unit sales increased by approximately22% in the same period.  This increasewas due primarily to an increased number of users, while average usage per customerincreased by approximately 2%.  We havereviewed our domestic promotional pricing policy, and expect to increase it inthe fiscal quarter ending March 31, 2003. In the international market, we continue to experience high demand fromthe UK and Europe, with demand from Australia higher than Q2 03, but slightlybehind Q3 02.  We have no plans tochange pricing in the international market in the fiscal quarter ending March31, 2003.

 

Sales of endoscopes to the ENT market decreased by approximately $4,000,with sales to domestic customers decreasing by $48,000 while sales tointernational distributors increased by $44,000.  Sales of endoscopes are more variable in both markets due to anumber of factors, such as local country promotions of competitor’s productsand particular needs of some customers that do not repeat consistently fromyear to year.

 

We shipped approximately 75,700 ENT EndoSheaths in Q3 03, an increaseof 16,500, or 28%, compared to shipments of approximately 59,200 in Q3 02.  However, lower average selling prices perunit resulted in a sales increase of 25%. 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 distributors comprisedapproximately 58% of total ENT EndoSheath unit shipments in Q3 03, compared toapproximately 59% in Q3 02.  During Q303, we acquired approximately 35 new domestic ENT customers, and unit shipmentsto all domestic customers increased by 29%, compared to Q3 02.  Unit shipments in Q3 03 to internationaldistributors increased by 27%, compared to Q3 02.  We experienced increased demand of 55% from the UK, and 17% fromother European countries, where fears of Mad-Cow Disease persist.  In the Pacific Rim, we experienced slightlyhigher demand, especially in Japan where we have a new distributor.  This was partially offset by lower demandfrom our distributor in Australia that is related to inventory levels inheritedfrom the prior distributor.  We expect shipmentlevels to this new distributor will return to levels of last year in the fourthfiscal quarter of fiscal 2003.

 

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

 

Sales of endoscopes and EndoSheaths to the GI andpulmonary markets decreased by approximately $30,000.  We did not ship any endoscopes to the GI market in Q3 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 GI EndoSheaths to increase, ashealth care providers cannot, in general, obtain reimbursement for theEndoSheath, thus discouraging its use. We increased the price of the GIEndoSheath in November 2002 to help us recover our costs to manufacture it.

 

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In the pulmonary market, we sold two endoscopes toEurope, where we expect higher demand for the EndoSheaths, compared to thedomestic market.  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.

 

#### *Industrial Segment*

 

The lower sales of the industrial segment’s products in Q3 03, comparedto Q3 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.

 

9 Months 03 Compared to 9 Months 02

 

Net sales for the nine months ended December 31, 2002 (“9 months 03”)decreased by $197,843, or 4% compared to the nine-month period ended December31, 2001 (“9 months 02”).  During thisperiod, sales of the medical segment increased by $336,082, or 13%, and salesof the industrial segment decreased by $533,925, or 21%.

 

Within the medical segment, sales to the ENT market increased byapproximately $402,000, while sales to the GI and pulmonary markets decreasedby approximately $71,000.  Sales ofaccessories, repair services and other medical products increased byapproximately $5,000.

 

#### *Medical Segment –ENT Market*

 

Sales of EndoSheaths to the ENT market increased by approximately$369,000, or 25%.  Sales of EndoSheathsincreased by $175,000, or 20%, to the domestic market, and by $194,000, or 34%,to the international market.  We believethis higher demand is due to the same reasons as stated above, and has beenrelatively consistent throughout the fiscal year.

 

Sales of endoscopes increased by $33,000, or 8%, compared to 9 months02.  Sales to domestic customersincreased by $78,000, or 38%, while sales to international distributorsdecreased by $45,000, or 20% in the period.

 

The number of ENT EndoSheath units shipped in 9 months 03 increased by33% in total, 30% to domestic customers and 36% to internationaldistributors.  We shipped approximately230,400 ENT EndoSheaths in 9 months 03, an increase of 57,300, compared toshipments of approximately 173,100 in 9 months 02.  However, lower average selling prices per unit resulted in asales increase of 25% in total, 20% from domestic customers and 34% 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.

 

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Shipments to international distributors comprised approximately 57% oftotal ENT EndoSheath unit shipments in 9 months 03, compared to approximately56% in 9 months 02.  Internationaldemand for the Company’s ENT EndoSheath continues to be high, especially inEurope.  During 9 months 03, we acquiredapproximately 140 new domestic ENT customers. We expect the ease of use of our Slide-On EndoSheath and lower unitprices will encourage more usage of it, both in domestic and internationalmarkets.  However, there can be no assurancethat the higher number of units shipped will more than offset the lower unitselling prices.

 

*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 four bronchoscopes tointernational distributors, and we expect to sell more in subsequent quarters,after the users gain experience with the new Slide-On bronchoscope EndoSheath.

 

#### *Industrial Segment*

 

The industrial segment experienced lower sales in 9 months 03, comparedto 9 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 December 31,2002, we expect demand from these markets will remain at current levels atleast for the foreseeable future.

 

Gross Profit

 

Gross profit in Q3 03 decreased to $346,931, or 21% of net sales,compared to $461,356, or 28% of net sales in Q3 02.  Gross profit increased by approximately $21,000 in the medicalsegment, due primarily to the higher sales volume and lower manufacturing costsof EndoSheaths for the ENT markets. Gross profit decreased in the industrial segment by approximately$135,000, due primarily to lower sales volume.

 

Gross profit in 9 months 03 decreased to $1,229,351, or 25% of netsales, compared to $1,709,000, or 34% of net sales in 9 months 02.  In the medical segment, gross profit wasapproximately $679,000, or 24% of sales, compared to approximately $680,000, or27%, in 9 months 02.  The higher grossprofit that resulted from higher unit volume of endoscopes and EndoSheaths soldto the ENT market was offset partially by the lower prices from these samemarkets.  In addition, the higher unitcosts of EndoSheaths sold to the GI and pulmonary markets resulted in lowergross profit.  Gross profit decreased inthe industrial segment by approximately $479,000, due primarily to lower salesvolume.

 

Operating Expenses

 

Selling, general and administrative (“SG&A”) expenses in Q3 03decreased by $64,242, or 8%, compared to Q3 02.  SG&A expenses amounted to 47% of net sales in Q3 03 and 51%in Q3 02.  The decrease in thesecategories was primarily attributable to lower legal costs related to patents.

 

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SG&A expenses increased by $178,675 in 9 months 03, compared to 9months 02.  SG&A expenses amountedto 48% of sales in 9 months 03, compared to 43% of sales in 9 months 02.  SG&A expenses increased in the medicaland corporate segments by approximately $165,000 and $25,000, respectively, anddecreased in the industrial segment by approximately $11,000.  The primary causes for the increase in themedical and corporate segments were higher costs for personnel, product promotionand commissions.  In the industrialsegment the decrease in SG&A expenses was due primarily to lowercommissions.

 

Research and development (“R&D”) expensesincreased by $56,429 in Q3 03 compared to Q3 02, and were 8% of sales in Q3 03,compared to 4% of sales in Q3 02.  Weincreased the effort devoted to R&D by adding personnel for specificproducts that we expect will result in higher sales of EndoSheaths to the ENTmarket in our fiscal year 2004.  Ourstrategy in new products has shifted from designing EndoSheaths only to preventcross-infection to designing EndoSheaths that will also allow health-careproviders to perform procedures in their offices that currently are only beingperformed in hospitals.  We receivedclearance from the FDA to market the first of these products in January2003.  We expect to continue increasingthis activity over the next twelve months. This will result in higher expenses for those periods, compared to thesame periods in prior years.  In thecorporate segment, we incurred higher costs on Complementary Metal OxideSemiconductor (“CMOS”) image sensor patent applications, as we are in theprosecution phase for these applications.

 

R&D expenses increased by $183,990 in 9 months 03,compared to 9 months 02, and were 7% of sales in 9 months 03, compared to 3% in9 months 02.  We increased the effortsdevoted to R&D for our new Slide-On bronchoscope EndoSheath and newproducts for the ENT market and incurred greater expense related to the CMOSimage sensor patent applications.

 

We recorded a reduction to expenses for the change invalue of non-qualified stock options. Stock-based compensation costs declined by $10,070 in Q3 03, compared toa decline of $75,025 in Q3 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 Q3 03, the changes in volatility and the closing share pricewere not as sharp as in Q3 02, resulting in less of a change to the liability.

 

We did not record equity in losses of 3DV Systems in Q3 03 nor in Q302.  For 9 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 Q3 03 was $.02, compared to $.01 per sharefor Q3 02.  For 9 months 03 the loss pershare was $.04, the same as for 9 months 02.

 

Liquidity and Capital Resources

 

At December 31, 2002,our principal sources of liquidity included $1.715 million in cash, cashequivalents and marketable securities, which is part of our working capital of$2.5 million.  As of December 31, 2002we had an agreement with a bank, which includes a revolving line of creditunder which we may borrow up to $1,000,000, net of up to $250,000 of anyoutstanding letters of credit and banker’s acceptances.  Borrowings under this loan arrangement mustbe fully cash collateralized.

 

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The agreement alsostipulates that when we achieve positive cash flow, as defined in theagreement, we will be eligible to negotiate changes to these loan arrangementsthat may include changing the borrowing base for revolving loans, and therelease of the pledged cash collateral. We expect our current balance of cash, cash equivalents and marketablesecurities is not sufficient to fund our operations for the next twelvemonths.  Accordingly, management ispursuing the possibilities of raising additional cash by selling equitysecurities.

 

At December 31, 2002, wehad acceptances payable totaling approximately $20,000, secured by acertificate of deposit of $125,000.

 

Our cash and cashequivalents decreased by approximately $2,312,000 in 9 months 03.  However, approximately $885,000 of thisusage resulted from an increase in our marketable securities, as we increasedthe duration of our investments to obtain higher yields.  The net usage of cash, cash equivalents andmarketable securities was approximately $1,427,000 for 9 months 03, compared toa use of approximately $295,000 for the same period last year.  The primary reasons for the higher usagewere the lower gross profit, the increased cost of operations and anon-repeating sale of our common stock of $600,000 that occurred in June2001.  These were partially offset by alower need for working capital totaling approximately $330,000.

 

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 all therequired payments to the supplier as of December 31, 2002.  The new ENT EndoSheath forming machine wasplaced in service in the fourth quarter of the fiscal year ended March 31,2002.  The new ENT bonding machine wasplaced in service in the third fiscal quarter ended December 31, 2002.  We have no other material purchasecommitments outstanding as of 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 ouroperations in certain facilities leased from non-related parties.  These leases expire on various dates throughAugust 2005.  In addition, we haveoperating 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 March31,
| 2003  |   | $       | 313,000 |   |
|-------|--------|---------|---------|--------|
| 2004  |   | 239,000 |    |
| 2005  |   | 157,000 |    |
| 2006  |   | 72,000  |    |
| 2007  |   | 2,000   |    |
| Total |   | $       | 783,000 |   |

 

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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.  As we believe we do not 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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## **Item 3.** QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In the normal course of business, we are subject to the risks associatedwith fluctuations in interest rates and changes in foreign currency exchangerates.

 

#### *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 Japanese suppliers,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 December 31, 2002, ourliabilities relating to Japanese Yen were approximately $30,500.

 

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

 

*a)**           **Evaluation of Disclosure Controls and 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.

 

21

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**PARTII - OTHER INFORMATION**

 

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

 
|   | (a)    | Exhibits            |
|--------|--------|---------------------|
|   |   | 10.1                | Supply Agreement, dated March 16, 1992 between the  Registrant and Pentax Corporation (formerly known as Asahi Optical Co., Ltd.)  and amendment thereto, dated October 1, 2002. |
|   |   |                |   |
|   |   | 99.1                | Certification pursuant to 18 U.S.C. §1350 |
|   |   |                |   |
|   | (b)    | Reports on Form 8-K |
|   |   | None.               |

 

22

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**SIGNATURES**

 

 

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

 

VISION-SCIENCES, INC.

 

 
| Date:  February 11, 2003 | /s/  Ron Hadani                                                                                                                         |   |
|--------------------------|-----------------------------------------------------------------------------------------------------------------------------------------|--------|
|                     | Ron  Hadani                                                                                                                             |
|                     | 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) |
|                          |                                                                                                                                         |        |  |

 

23

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CERTIFICATIONS

I, Ron Hadani, certify that:

 
| 1.     | I have reviewed this quarterly report on Form 10-Q  of Vision-Sciences, Inc.;                                                                                                                                                                                                                                                                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.     | Based on my  knowledge, this quarterly report does not contain any untrue statement of a  material fact or omit to state a material fact necessary to make the  statements made, in light of the circumstances under which such statements  were made, not misleading with respect to the period covered by this  quarterly report;                                                                 |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.     | Based on my knowledge, the financial statements, and  other financial information included in this quarterly report, fairly present  in all material respects the financial condition, results of operations and  cash flows of the registrant as of, and for, the periods presented in this  quarterly report;                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.     | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and  procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the  registrant and we have:                                                                                                                                                                   |
| a)     | designed such disclosure controls and procedures to  ensure that material information relating to the registrant, including its  consolidated subsidiaries, is made known to us by others within those  entities, particularly during the period in which this quarterly report is  being prepared;                                                                                                 |
| b)     | evaluated the effectiveness of the registrant’s  disclosure controls and procedures as of a date within 90 days prior to the  filing date of this quarterly report (the “Evaluation Date”); and                                                                                                                                                                                      |
| c)     | presented in this quarterly report our conclusions  about the effectiveness of the disclosure controls and procedures based on  our evaluation as of the Evaluation Date;                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 5.     | The registrant’s other certifying officers and I  have disclosed, based on our most recent evaluation, to the registrant’s  auditors and the audit committee of registrant’s board of directors (or  persons performing the equivalent functions):                                                                                                                                   |
| a)     | all significant deficiencies in the design or  operation of internal controls which could adversely affect the registrant’s  ability to record, process, summarize and report financial data and have  identified for the registrant’s auditors any material weaknesses in internal  controls; and                                                                                        |
| b)     | any fraud, whether or not material, that involves  management or other employees who have a significant role in the registrant’s  internal controls; and                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 6.     | The registrant’s other certifying officers and I  have indicated in this quarterly report whether or not there were significant  changes in internal controls or in other factors that could significantly  affect internal controls subsequent to the date of our most recent  evaluation, including any corrective actions with regard to significant  deficiencies and material weaknesses. |

 
|   |              | /s/ Ron Hadani          |   |
|--------|-------------------|-------------------------|--------|
| Dated: | February 11, 2003 | Ron Hadani              |
|   |              | Chief Executive Officer |

 

24

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CERTIFICATIONS

I, James A. Tracy, certify that:

 
| 1.     | I have reviewed this quarterly report on Form 10-Q  of Vision-Sciences, Inc.;                                                                                                                                                                                                                                                                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.     | Based on my knowledge, this quarterly report does  not contain any untrue statement of a material fact or omit to state a  material fact necessary to make the statements made, in light of the  circumstances under which such statements were made, not misleading with  respect to the period covered by this quarterly report;                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.     | Based on my knowledge, the financial statements, and  other financial information included in this quarterly report, fairly present  in all material respects the financial condition, results of operations and  cash flows of the registrant as of, and for, the periods presented in this  quarterly report;                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.     | The registrant’s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and procedures  (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and  we have:                                                                                                                                                                   |
| a)     | designed such disclosure controls and procedures to  ensure that material information relating to the registrant, including its  consolidated subsidiaries, is made known to us by others within those  entities, particularly during the period in which this quarterly report is  being prepared;                                                                                                 |
| b)     | evaluated the effectiveness of the registrant’s  disclosure controls and procedures as of a date within 90 days prior to the  filing date of this quarterly report (the “Evaluation Date”); and                                                                                                                                                                                      |
| c)     | presented in this quarterly report our conclusions  about the effectiveness of the disclosure controls and procedures based on  our evaluation as of the Evaluation Date;                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 5.     | The registrant’s other certifying officers and I  have disclosed, based on our most recent evaluation, to the registrant’s  auditors and the audit committee of registrant’s board of directors (or  persons performing the equivalent functions):                                                                                                                                   |
| a)     | all significant deficiencies in the design or  operation of internal controls which could adversely affect the registrant’s  ability to record, process, summarize and report financial data and have  identified for the registrant’s auditors any material weaknesses in internal  controls; and                                                                                        |
| b)     | any fraud, whether or not material, that involves  management or other employees who have a significant role in the registrant’s  internal controls; and                                                                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 6.     | The registrant’s other certifying officers and I  have indicated in this quarterly report whether or not there were significant  changes in internal controls or in other factors that could significantly  affect internal controls subsequent to the date of our most recent  evaluation, including any corrective actions with regard to significant deficiencies  and material weaknesses. |

 
|   |              | /s/ James A. Tracy      |   |
|--------|-------------------|-------------------------|--------|
| Dated: | February 11, 2003 | James A Tracy           |
|   |              | Chief Financial Officer |

 

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