SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D. C. 20459




FORM
10-Q




(Mark One)x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended September 30, 2009oro
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
      EXCHANGE ACT OF 1934For
      the transition period
      from                          to




COMMISSION
FILE NUMBER 0-20970




VISION-SCIENCES, INC.


(Exact
name of registrant as specified in its charter)




Delaware
            13-3430173(State
      or other jurisdiction of
              incorporation
      or organization)
            (IRS
      Employer
              Identification
      Number)40
      Ramland Road South, Orangeburg, NY
            10962(Address
      of principal executive offices)
            (Zip
      Code)




(845) 365-0600


(Registrant’s
telephone number, including area code)




None


(Former
name, former address, and


former
fiscal year if changed since last report)




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirement for the past 90 days. Yes x    No o




Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate website, if any every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the Registrant was required to submit
and post such files. Yes o  No  o





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




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




Indicate by check mark whether the
registrant is a shell company (as defined by Rule 12b-2 of the Exchange
Act). Yes o    No x




Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of November 12, 2009




Common
      Stock, par value of $0.01
            36,855,776(Title
      of Class)
            (Number
      of Shares)








VISION-SCIENCES, INC.


TABLE
OF CONTENTS




Part I.
            Financial
      InformationItem 1.
            Financial
      StatementsConsolidated
      Balance Sheets
            3Consolidated
      Statements of Operations
            4Consolidated
      Statement of Stockholders’ Equity
            5Consolidated
      Statements of Cash Flows
            6Notes
      to Consolidated Financial Statements
            7Item 2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            13Item 3.
            Quantitative
      and Qualitative Disclosures about Market Risk
            24Item 4.
            Controls
      and Procedures
            24Part II.
            Other
      InformationItem 1.
            Legal
      Proceedings
            25Item 1A.
            Risk
      Factors
            25Item 2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            25Item 3.
            Defaults
      Upon Senior Securities
            25Item 4.
            Submission
      of Matters to a Vote of Stockholders
            26Item 5.
            Other
      Information
            26Item 6.
            Exhibits
            26Signatures
            27




2


PART
I—FINANCIAL INFORMATION


Item 1:
Financial Statements




Vision-Sciences, Inc.
and Subsidiaries


Condensed
Consolidated Balance Sheets


(In
thousands, except per share amounts)




September
      30,
              
              
              March
      31,2009
              
              
              2009ASSETS
              
              (
      unaudited )Current
      assets:Cash
      and cash equivalents
              
              $
              661
              
              
              $
              1,975Short-term
      investments
              
              
              4,431
              
              
              
              7,948Accounts
      receivable, net of allowance for doubtful accounts of $310and
      $283, respectively
              
              
              1,851
              
              
              
              1,818Inventories,
      net
              
              
              5,349
              
              
              
              5,486Prepaid
      expenses and other current assets
              
              
              404
              
              
              
              397Current
      assets of discontinued operations
              
              
              -
              
              
              
              9Total
      current assets
              
              
              12,696
              
              
              
              17,633Property
      and equipment, at cost:Machinery
      and equipment
              
              
              3,227
              
              
              
              3,069Furniture
      and fixtures
              
              
              226
              
              
              
              132Leasehold
      improvements
              
              
              343
              
              
              
              1633,796
              
              
              
              3,364Less—accumulated
      depreciation and amortization
              
              
              1,878
              
              
              
              1,576Total
      property and equipment, net
              
              
              1,918
              
              
              
              1,788Other
      assets, net of accumulated amortization of $81 and $76,respectively
              
              
              85
              
              
              
              65Total
      assets
              
              $
              14,699
              
              
              $
              19,486LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Capital
      lease obligations
              
              $
              46
              
              
              $
              61Accounts
      payable
              
              
              1,088
              
              
              
              1,014Accrued
      expenses
              
              
              1,807
              
              
              
              1,966Current
      liabilities of discontinued operations
              
              
              -
              
              
              
              6Total
      current liabilities
              
              
              2,941
              
              
              
              3,047Capital
      lease obligations, net of current portion
              
              
              28
              
              
              
              28Total
      liabilities
              
              
              2,969
              
              
              
              3,075Commitments
      and ContingenciesStockholders’
      equity:Preferred
      stock, $0.01 par value—Authorized—5,000
      sharesissued
      and outstanding—none
              
              
              -
              
              
              
              -Common
      stock, $0.01 par value—Authorized—50,000
      sharesissued
      and outstanding—36,854,001 shares and 36,817,941 sharesat
      September 30, 2009 and March 31, 2009, respectively
              
              
              369
              
              
              
              368Additional
      paid-in capital
              
              
              80,987
              
              
              
              80,031Accumulated
      deficit
              
              
              (69,626
              )
              
              
              (63,988
              )Total
      stockholders’ equity
              
              
              11,730
              
              
              
              16,411Total
      liabilities and stockholders’ equity
              
              $
              14,699
              
              
              $
              19,486




See
accompanying notes to consolidated financial statements.


3




Vision-Sciences, Inc.
and Subsidiaries


Condensed
Consolidated Statements of Operations


(In
thousands, except per share amounts)


(Unaudited)




Three
      Months Ended
              
              
              Six
      Months EndedSeptember
      30,
              
              
              September
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Net
      sales
              
              $
              2,889
              
              
              $
              2,785
              
              
              $
              6,207
              
              
              $
              5,481Cost
      of sales
              
              
              2,424
              
              
              
              2,560
              
              
              
              4,954
              
              
              
              4,607Gross
      profit
              
              
              465
              
              
              
              225
              
              
              
              1,253
              
              
              
              874Selling,
      general, and administrative expenses
              
              
              2,707
              
              
              
              2,575
              
              
              
              5,189
              
              
              
              5,266Research
      and development expenses
              
              
              897
              
              
              
              1,514
              
              
              
              1,683
              
              
              
              2,685Restructuring
      charge reversal
              
              
              -
              
              
              
              (126
              )
              
              
              -
              
              
              
              (98
              )Loss
      from operations
              
              
              (3,139
              )
              
              
              (3,738
              )
              
              
              (5,619
              )
              
              
              (6,979
              )Interest
      income
              
              
              21
              
              
              
              72
              
              
              
              71
              
              
              
              151Interest
      expense
              
              
              (46
              )
              
              
              (2
              )
              
              
              (46
              )
              
              
              (16
              )Other,
      net
              
              
              -
              
              
              
              26
              
              
              
              (28
              )
              
              
              26Gain
      on sale of product line, net of direct costs
              
              
              -
              
              
              
              1,755
              
              
              
              -
              
              
              
              4,985Loss
      before provision for income taxes
              
              
              (3,164
              )
              
              
              (1,887
              )
              
              
              (5,622
              )
              
              
              (1,833
              )Provision
      for income taxes
              
              
              6
              
              
              
              -
              
              
              
              16
              
              
              
              9Net
      loss from continuing operations
              
              
              (3,170
              )
              
              
              (1,887
              )
              
              
              (5,638
              )
              
              
              (1,842
              )Net
      loss from discontinued operations
              
              
              -
              
              
              
              (586
              )
              
              
              -
              
              
              
              (774
              )Net
      loss
              
              $
              (3,170
              )
              
              $
              (2,473
              )
              
              $
              (5,638
              )
              
              $
              (2,616
              )Net
      loss per common share - basic and diluted:Continuing
      operations
              
              $
              (0.09
              )
              
              $
              (0.05
              )
              
              $
              (0.15
              )
              
              $
              (0.05
              )Discontinued
      operations
              
              
              -
              
              
              
              (0.02
              )
              
              
              -
              
              
              
              (0.02
              )Net
      loss per common share - basic and diluted
              
              $
              (0.09
              )
              
              $
              (0.07
              )
              
              $
              (0.15
              )
              
              $
              (0.07
              )Shares
      used in computing net lossper
      common share
              
              
              36,854,001
              
              
              
              36,700,766
              
              
              
              36,851,220
              
              
              
              36,012,908






See
accompanying notes to consolidated financial statements.




4




Vision-Sciences, Inc.
and Subsidiaries


Condensed
Consolidated Statements of Stockholders’ Equity


(In
thousands, except per share amounts)


(Unaudited)






Preferred Stock
              
              
              Common Stock
              
              
              Additional
              
              
              
              
              
              TotalNumber
              
              
              $0.01
              
              
              Number
              
              
              $0.01
              
              
              Paid-in
              
              
              Accumulated
              
              
              Stockholders’of Shares
              
              
              Par Value
              
              
              of Shares
              
              
              Par Value
              
              
              Capital
              
              
              Deficit
              
              
              EquityBalance,
      March 31, 2008
              
              
              5,000
              
              
              $
              -
              
              
              
              35,648
              
              
              $
              356
              
              
              $
              77,478
              
              
              $
              (55,763
              )
              
              $
              22,071Exercise
      of stock options
              
              
              -
              
              
              
              -
              
              
              
              1,170
              
              
              
              12
              
              
              
              1,587
              
              
              
              -
              
              
              
              1,599Stock
      based compensationexpense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              966
              
              
              
              -
              
              
              
              966Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (8,225
              )
              
              
              (8,225
              )Balance,
      March 31, 2009
              
              
              5,000
              
              
              
              -
              
              
              
              36,818
              
              
              
              368
              
              
              
              80,031
              
              
              
              (63,988
              )
              
              
              16,411Exercise
      of stock options
              
              
              -
              
              
              
              -
              
              
              
              36
              
              
              
              1
              
              
              
              40
              
              
              
              -
              
              
              
              41Stock
      based compensationexpense
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              916
              
              
              
              -
              
              
              
              916Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (5,638
              )
              
              
              (5,638
              )Balance,
      September 30, 2009
              
              
              5,000
              
              
              $
              -
              
              
              
              36,854
              
              
              $
              369
              
              
              $
              80,987
              
              
              $
              (69,626
              )
              
              $
              11,730




See
accompanying notes to consolidated financial statements.




5


Vision-Sciences, Inc.
and Subsidiaries


Condensed
Consolidated Statements of Cash Flows


(In
thousands)


(Unaudited)




Six
      Months EndedSeptember
      30,2009
              
              
              2008Cash
      flows from operating activities:Net
      loss
              
              $
              (5,638
              )
              
              $
              (2,616
              )Adjustments
      to reconcile net loss to net cash used in operating
    activitiesDepreciation
      and amortization
              
              
              305
              
              
              
              206Gain
      on sale of product line
              
              
              -
              
              
              
              (4,985
              )Stock-based
      compensation expense
              
              
              916
              
              
              
              846Intangible
      assets impairment
              
              
              -
              
              
              
              315Loss
      on investments
              
              
              28
              
              
              
              -Changes
      in assets and liabilities:Accrued
      interest receivable
              
              
              34
              
              
              
              (65
              )Accounts
      receivable
              
              
              (33
              )
              
              
              (783
              )Inventories
              
              
              137
              
              
              
              (2,581
              )Prepaid
      expenses and other current assets
              
              
              22
              
              
              
              104Other
      assets
              
              
              (23
              )
              
              
              22Accounts
      payable
              
              
              74
              
              
              
              (874
              )Accrued
      expenses
              
              
              (165
              )
              
              
              (255
              )Net
      cash used in operating activities
              
              
              (4,343
              )
              
              
              (10,666
              )Cash
      flows from investing activities:Purchase
      of short-term investments
              
              
              (2,572
              )
              
              
              (15,270
              )Proceeds
      from short-term investment sales/maturities
              
              
              5,998
              
              
              
              9,759Purchase
      of property and equipment
              
              
              (431
              )
              
              
              (422
              )Proceeds
      from sale of product line, net of direct costs
              
              
              -
              
              
              
              4,985Net
      cash provided by (used in) investing activities
              
              
              2,995
              
              
              
              (948
              )Cash
      flows from financing activities:Payments
      on capital leases
              
              
              (15
              )
              
              
              (28
              )Exercise
      of stock options
              
              
              41
              
              
              
              1,591Net
      cash provided by financing activities
              
              
              26
              
              
              
              1,563Net
      decrease in cash and cash equivalents
              
              
              (1,322
              )
              
              
              (10,051
              )Cash
      and cash equivalents from continuing operations, beginning of
      period
              
              $
              1,975
              
              
              $
              10,655Cash
      and cash equivalents from discontinued operations, beginning of
      period
              
              
              8
              
              
              
              -Cash
      and cash equivalents from continuing operations, end of
    period
              
              $
              661
              
              
              $
              604Supplemental
      disclosure of cash flow information:Cash
      paid during the period for interest
              
              $
              -
              
              
              $
              16Cash
      paid during the period for income taxes
              
              $
              16
              
              
              $
              9




See
accompanying notes to consolidated financial statements.




6




VISION-SCIENCES, INC.
AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited,
in thousands except per share amounts)




Note
1.       Basis of Presentation




Vision-Sciences, Inc.
and subsidiaries (the “Company” – which may be referred to as “our”, “us” or
“we”) have prepared the consolidated financial statements included here
according to generally accepted accounting principles in the United States of
America (“U.S. GAAP”), without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission (“SEC”) and include, in the opinion of
management, all adjustments that we consider necessary for a fair presentation
of such information.  We have condensed or omitted certain information
and footnote disclosures normally included in financial statements pursuant to
those rules and regulations. We believe, however, that our disclosures are
adequate to make the information presented not misleading. The results for the
interim periods presented are not necessarily indicative of results to be
expected for the full fiscal year. Please read these consolidated financial
statements in conjunction with the consolidated financial statements and the
notes thereto included in our Annual Report on Form 10-K for the fiscal
year ended March 31, 2009.





The
condensed consolidated statements of operations for the three and six months
ended September 30, 2008 have been reclassified to reflect discontinued
operations. Events subsequent to September 30, 2009 were evaluated until the
time of the filing of this Form 10-Q with the SEC on November 12,
2009.





Note
2.       Summary of Significant Accounting
Policies





Our
consolidated financial statements are prepared in accordance with U.S. GAAP.
These accounting principles require us to make certain estimates, judgments and
assumptions. We believe that the estimates, judgments and assumptions upon which
we rely are reasonable, based upon information available to us at the time that
these estimates, judgments and assumptions are made. These estimates, judgments
and assumptions can affect the reported amounts of assets and liabilities as of
the date of the financial statements as well as the reported amounts of revenues
and expenses during the periods presented. To the extent there are any
differences (other than nominal differences) between these estimates, judgments
or assumptions and actual results, our financial statements will be affected.
The accounting policies that reflect our more significant estimates, judgments
and assumptions and which we believe are the most critical to aid in fully
understanding and evaluating our reported financial results include the
following:





• Revenue
recognition


•
Accounting for income taxes


• Other
contingencies


•
Stock-based compensation expense


•
Allowances for doubtful accounts


•
Inventory obsolescence reserves





The
accompanying condensed consolidated financial statements reflect the accounts of
the Company. All significant inter-company accounts and transactions have been
eliminated in consolidation.





In many
cases, the accounting treatment of a particular transaction is specifically
dictated by U.S. GAAP and does not require management’s judgment in its
application. There are also areas in which management’s judgment in selecting
among available alternatives would not produce a materially different result.
Management has reviewed these critical accounting policies and related
disclosures with the Audit Committee of the Board of Directors (the
“Board”).





During
the first six months of fiscal 2010, there were no significant changes in our
critical accounting policies and estimates. You should refer to Critical Accounting Policies and
Estimates in Part IV, Page F-6 of our Annual Report on
Form 10-K for the fiscal year ended March 31, 2009 for a more complete
discussion of our critical accounting policies and estimates.





Recently
Adopted Accounting Standards





In June
2009, the Financial Accounting Standards Board (the “FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – A
Replacement of FAS Statement No. 162(“SFAS 168”). SFAS 168 made the FASB
Accounting Standards Codification (the “Codification”) the single source of U.S.
GAAP used by nongovernmental entities in the preparation of financial
statements, except for rules and interpretive releases of the SEC under
authority of federal securities laws, which are sources of authoritative
accounting guidance for SEC registrants. The Codification is meant to simplify
user access to all authoritative accounting guidance by reorganizing U.S. GAAP
pronouncements into roughly 90 accounting topics within a consistent structure;
its purpose is not to create new accounting and reporting guidance. The
Codification supersedes all existing non-SEC accounting and reporting standards
and was effective for us beginning July 1, 2009. The adoption of the
Codification changed our references to U.S. GAAP accounting standards, but did
not impact our results of operations, financial position, or
liquidity.





7


Accounting
Standards Updates Not Yet Effective





In August
2009, the FASB issued Accounting Standards Update No. 2009-05 (“ASC Update
2009-05”), an update to Accounting Standards Codification (“ASC”) 820 (Topic
820, Fair Value Measurements
and Disclosures). This update provides amendments to reduce potential
ambiguity in financial reporting when measuring the fair values of liabilities.
Among other provisions, this update provides clarification that in circumstances
in which a quoted price in an active market for the identical liability is not
available, a reporting entity is required to measure fair value using one or
more of the valuation techniques described in ASC Update 2009-05. ASC Update
2009-05 will become effective for our interim consolidated financial statements
for the quarter ended December 31, 2009 (our third quarter of fiscal 2010). We
do not expect that the provisions of the update will have a material effect on
our results of operations, financial position, or liquidity.





Note
3.       Inventories





Inventories
are stated at the lower of cost or market using the first-in, first-out (“FIFO”)
method and consist of the following:




September
      30,
              
              
              March
      31,2009
              
              
              2009Raw
      materials
              
              $
              4,342
              
              
              $
              4,253Work-in-process
              
              
              454
              
              
              
              369Finished
      goods
              
              
              553
              
              
              
              864$
              5,349
              
              
              $
              5,486




Raw
materials include components purchased from independent suppliers. Most
purchased components are available from multiple sources. However, some
components are available only from a limited number of suppliers, and several
key components are supplied to us by single source suppliers, with whom we have
long-term supply arrangements, but no long-term supply agreements.





Note
4.       Financial Instruments





Short-Term
Investments





We
classify investments with original maturities of greater than 90 days in
certificates of deposit, corporate bonds, and government securities as
short-term investments. We intend to hold these investments to maturity. Our
short-term investments are carried at amortized cost in our condensed
consolidated balance sheets.





The
following table summarizes these securities classified as held to
maturity.




September
      30, 2009
              
              
              March 31,
      2009Held
      to maturity less than one year:
              
              Fair
      Value
              
              
              Cost
              
              
              Fair
      Value
              
              
              CostCertificates
      of deposit
              
              $
              3,496
              
              
              $
              3,504
              
              
              $
              4,262
              
              
              $
              4,299Corporate
      bonds
              
              
              801
              
              
              
              802
              
              
              
              2,768
              
              
              
              2,875Government
      securities
              
              
              125
              
              
              
              125
              
              
              
              774
              
              
              
              774Total
      short-term investments
              
              $
              4,422
              
              
              $
              4,431
              
              
              $
              7,804
              
              
              $
              7,948


Fair
Value Measurements





The
carrying amounts reflected in our condensed consolidated balance sheets for cash
and cash equivalents, accounts receivable, other current assets, accounts
payable, accrued expenses, and capital lease obligations approximate fair value
due to their short-term nature.





Note
5.       Stock-Based Awards




Stock
Option Plans





Our first
stock option plan (the “1990 Plan”) allowed us to grant key employees and
consultants incentive and non-statutory stock options at the fair value of the
stock on the date of grant. Options became exercisable at varying dates ranging
up to five years from the date of grant. The Board had authorized the issuance
of options for the purchase of up to 4,375,000 shares of common stock under the
1990 Plan. This plan expired in 2001 and was replaced with the 2000 Plan. The
terms of the 2000 Plan are substantially the same as the 1990 Plan. Under the
2000 Plan, the Board and our stockholders authorized the issuance of options for
the purchase of up to 4,500,000 shares of common stock of which 45,583 shares
remain available for future grants as of September 30, 2009. We do not grant any
new options under the 1990 Plan.




8


In August
2007, our stockholders approved our 2007 Stock Incentive Plan (the “2007 Plan”).
Under the 2007 Plan, we are authorized to issue options for the purchase of up
to 4,000,000 shares of common stock. The terms of the 2007 Plan are
substantially the same as the 2000 Plan. Under the 2007 Plan, we grant options
to both employees and consultants with vesting periods ranging from immediate to
six years. As of September 30, 2009, there remain 1,381,338 shares available for
future grants under the 2007 Plan.





In July
2003, we adopted, and our stockholders approved, the 2003 Director Option Plan,
which was amended in August 2008 (the “Amended 2003 Plan”). The Amended 2003
Plan increased the annual automatic grant from 4,000 options to 10,000 options
per outside director per year, and increased the maximum number of options
available under the Amended 2003 Plan from 200,000 to 450,000. The automatic
grant is issued at the annual shareholder’s meeting, typically held in September
of each year. During each of our 2008 and 2009 annual meetings held in August
2008 and September 2009, respectively, 10,000 options were granted to each of
our then and current five outside directors. If the number of outside directors
remains unchanged, we would be required to grant options to purchase an
aggregate of 50,000 shares at each of the annual shareholder’s meeting scheduled
for September 2010.





The
Amended 2003 Plan also provides for granting newly elected outside directors a
one-time grant of 10,000 options. In May and June 2009, two outside directors
resigned for personal reasons and were replaced by two new outside directors.
Accordingly, in July 2009, the two new outside directors were each granted
10,000 options. As of September 30, 2009, there remain 282,000 shares available
for future grants under the Amended 2003 Plan.





Stock-Based
Compensation Expense




We
account for stock-based awards issued to employees in accordance with the
provisions of ASC 718 (Topic 718, Compensation – Stock
Compensation). We recognize stock-based compensation expense on a
straight-line uniform basis over the service period of the award, which is
generally four years for employees. Stock-based awards issued to consultants are
accounted for in accordance with the provisions of ASC 718 and ASC 505-50
(Subtopic 50 “Equity-Based Payments to Non-Employees” of Topic 505, Equity). Options granted to
consultants are periodically revalued as the options vest, and are recognized as
an expense over the related period of service or the vesting period, whichever
is longer.





We are
required to estimate the stock awards that we ultimately expect to vest and to
reduce stock-based compensation expense for the effects of estimated forfeitures
of awards over the expense recognition period. Although we estimate forfeitures
based on historical experience, actual forfeitures in the future may differ. In
addition, to the extent our actual forfeitures are different than our estimates,
we record a true-up for the difference in the period that the awards vest, and
such true-ups could materially affect our operating results.





In
determining whether an award is expected to vest, we use an estimated,
forward-looking forfeiture rate based upon our historical forfeiture rates.
Stock-based compensation expense recorded using an estimated forfeiture rate is
updated for actual forfeitures quarterly. We also consider, each quarter,
whether there have been any significant changes in facts and circumstances that
would affect our forfeiture rate.





We
recorded stock-based compensation expense for the three and six months ended
September 30, 2009 and 2008 in the condensed consolidated statement of
operations as follows:




Three
      Months Ended
              
              
              Six
      Months EndedSeptember
      30,
              
              
              September
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Cost
      of sales
              
              $
              130
              
              
              $
              58
              
              
              $
              203
              
              
              $
              71Selling,
      general, and administrative expenses
              
              
              466
              
              
              
              261
              
              
              
              646
              
              
              
              378Research
      and development expenses
              
              
              (1
              )
              
              
              358
              
              
              
              67
              
              
              
              397Total
      stock-based compensation expense
              
              $
              595
              
              
              $
              677
              
              
              $
              916
              
              
              $
              846




The fair
value of the stock options granted was estimated on the date of grant using a
Black-Scholes valuation model that used the assumptions noted in the following
table. The risk-free interest rate assumption we use is based upon United States
Treasury interest rates appropriate for the expected life of the awards. The
expected life (estimated period of time that we expect employees, consultants
and directors to hold their stock options) was estimated based on historical
rates for two group classifications, (i) employees and consultants and (ii)
outside directors. Expected volatility was based on historical volatility of our
stock price for a period equal to the stock option’s expected life and
calculated on a daily basis. The expected dividend rate is zero since we do not
currently pay cash dividends on our common stock and do not anticipate doing so
in the foreseeable future. Under the provisions of ASC 718, members of the Board
are considered employees for calculation of stock-based compensation
expense.





9
 
 Three
      Months Ended
                
                Six
      Months EndedSeptember
      30,
                
                September
      30,2009
                
                2008
                
                2009
                
                2008Risk-free
      interest rate
                
                2.75%
                
                2.95%
                
                2.46%
                
                3.07%Expected
      life (in years)
                
                6.25
                
                6.25
                
                6.24
                
                6.25Expected
      volatility
                
                88%
                
                79%
                
                87%
                
                78%Expected
      dividend yield
                
                --
                
                --
                
                --
                
                --


A summary
of our stock options activity for the six months ended September 30, 2009 was as
follows:




Weighted
      Avg.RemainingNumber
              
              Exercise
              
              Weighted
      Avg.
              
              Contractual
      Lifeof
      Shares
              
              Price
      Range
              
              Exercise
      Price
              
              in
      YearsOutstanding,
      March 31, 2009
              
              5,940,694
              
              $
      0.79–$ 5.10
              
              $2.04
              
              6.61Granted
              
              798,636
              
              $
      0.85–$ 1.50
              
              1.19Exercised
              
              (36,060)
              
              $1.12
              
              1.12Canceled
              
              (343,986)
              
              $
      0.98–$ 4.88
              
              2.03Outstanding,
      September 30,  2009
              
              6,359,284
              
              $
      0.79–$ 5.10
              
              $1.94
              
              6.57Vested
      and expected to vest, September 30, 2009
              5,547,422
              
              $
      0.79–$ 5.10
              
              $1.86
              
              6.27Exercisable,
      September 30, 2009
              
              3,858,681
              
              $
      0.79–$ 5.10
              
              $1.64
              
              5.13


At
September 30, 2009, unrecognized stock-based compensation expense related to
stock options was approximately $2.4 million and is expected to be recognized
over a weighted average period of approximately 2.7 years.





The
weighted average fair value of options granted during the three months ended
September 30, 2009 and 2008 was $0.87 and $2.59 per share, respectively. The
weighted average fair value of options granted during the six months ended
September 30, 2009 and 2008 was $0.88 and $2.74 per share,
respectively.





The total
intrinsic value (the excess of the market price over the exercise price) was
approximately $1.1 million for stock options outstanding, $0.8 million for stock
options exercisable, and $1.0 million for stock options vested and expected to
vest as of September 30, 2009. The total intrinsic value for stock options
exercised during the three months ended September 30, 2008 was approximately
$0.2 million. There were no stock options exercised during the three months
ended September 30, 2009. The total intrinsic value for stock options exercised
during the six months ended September 30, 2009 and 2008 was approximately $6
thousand and $2.5 million, respectively.





We do not
expect to realize any tax benefits from future disqualifying dispositions, if
any, because we currently have a full valuation allowance against our deferred
tax assets.





Note
6.     Discontinued Operations




During
the third quarter of fiscal 2009, we sold the assets of BEST DMS Inc.
(“BEST-DMS”) to Ghiglieri Winchester Inc., the successor to Best Dysphasia
Management Services, Inc. This transaction was signed on November 7,
2008, closed on November 10, 2008, and was effective October 28, 2008.
BEST-DMS formerly constituted our health services segment.




In
accordance with the provisions of ASC 205-20 (Subtopic 20 “Discontinued
Operations” of Topic 205, Presentation of Financial
Statements), we classified the BEST-DMS assets that were sold as
discontinued operations for all periods presented. Accordingly, depreciation and
amortization associated with those assets was discontinued. Additionally, since
all assets were part of the health services segment, we determined that these
assets comprised operations and cash flows that can be clearly distinguished,
operationally and for financial reporting purposes, from the rest of our
operations.





Net sales
and pretax loss from discontinued operations for the three and six months ended
September 30, 2008 are shown below. There was no impact for discontinued
operations in our condensed consolidated statement of operations for the current
fiscal year.




Net
      Sales
              
              
              Pretax
      LossThree
      months ended September 30, 2008
              
              $
              268
              
              
              $
              (586
              )Six
      months ended September 30, 2008
              
              $
              501
              
              
              $
              (774
              )







10


Note
7.     Segment Information





We
design, develop, manufacture, and market products for endoscopy in two
reportable segments, medical and industrial.





Our
medical segment designs, manufactures, and sells our advanced line of
endoscopy-based products, including our state-of-the-art flexible endoscopes and
our Slide-On EndoSheath® technology, for a variety of specialties and
markets.





Our
industrial segment, through our wholly-owned subsidiary, Machida, Inc.
(“Machida”), designs, manufactures, and sells borescopes to a variety of users,
primarily in the aircraft engine-manufacturing and aircraft engine-maintenance
industries. A borescope is an instrument that uses optical fibers for the visual
inspection of narrow cavities.





Our two
current reportable segments follow the accounting policies described in the
Critical Accounting Policies
and Estimatessection of our Form 10-K for fiscal 2009, on page F-6. We
evaluate segment performance based upon operating income. Identifiable assets
are those used directly in the operations of each segment and general corporate
assets, such as cash and short-term investments are allocated to each
segment.





11


The
following table presents key financial highlights, by reportable
segments:




ContinuingThree
      months ended September 30,
              
              Medical
              
              
              Industrial
              
              
              Adjustments
      *
              
              
              Operations2009Sales
      to external customers
              
              $
              2,248
              
              
              $
              641
              
              
              $
              -
              
              
              $
              2,889Gross
      profit
              
              
              293
              
              
              
              172
              
              
              
              -
              
              
              
              465Operating
      loss
              
              
              (3,066
              )
              
              
              (73
              )
              
              
              -
              
              
              
              (3,139
              )Interest
      expense, net
              
              
              (25
              )
              
              
              -
              
              
              
              -
              
              
              
              (25
              )Depreciation
      and amortization
              
              
              150
              
              
              
              5
              
              
              
              -
              
              
              
              155Stock-based
      compensation
              
              
              539
              
              
              
              56
              
              
              
              -
              
              
              
              595Total
      assets
              
              
              15,625
              
              
              
              2,268
              
              
              
              (3,194
              )
              
              
              14,699Expenditures
      for fixed assets
              
              
              241
              
              
              
              -
              
              
              
              -
              
              
              
              2412008Sales
      to external customers
              
              $
              2,141
              
              
              $
              644
              
              
              $
              -
              
              
              $
              2,785Gross
      profit
              
              
              (107
              )
              
              
              332
              
              
              
              -
              
              
              
              225Operating
      (loss) income
              
              
              (3,833
              )
              
              
              95
              
              
              
              -
              
              
              
              (3,738
              )Interest
      income, net
              
              
              70
              
              
              
              -
              
              
              
              -
              
              
              
              70Depreciation
      and amortization
              
              
              82
              
              
              
              8
              
              
              
              -
              
              
              
              90Stock-based
      compensation
              
              
              677
              
              
              
              -
              
              
              
              -
              
              
              
              677Total
      assets
              
              
              26,152
              
              
              
              2,761
              
              
              
              (4,082
              )
              
              
              24,831Expenditures
      for fixed assets
              
              
              5
              
              
              
              -
              
              
              
              -
              
              
              
              5Six
      months ended September 30,2009Sales
      to external customers
              
              $
              4,853
              
              
              $
              1,354
              
              
              $
              -
              
              
              $
              6,207Gross
      profit
              
              
              733
              
              
              
              520
              
              
              
              -
              
              
              
              1,253Operating
      (loss) income
              
              
              (5,682
              )
              
              
              63
              
              
              
              -
              
              
              
              (5,619
              )Interest
      income, net
              
              
              25
              
              
              
              -
              
              
              
              -
              
              
              
              25Depreciation
      and amortization
              
              
              295
              
              
              
              10
              
              
              
              -
              
              
              
              305Stock-based
      compensation
              
              
              846
              
              
              
              70
              
              
              
              -
              
              
              
              916Expenditures
      for fixed assets
              
              
              431
              
              
              
              -
              
              
              
              -
              
              
              
              4312008Sales
      to external customers
              
              $
              4,141
              
              
              $
              1,340
              
              
              $
              -
              
              
              $
              5,481Gross
      profit
              
              
              371
              
              
              
              503
              
              
              
              -
              
              
              
              874Operating
      (loss) income
              
              
              (7,032
              )
              
              
              53
              
              
              
              -
              
              
              
              (6,979
              )Interest
      income, net
              
              
              135
              
              
              
              -
              
              
              
              -
              
              
              
              135Depreciation
      and amortization
              
              
              163
              
              
              
              17
              
              
              
              -
              
              
              
              180Stock-based
      compensation
              
              
              846
              
              
              
              -
              
              
              
              -
              
              
              
              846Expenditures
      for fixed assets
              
              
              398
              
              
              
              -
              
              
              
              -
              
              
              
              398September
      30,*
      Adjustments
              
              2009
              
              
              2008Intercompany
      eliminations
              
              $
              (1,779
              )
              
              $
              (2,667
              )Investment
      in subsidiaries
              
              
              (1,415
              )
              
              
              (1,415
              )Total
      assets
              
              $
              (3,194
              )
              
              $
              (4,082
              )




Note
8.     Subsequent Events





On
November 9, 2009, we entered into a three-year $5.0 million revolving loan
agreement (the “Loan”) with our Chairman, Lewis C. Pell (the “Lender”). Any
amounts drawn against the Loan (an “Advance”) accrue interest at a per annum
rate of 7.5%. The Lender will receive an availability fee equal to a per annum
rate of 0.5% on the unused portion of the Loan calculated based on the
difference between the average annual principal amount of the outstanding
Advances under the Loan and the maximum advance of $5.0 million. The
availability of advances under the Loan is subject to customary conditions.
Subject to the terms of the Loan, we will be required to prepay all amounts
outstanding under the Loan in the event of a change of control of the Company
and we will be required to prepay part or all of the amounts outstanding in the
event we secure other financing or consummate a sale or license of assets, in
each case resulting in net proceeds of $5.0 million or greater.





12


In
addition, the Lender will receive two five-year warrants to purchase an
aggregate of up to 651,515 shares of our common stock. The first warrant (the
“Initial Warrant Shares”) to purchase up to 272,727 shares of our common stock
at an exercise price of $1.375 per share (representing 7.5% warrant coverage, or
approximately 0.7% of our outstanding common stock) is immediately vested upon
issuance. The second warrant (the “Additional Warrant Shares”) to purchase up to
an additional 378,788 shares of our common stock at an exercise price of $1.65
per share (representing up to an additional 12.5% warrant coverage, or
approximately 1.0% of our outstanding common stock) vests at the time that each
Advance is made in an amount equal to (i) the product of the amount of the
Additional Warrant Shares multiplied by (ii) a ratio, (A) the numerator of which
shall be the amount of the new Advance and (B) the denominator of which shall be
$5.0 million.




On
November 8, 2009, the Board received the resignation, effective immediately, of
Mr. Ron Hadani as our President and Chief Executive Officer and as a member of
the Board. Mr. Hadani resigned due to personal reasons and his resignation was
not caused by any disagreement with us or the management or the Board. In
connection with Mr. Hadani’s resignation, we have offered Mr. Hadani certain
severance payments and other benefits.





On
November 9, 2009, the Board appointed Mr. Warren Bielke, age 62, a current
member of the Board to serve, effective immediately, as Interim Chief Executive
Officer (“Interim CEO”), until the earlier of his resignation or such time as a
Chief Executive Officer is selected by the Board. Mr. Bielke will continue to
serve as a member on the Board. Mr. Bielke has served as a member of the Board
since 2005, served on the Audit Committee until April 2009 and, until his
appointment as Interim CEO, served as a consultant to us managing our sales and
marketing efforts. Mr. Bielke served as a consultant to us pursuant to a
Consulting Agreement between Mr. Bielke and us effective April 7, 2009 and filed
with the SEC as an exhibit to our Annual Report on Form 10-K for the fiscal
year ended March 31, 2009. This Consulting Agreement will be terminated in
connection with his role as Interim CEO.





In
connection with Mr. Bielke’s position as Interim CEO, we entered into an
Employment Agreement, effective November 9, 2009, with Mr. Bielke, pursuant to
which he will be entitled to receive a base salary of $255,000 per year, a
performance-based incentive compensation as determined by the Compensation
Committee of the Board, and certain other benefits. Upon entering into the
Employment Agreement and with respect to each three month period of employment,
Mr. Bielke will be granted an immediately vested option to purchase 100,000
shares of our common stock in accordance with our 2007 Plan.





On
November 9, 2009, we issued a press release announcing the resignation of Mr.
Hadani and the appointment of Mr. Bielke as Interim CEO.





Item 2.  Management’s
Discussion and Analysis of Financial Condition and Results of
Operations





Forward
Looking Statements





This
Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of The Private Securities Litigation Reform Act of 1995, which are
subject to various risks and uncertainties that could cause our actual results
to differ materially from those expressed or implied in such statements. Such
factors include, but are not limited to, further weakening of economic
conditions that could adversely affect the level of demand for our products;
pricing pressures, including cost-containment measures which could adversely
affect the price of, or demand for, our products; availability of parts on
acceptable terms; our ability to design new products and the success of such new
products, renewing our exclusive distribution agreement with Medtronic Xomed,
Inc. on acceptable terms, changes in foreign exchange markets; changes in
financial markets and changes in the competitive environment. Examples of
forward-looking statements include statements about expectations about future
financial results, future products and future sales of new and existing
products, future expenditures, and capital resources to meet anticipated
requirements. Generally, words such as “expect” “believe”, “anticipate”, “may”,
“will”, “plan”, “intend”, “estimate”, “could”, and other similar expressions are
intended to identify forward-looking statements. The forward-looking statements
are based on our future plans, strategies, projections and predictions and
involve risks and uncertainties, and our actual results may differ significantly
from those discussed in the forward-looking statements. Factors that might cause
such a difference could include the availability of capital resources; the
availability of third-party reimbursement; government regulation; the
availability of raw material components; our dependence on certain distributors
and customers; competition; technological difficulties; general economic
conditions and other risks detailed in this Quarterly Report on Form 10-Q
and any subsequent periodic filings we make with the Securities and Exchange
Commission (“SEC”). While we believe the assumptions underlying such
forward-looking statements are reasonable, there can be no assurance that future
events or developments will not cause such statements to be inaccurate. All
forward-looking statements contained in this report are qualified in their
entirety by this cautionary statement. We do not undertake an obligation to
update our forward-looking statements to reflect future events or
circumstances.





Registered
Trademarks, Trademarks and Service Marks




Vision-Sciences, Inc.
owns the registered trademarks Vision Sciences®,
Slide-On®,
EndoSheath®, and
The Vision System®. Not
all products referenced in this report are approved or cleared for sale,
distribution, or use.





13


Executive
Summary





We
design, develop, manufacture, and market products for endoscopy - the science of
using an instrument, known as an endoscope - to provide minimally invasive
access to areas not readily visible to the human eye. We operate in two
segments, medical and industrial. Our medical segment designs, manufactures, and
sells our advanced line of endoscopy-based products, including our
state-of-the-art flexible fiber and video endoscopes and our Slide-On EndoSheath
technology, for a variety of specialties and markets. Our industrial
segment, through
our wholly-owned subsidiary, Machida, Inc. (“Machida”), designs, manufactures,
and sells borescopes to a variety of users, primarily in the aircraft
engine-manufacturing and aircraft engine-maintenance industries. A borescope is
an instrument that uses optical fibers for the visual inspection of narrow
cavities.





Within
our medical segment we target four main areas for our fiber and video endoscopes
and our EndoSheath technology: ENT (ear, nose and throat), urology,
gastroenterology (“GI”), and pulmonology. Within the ENT area, we manufacture
ENT endoscopes and sell these scopes exclusively to Medtronic Xomed, Inc., the
ENT subsidiary of Medtronic, Inc. (“Medtronic”) for use by ENT physicians. Our
TNE (trans-nasal esophagoscopy) endoscopes are manufactured by us, and are
marketed to ENT and GI physicians. The TNE endoscopes, which are sold to the ENT
physicians, are marketed and distributed by Medtronic.  Within the
urology area, we manufacture, market, and sell our cystoscopes and EndoSheath
technology to urologists and other urology-gynecology related
physicians.  Within the GI area, we manufacture, market, and sell our
TNE scopes and EndoSheath technology to GI physicians, primary care physicians,
and others with a GI focus as part of their practice. We manufacture, market,
and sell our recently released bronchoscope (an endoscope that allows detailed
viewing of the lungs) and EndoSheath technology for bronchoscopy to
pulmonologists, oncologists, thoracic surgeons, and other pulmonology-related
physicians.





New
Product Releases




In the
first quarter of fiscal 2010, we began commercial manufacturing and sales of our
newly developed line of ENT-4000 products, a new line of products incorporating
state-of-the-art fiber optic technology to replace the ENT-2000, a standard
scope for office and hospital based laryngeal care, and the ENT-3000, a portable
laryngoscope utilizing a battery-powered LED light source.




In the
first quarter of fiscal 2010, we also initiated commercial manufacturing and
sales of the BRS-5000, our new, digital, video-based flexible bronchoscope (an
endoscope which allows detailed viewing of the lungs), which is utilized with
our EndoSheath technology. The BRS-5000 is a CCD-based video imaging endoscopy
system, which includes an integrated built-in LED light source and operates with
our streamlined, multi-functional 5000-Series processor. This streamlined
video-based system eliminates the need for a separate camera head, light source
and video monitor. It is marketed to pulmonologists, oncologists, thoracic
surgeons, and other pulmonology-related physicians.





Results
of Operations





Net sales
by market and by category for the three and six months ended September 30, 2008
have been reclassified to conform to the current year’s
presentation.





Three
months ended September 30, 2009 compared to the three months ended
September 30, 2008 (in thousands, except percentages)





Net
Sales





Net sales
increased $0.1 million, or 4%, in the second quarter of fiscal 2010 to $2.9
million compared to $2.8 million in the second quarter of fiscal 2009. During
the second quarter of fiscal 2010, our medical segment’s net sales of $2.2
million increased by $0.1 million, or 5%, while our industrial segment’s net
sales of $0.6 million remained flat compared to the same period last
year.





In the
medical segment, we track sales of endoscopes and EndoSheath disposables by
market. We also track sales of peripherals and accessories which can be sold to
more than one market. Sales by segment, market, and by category for the three
months ended September 30, 2009 and 2008 were as follows:




Three
      Months EndedSeptember
      30,Market/Category
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageENT
      and TNE
              
              $
              1,007
              
              
              $
              1,249
              
              
              $
              (242
              )
              
              
              -19
              %Urology
              
              
              520
              
              
              
              718
              
              
              
              (198
              )
              
              
              -28
              %Bronchoscopy
              
              
              136
              
              
              
              -
              
              
              
              136
              
              
              
              100
              %Repairs,
      peripherals, and accessories
              
              
              585
              
              
              
              174
              
              
              
              411
              
              
              
              236
              %Total
      medical sales
              
              $
              2,248
              
              
              $
              2,141
              
              
              $
              107
              
              
              
              5
              %Borescopes
              
              
              411
              
              
              
              446
              
              
              
              (35
              )
              
              
              -8
              %Repairs
              
              
              230
              
              
              
              198
              
              
              
              32
              
              
              
              16
              %Total
      industrial sales
              
              $
              641
              
              
              $
              644
              
              
              $
              (3
              )
              
              
              0
              %Total
    sales
              
              $
              2,889
              
              
              $
              2,785
              
              
              $
              104
              
              
              
              4
              %




14




Medical
      Segment




Medical
      Segment – ENT and TNE Markets




Sales to
the ENT and TNE markets include both our ENT and TNE endoscopes and EndoSheath
disposables and were as follows:




Three
      Months EndedSeptember
      30,ENT/TNE
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              974
              
              
              $
              1,231
              
              
              $
              (257
              )
              
              
              -21
              %Slide-On
      EndoSheaths
              
              
              33
              
              
              
              18
              
              
              
              15
              
              
              
              83
              %Total
      ENT/TNE market
              
              $
              1,007
              
              
              $
              1,249
              
              
              $
              (242
              )
              
              
              -19
              %




Net sales
to the ENT and TNE markets decreased $0.2 million, or 19%, in the second quarter
of fiscal 2010 to $1.0 million compared to $1.2 million in the second quarter of
fiscal 2009. The decrease in net sales was primarily attributable to a lower
sales to Medtronic  of our fiberscopes ($0.1 million) and digital
processing units, a component of our videoscope product line ($0.2 million),
which was partially offset by increased sales of our videoscopes ($0.1
million).
  Medical
Segment – Urology Market







Sales to
the urology market include urology endoscopes and EndoSheath disposables and
were as follows:




Three
      Months EndedSeptember
      30,Urology
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              176
              
              
              $
              473
              
              
              $
              (297
              )
              
              
              -63
              %Slide-On
      EndoSheaths
              
              
              344
              
              
              
              245
              
              
              
              99
              
              
              
              40
              %Total urology market
              
              $
              520
              
              
              $
              718
              
              
              $
              (198
              )
              
              
              -28
              %




Net sales
to the urology market decreased $198 thousand, or 28%, in the second quarter of
fiscal 2010 to $520 thousand compared to $718 thousand in the second quarter of
fiscal 2009. The second quarter of fiscal 2009 benefited from initial orders for
videoscopes from our then-independent sales representatives and international
distributors ($306 thousand), which were not repeated in the current fiscal
year. Higher international sales of our EndoSheath disposables partially offset
the decrease in net sales of urology endoscopes ($85 thousand).





Medical
Segment – Bronchoscopy Market





Sales to
the bronchoscopy market include bronchoscopy endoscopes and EndoSheath
disposables and were as follows:




Three
      Months EndedSeptember
      30,Bronchoscopy
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              131
              
              
              $
              -
              
              
              $
              131
              
              
              
              100
              %Slide-On
      EndoSheaths
              
              
              5
              
              
              
              -
              
              
              
              5
              
              
              
              100
              %Total bronchoscopy
      market
              
              $
              136
              
              
              $
              -
              
              
              $
              136
              
              
              
              100
              %




In the
first quarter of fiscal 2010, we launched our video bronchoscope (an endoscope
that allows detailed viewing of the lungs) and EndoSheath technology for
bronchoscopy to pulmonologists, oncologists, thoracic surgeons, and other
pulmonology-related physicians.





Medical
      Segment – Repairs, Peripherals, and
Accessories




Net sales
of repairs, peripherals, and accessories increased $411 thousand, or 236%, in
the second quarter of fiscal 2010 to $585 thousand compared to $174 thousand in
the second quarter of fiscal 2009. The increase was primarily attributable to
higher repairs sales ($69 thousand) and higher sales volume of peripherals and
accessories for our ENT endoscopes ($342 thousand).





15


Industrial
      Segment




Net sales
of industrial products remained relatively flat in the second quarter of fiscal
2010 at $641 thousand compared to $644 thousand in the second quarter of fiscal
2009. This segment’s products are mature, and therefore, we expect future sales
to remain relatively flat.




Gross
Profit




Gross
profit, measured as net sales less cost of sales, was as follows:




Three
      Months EndedSeptember
      30,Gross
      profit
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageMedical
              
              $
              293
              
              
              $
              (107
              )
              
              $
              400
              
              
              
              374
              %As
      percentage of sales
              
              
              13
              %
              
              
              -5
              %
              
              
              18
              %Industrial
              
              
              172
              
              
              
              332
              
              
              
              -160
              
              
              
              -48
              %As
      percentage of sales
              
              
              27
              %
              
              
              52
              %
              
              
              -25
              %Total
      gross profit
              
              $
              465
              
              
              $
              225
              
              
              $
              240
              
              
              
              107
              %As
      percentage of sales
              
              
              16
              %
              
              
              8
              %
              
              
              8
              %




Gross
profit increased $240 thousand, or 107%, in the second quarter of fiscal 2010 to
$465 thousand, or 16% of net sales, compared to $225 thousand, or 8% of net
sales, in the second quarter of fiscal 2009. In the medical segment, gross
profit in the second quarter of fiscal 2009 reflected the start-up costs
associated with manufacturing our videoscope line of products. We achieved an
improved gross profit for our videoscope family of products in the second
quarter of fiscal 2010 as net sales for these products increased by $113
thousand, or 26%, compared to the same period last year. We have put into place
continuous improvements for our videoscope line of products, which we believe
should result in improved gross margins across our entire family of products. In
the industrial segment, gross profit decreased $160 thousand, or 48%, in the
second quarter of fiscal 2010 to $172 thousand compared to $332 thousand in the
second quarter of fiscal 2009. The decrease was primarily attributable to
unfavorable labor and overhead absorption ($37 thousand) and lower borescope
sales ($35 thousand).





Operating
Expenses





Total
operating expenses decreased $0.4 million, or 9%, in the second quarter of
fiscal 2010 to $3.6 million compared to $4.0 million in the second quarter of
fiscal 2009. Selling, general, and administrative (“SG&A”) expenses
increased $0.1 million, or 5%, and research and development (“R&D”) expenses
decreased $0.6 million, or 41%.





Operating
expenses, by segment, were as follows:




Three
      Months EndedSeptember
      30,Operating
      expenses
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageSG&AMedical
              
              $
              2,462
              
              
              $
              2,338
              
              
              $
              124
              
              
              
              5
              %Industrial
              
              
              245
              
              
              
              237
              
              
              
              8
              
              
              
              3
              %Total
      SG&A
              
              
              2,707
              
              
              
              2,575
              
              
              
              132
              
              
              
              5
              %R&D
      Medical
              
              
              897
              
              
              
              1,514
              
              
              
              (617
              )
              
              
              -41
              %Sub-total operating
      expenses
              
              
              3,604
              
              
              
              4,089
              
              
              
              (485
              )
              
              
              -12
              %Restructing
      charge reversal
              
              
              -
              
              
              
              (126
              )
              
              
              126
              
              
              
              100
              %Total operating
      expenses
              
              $
              3,604
              
              
              $
              3,963
              
              
              $
              (359
              )
              
              
              -9
              %




SG&A
Expenses – Medical Segment:





SG&A
expenses in the medical segment increased $124 thousand, or 5%, in the second
quarter of fiscal 2010 primarily attributable to higher stock-based compensation
($161 thousand), partially offset by lower legal fees ($54
thousand).




SG&A
Expenses – Industrial Segment





SG&A
expenses in the industrial segment increased $8 thousand, or 3%, in the second
quarter of fiscal 2010 primarily attributable to higher stock-based compensation
($44 thousand) and sales commissions ($17 thousand), partially offset by lower
expenses for office supplies ($29 thousand) and bad debt ($18
thousand).





16


R&D
Expenses




R&D
expenses decreased $617 thousand, or 41%, in the second quarter of fiscal 2010
primarily attributable to lower stock-based compensation ($359 thousand),
reduced R&D materials purchases ($131 thousand), lower consulting expenses
($57 thousand), and reduced spending for new product development as the latest
product innovations moved from the development stage into production ($46
thousand).





Restructuring
Charge Reversal





In the second quarter of fiscal 2009,
we reduced our restructuring reserve for severance and other termination costs
related to the staff reduction and relocation of our Natick, MA facility by $126
thousand.





Other
Income (Expense)




Other
income (expense) was as follows:




Three
      Months EndedSeptember
      30,Other
      (expense) income
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageInterest
      income
              
              $
              21
              
              
              $
              72
              
              
              $
              (51
              )
              
              
              -71
              %Interest
      expense
              
              
              (46
              )
              
              
              (2
              )
              
              
              (44
              )
              
              
              2200
              %Gain
      on sale of product line, net of direct costs
              
              
              -
              
              
              
              1,755
              
              
              
              (1,755
              )
              
              
              -100
              %Other,
      net
              
              
              -
              
              
              
              26
              
              
              
              (26
              )
              
              
              -100
              %Total
      other (expense) income
              
              $
              (25
              )
              
              $
              1,851
              
              
              $
              (1,876
              )
              
              
              -101
              %




Interest
Income




Interest
income decreased $51 thousand, or 71%, in the second quarter of fiscal 2010
primarily attributable to lower cash and short-term investments
balances.




Interest
Expense




Interest
expense increased $44 thousand, or 2200%, in the second quarter of fiscal 2010
as a result of the amortization of interest for our short-term investments in
corporate bonds. We carry these investments at amortized cost in our condensed
consolidated balance sheet.





Gain
on Sale of Product Line, Net of Direct Costs




In the
second quarter of fiscal 2009, we received $2.0 million from Medtronic in
connection with achieving certain milestones related to the transition of the
ENT EndoSheath disposables production from our Natick facility to Medtronic’s
facility in Jacksonville, FL. This payment was partially offset by direct costs
of $0.2 million resulting in a net gain of $1.8 million.





Other,
Net




In the
second quarter of fiscal 2009, we recorded other income of $26 thousand related
to the collection of accounts receivable balances that were previously written
off as bad debt.





17


Net
Loss




Net loss
was as follows:




Three
      Months EndedSeptember
      30,Net
      loss
              
              2009
              
              
              2008
              
              
              DifferenceLoss
      before provision for income taxes
              
              $
              (3,164
              )
              
              $
              (1,887
              )
              
              $
              (1,277
              )Provision
      for income taxes
              
              
              6
              
              
              
              -
              
              
              
              6Net
      loss from continuing operations
              
              
              (3,170
              )
              
              
              (1,887
              )
              
              
              (1,283
              )Net
      loss from discontinued operations
              
              
              -
              
              
              
              (586
              )
              
              
              586Net
      loss
              
              $
              (3,170
              )
              
              $
              (2,473
              )
              
              $
              (697
              )





Loss
Before Provision for Income Taxes





Loss
before provision for income taxes increased $1.3 million in the second quarter
of fiscal 2010 to $3.2 million compared to $1.9 million in the second quarter of
fiscal 2009. The higher loss was primarily attributable to the net gain on sale
of product line of $1.8 million recognized in the second quarter of fiscal 2009,
partially offset by reduced R&D expenses of $0.6 million in the second
quarter of fiscal 2010.





Provision
for Income Taxes





In the
second quarter of fiscal 2010, we recorded a provision for state income taxes of
$6 thousand. We did not record a provision in the second quarter of fiscal 2009
as a result of the operating losses we sustained.





Net
Loss from Continuing Operations





Net loss
from continuing operations increased $1.3 million in the second quarter of
fiscal 2010 to $3.2 million compared to $1.9 million in the second quarter of
fiscal 2009. The higher loss was primarily attributable to items noted for the
loss before provision for income taxes (net effect of $1.1
million).





Net Loss from Discontinued
Operations





Operating
results for discontinued operations were as follows:





Three
      Months EndedSeptember
      30,Description
              
              2009
              
              
              2008Net
      sales
              
              $
              -
              
              
              $
              268Gross
      margin
              
              
              -
              
              
              
              32.8
              %Net
      loss from discontinued operations
              
              
              -
              
              
              
              (586
              )





Net
Loss





Net loss
increased $0.7 million in the second quarter of fiscal 2010 to $3.2 million
compared to $2.5 million in the second quarter of fiscal 2009. The higher loss
was primarily attributable to items noted for the loss before provision for
income taxes (net effect of $1.1 million), partially offset by the net loss from
discontinued operations of $0.6 million in the second quarter of fiscal
2009.





Six
months ended September 30, 2009 compared to the six months ended
September 30, 2008 (in thousands, except percentages)





Net
Sales





Net sales
increased $0.7 million, or 13%, in the first half of fiscal 2010 to $6.2 million
compared to $5.5 million in the first half of fiscal 2009. During the first half
of fiscal 2010, our medical segment’s net sales of $4.9 million increased by
$0.7 million, or 17%, and our industrial segment’s net sales of $1.3 million
increased by $14 thousand, or 1%, compared to the same period last
year.





18


Sales by
segment, market, and by category for the six months ended September 30, 2009 and
2008 were as follows:




Six
      Months EndedSeptember
      30,Market/Category
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageENT
      and TNE
              
              $
              2,194
              
              
              $
              2,201
              
              
              $
              (7
              )
              
              
              0
              %Urology
              
              
              1,258
              
              
              
              1,356
              
              
              
              (98
              )
              
              
              -7
              %Bronchoscopy
              
              
              332
              
              
              
              -
              
              
              
              332
              
              
              
              100
              %Repairs,
      peripherals, and accessories
              
              
              1,069
              
              
              
              584
              
              
              
              485
              
              
              
              83
              %Total
      medical sales
              
              
              4,853
              
              
              
              4,141
              
              
              
              712
              
              
              
              17
              %Borescopes
              
              
              971
              
              
              
              905
              
              
              
              66
              
              
              
              7
              %Repairs
              
              
              383
              
              
              
              435
              
              
              
              (52
              )
              
              
              -12
              %Total
      industrial sales
              
              
              1,354
              
              
              
              1,340
              
              
              
              14
              
              
              
              1
              %Total
    sales
              
              $
              6,207
              
              
              $
              5,481
              
              
              $
              726
              
              
              
              13
              %


Medical
Segment




Medical
Segment – ENT and TNE Markets




Sales to
the ENT and TNE markets were as follows:




Six
      Months EndedSeptember
      30,ENT/TNE
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              2,132
              
              
              $
              2,172
              
              
              $
              (40
              )
              
              
              -2
              %Slide-On
      EndoSheaths
              
              
              62
              
              
              
              29
              
              
              
              33
              
              
              
              114
              %Total
      ENT/TNE market
              
              $
              2,194
              
              
              $
              2,201
              
              
              $
              (7
              )
              
              
              0
              %


Net sales
to the ENT and TNE markets remained relatively flat in the first half of fiscal
2010 at $2.2 million as compared with the first half of fiscal
2009.
  Medical
Segment – Urology Market




Sales to
the urology market were as follows:




Six
      Months EndedSeptember
      30,Urology
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              548
              
              
              $
              897
              
              
              $
              (349
              )
              
              
              -39
              %Slide-On
      EndoSheaths
              
              
              710
              
              
              
              459
              
              
              
              251
              
              
              
              55
              %Total urology market
              
              $
              1,258
              
              
              $
              1,356
              
              
              $
              (98
              )
              
              
              -7
              %


Net sales
to the urology market decreased $0.1 million, or 7%, in the first half of fiscal
2010 to $1.3 million compared to $1.4 million in the first half of fiscal 2009.
The first half of fiscal 2009 benefited from initial orders for videoscopes from
our then independent sales reps and international distributors ($0.3 million),
which was not repeated in the current fiscal year. Higher international sales of
our EndoSheath disposables partially offset the decrease in net sales of urology
endoscopes ($0.2 million).





Medical
Segment – Bronchoscopy Market





Sales to
the bronchoscopy market were as follows:




Six
      Months EndedSeptember
      30,Bronchoscopy
      market
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageEndoscopes
              
              $
              313
              
              
              $
              -
              
              
              $
              313
              
              
              
              100
              %Slide-On
      EndoSheaths
              
              
              19
              
              
              
              -
              
              
              
              19
              
              
              
              100
              %Total bronchoscopy
      market
              
              $
              332
              
              
              $
              -
              
              
              $
              332
              
              
              
              100
              %





19


In the
first quarter of fiscal 2010, we launched our video bronchoscope (an endoscope
that allows detailed viewing of the lungs) and EndoSheath technology for
bronchoscopy to pulmonologists, oncologists, thoracic surgeons and other
pulmonology-related physicians.




Medical
Segment – Repairs, Peripherals, and Accessories




Net sales
of repairs, peripherals, and accessories increased $0.5 million, or 83%, in the
first half of fiscal 2010 to $1.1 million compared to $0.6 million in the first
half of fiscal 2009. The increase was primarily attributable to higher repairs
sales ($0.1 million) and higher sales volume of peripherals and accessories for
our ENT endoscopes ($0.4 million).




Industrial
Segment




Net sales
of industrial products increased $14 thousand, or 1%, in the first half of
fiscal 2010 to $1.4 million compared to $1.3 million in the first half of fiscal
2009. This segment’s products are mature, and we therefore expect future sales
to remain relatively flat.




Gross
Profit




Gross
profit was as follows:




Six
      Months EndedSeptember
      30,Gross
      profit
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageMedical
              
              $
              733
              
              
              $
              371
              
              
              $
              362
              
              
              
              98
              %As
      percentage of sales
              
              
              15
              %
              
              
              9
              %
              
              
              6
              %Industrial
              
              
              520
              
              
              
              503
              
              
              
              17
              
              
              
              3
              %As
      percentage of sales
              
              
              38
              %
              
              
              38
              %
              
              
              0
              %Total
      gross profit
              
              $
              1,253
              
              
              $
              874
              
              
              $
              379
              
              
              
              43
              %As
      percentage of sales
              
              
              20
              %
              
              
              16
              %
              
              
              4
              %




Gross
profit increased $0.4 million, or 43%, in the first half of fiscal 2010 to $1.3
million, or 20% of net sales, compared to $0.9 million, or 16% of net sales, in
the first half of fiscal 2009. In the medical segment, gross profit in the first
half of fiscal 2009 reflected the start-up costs associated with manufacturing
our videoscope line of products. We improved our gross profit for our videoscope
family of products in the first half of fiscal 2010 as net sales for these
products increased by $0.5 million, or 65%, compared to the same period last
year. In the industrial segment, gross profit increased $17 thousand, or 3%, in
the first half of fiscal 2010 to $520 thousand compared to $503 thousand in the
first half of fiscal 2009. The increase was primarily attributable to
manufacturing efficiencies.





Operating
Expenses





Total
operating expenses decreased $1.0 million, or 12%, in the first half of fiscal
2010 to $6.9 million compared to $7.9 million in the first half of fiscal 2009.
SG&A expenses decreased $0.1 million, or 1%, and R&D expenses decreased
$1.0 million, or 37%.





Operating
expenses, by segment, were as follows:




Six
      Months EndedSeptember
      30,Operating
      expenses
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageSG&AMedical
              
              $
              4,732
              
              
              $
              4,816
              
              
              $
              (84
              )
              
              
              -2
              %Industrial
              
              
              457
              
              
              
              450
              
              
              
              7
              
              
              
              2
              %Total
      SG&A
              
              
              5,189
              
              
              
              5,266
              
              
              
              (77
              )
              
              
              -1
              %R&D
      Medical
              
              
              1,683
              
              
              
              2,685
              
              
              
              (1,002
              )
              
              
              -37
              %Sub-total operating
      expenses
              
              
              6,872
              
              
              
              7,951
              
              
              
              (1,079
              )
              
              
              -14
              %Restructing
      charge reversal
              
              
              -
              
              
              
              (98
              )
              
              
              98
              
              
              
              100
              %Total operating
      expenses
              
              $
              6,872
              
              
              $
              7,853
              
              
              $
              (981
              )
              
              
              -12
              %




20


SG&A
Expenses – Medical Segment:





SG&A
expenses in the medical segment decreased $84 thousand, or 2%, in the first half
of fiscal 2010 primarily attributable to lower bonus expense ($135 thousand) and
reduced spending on tradeshows ($66 thousand), partially offset by higher
consulting expenses ($125 thousand).




SG&A
Expenses – Industrial Segment





SG&A
expenses in the industrial segment increased $7 thousand, or 2%, in the first
half of fiscal 2010 primarily attributable to higher stock-based compensation
($54 thousand), partially offset by lower expenses for office supplies ($28
thousand) and bad debt ($18 thousand).





R&D
Expenses




R&D
expenses decreased $1.0 million, or 37%, in the first half of fiscal 2010
primarily attributable to lower stock-based compensation ($0.3 million), reduced
spending for new product development as the latest product innovations moved
from the development stage into production ($0.2 million), reduced R&D
materials purchases ($0.1 million), reduced consulting expenses ($0.1 million),
and lower allocations from manufacturing ($0.1 million).





Restructuring
Charge Reversal





In the first half of fiscal 2009, we
recorded a net adjustment of $98 thousand reducing our restructuring reserve for
severance and other termination costs related to the staff reduction and
relocation of our Natick, MA facility.





Other
Income (Expense)




Other
income (expense) was as follows:




Six
      Months EndedSeptember
      30,Other
      (expense) income
              
              2009
              
              
              2008
              
              
              Difference
              
              
              PercentageInterest
      income
              
              $
              71
              
              
              $
              151
              
              
              $
              (80
              )
              
              
              -53
              %Interest
      expense
              
              
              (46
              )
              
              
              (16
              )
              
              
              (30
              )
              
              
              188
              %Gain
      on sale of product line, net of direct costs
              
              
              -
              
              
              
              4,985
              
              
              
              (4,985
              )
              
              
              -100
              %Other,
      net
              
              
              (28
              )
              
              
              26
              
              
              
              (54
              )
              
              
              -208
              %Total
      other (expense) income
              
              $
              (3
              )
              
              $
              5,146
              
              
              $
              (5,149
              )
              
              
              -100
              %




Interest
Income




Interest
income decreased $80 thousand, or 53%, in the first half of fiscal 2010
primarily attributable to lower cash and short-term investments
balances.





Interest
Expense




Interest
expense increased $30 thousand, or 188%, in the first half of fiscal 2010 as a
result of the amortization of interest for our short-term investments in
corporate bonds.





Gain
on Sale of Product Line, Net of Direct Costs




In the
first half of fiscal 2009, we received $5.0 million from Medtronic, of which
$3.0 million was related to the asset purchase agreement and $2.0 million was in
connection with achieving certain milestones related to the transition of the
ENT EndoSheath disposables production from our Natick facility to Medtronic’s
facility in Jacksonville, FL.





Other,
Net




In the
first half of fiscal 2010, we recorded a loss on investments of $28 thousand. In
the first half of fiscal 2009, we recorded other income of $26 thousand related
to the collection of accounts receivable balances that were previously written
off as bad debt.





21


Net
Loss




Net loss
was as follows:




Six
      Months EndedSeptember
      30,Net
      loss
              
              2009
              
              
              2008
              
              
              DifferenceLoss
      before provision for income taxes
              
              $
              (5,622
              )
              
              $
              (1,833
              )
              
              $
              (3,789
              )Provision
      for income taxes
              
              
              16
              
              
              
              9
              
              
              
              7Net
      loss from continuing operations
              
              
              (5,638
              )
              
              
              (1,842
              )
              
              
              (3,796
              )Net
      loss from discontinued operations
              
              
              -
              
              
              
              (774
              )
              
              
              774Net
      loss
              
              $
              (5,638
              )
              
              $
              (2,616
              )
              
              $
              (3,022
              )




Loss
Before Provision for Income Taxes





Loss
before provision for income taxes increased $3.8 million in the first half of
fiscal 2010 to $5.6 million compared to $1.8 million in the first half of fiscal
2009. The higher loss was primarily attributable to the net gain on sale of
product line of $5.0 million recognized in the first half of fiscal 2009,
partially offset by reduced R&D expenses of $1.0 million in the first half
of fiscal 2010.





Provision
for Income Taxes





Provision
for income taxes increased $7 thousand in the first half of fiscal 2010 to $16
thousand compared to $9 thousand in the first half of fiscal 2009.





Net
Loss from Continuing Operations





Net loss
from continuing operations increased $3.8 million in the first half of fiscal
2010 to $5.6 million compared to $1.8 million in the first half of fiscal 2009.
The higher loss was primarily attributable to items noted for the loss before
provision for income taxes (net effect of $4.0 million).





Net Loss from Discontinued
Operations





Operating
results for discontinued operations were as follows:





Six
      Months EndedSeptember
      30,Description
              
              2009
              
              
              2008Net
      sales
              
              $
              -
              
              
              $
              501Gross
      margin
              
              
              -
              
              
              
              25.6
              %Net
      loss from discontinued operations
              
              
              -
              
              
              
              (774
              )





Net
Loss





Net loss
increased $3.0 million in the first half of fiscal 2010 to $5.6 million compared
to $2.6 million in the first half of fiscal 2009. The higher loss was primarily
attributable to items noted for the loss before provision for income taxes (net
effect of $4.0 million), partially offset by the net loss from discontinued
operations of $0.8 million in the first half of fiscal 2009.





Liquidity
and Capital Resources
 
 At
September 30, 2009, our principal source of liquidity was working capital
of approximately $9.8 million, including $5.1 million in cash and short-term
investments. Our cash and cash equivalents decreased $1.3 million during the
first half of fiscal 2010 as compared to $10.1 million in the first half of
fiscal 2009. The lower decrease was primarily attributable to lower net cash
used in operating activities ($6.3 million).
 
 In the
first half of fiscal 2010, we used $4.3 million of net cash in our operating
activities compared to a decrease of $10.7 million in the first half of fiscal
2009. The decrease in cash used in operations was primarily attributable to
favorable changes in inventories ($2.7 million), accounts payable ($0.9
million), and accounts receivable ($0.8 million).


22


In the
first half of fiscal 2010, we provided $3.0 million of net cash from our
investing activities compared to $0.9 million used in investing activities in
the first half of fiscal 2009. The increase was primarily attributable to the
proceeds yielded from sales and maturities of our short-term investments ($6.0
million), partially offset by purchases of short-term investments ($2.6
million).





In the
first half of fiscal 2010, we provided $27 thousand of net cash from our
financing activities compared to $1.6 million in the first half of fiscal 2009.
The decrease was primarily attributable to lower proceeds from the exercise of
stock options ($1.6 million).





We have
incurred losses since our inception, and losses are expected to continue through
at least fiscal years 2010 and 2011. We have funded the losses principally with
proceeds from operations, proceeds from public and private equity financings,
payments from Medtronic related to the sale of certain assets related to our ENT
EndoSheath technology business, and the sale of other assets. We believe that
our cash, short-term investments, and capital available under the $5.0 million
revolving loan agreement with our Chairman, which was signed on November 9,
2009, will be sufficient to fund our working capital, capital expenditures, and
future operating losses until September 30, 2010. However, if our performance
expectations fall short or our expenses exceed expectations, we will need to
either secure additional financing or reduce expenses or a combination thereof,
and in such instance, the failure to do so would have a material adverse impact
on our financial condition. There can be no assurance that any contemplated
external financing will be available on terms acceptable to us, if at
all.





We have
no off-balance sheet arrangements that have, or are reasonably likely to have, a
current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures, or capital resources.




Subsequent
Events
 
 On
November 9, 2009, we entered into a three-year $5.0 million revolving loan
agreement (the “Loan”) with our Chairman, Lewis C. Pell (the “Lender”). Any
amounts drawn against the Loan (an “Advance”) accrue interest at a per annum
rate of 7.5%. The Lender will receive an availability fee equal to a per annum
rate of 0.5% on the unused portion of the Loan calculated based on the
difference between the average annual principal amount of the outstanding
Advances under the Loan and the maximum advance of $5.0 million. The
availability of advances under the Loan is subject to customary conditions.
Subject to the terms of the Loan, we will be required to prepay all amounts
outstanding under the Loan in the event of a change of control of the Company
and we will be required to prepay part or all of the amounts outstanding in the
event we secure other financing or consummate a sale or license of assets, in
each case resulting in net proceeds of $5.0 million or
greater.
  In
addition, the Lender will receive two five-year warrants to purchase an
aggregate of up to 651,515 shares of our common stock. The first warrant (the
“Initial Warrant Shares”) to purchase up to 272,727 shares of our common stock
at an exercise price of $1.375 per share (representing 7.5% warrant coverage, or
approximately 0.7% of our outstanding common stock) is immediately vested upon
issuance. The second warrant (the “Additional Warrant Shares”) to purchase up to
an additional 378,788 shares of our common stock at an exercise price of $1.65
per share (representing up to an additional 12.5% warrant coverage, or
approximately 1.0% of our outstanding common stock) vests at the time that each
Advance is made in an amount equal to (i) the product of the amount of the
Additional Warrant Shares multiplied by (ii) a ratio, (A) the numerator of which
shall be the amount of the new Advance and (B) the denominator of which shall be
$5.0 million.
 
 On
November 8, 2009, the Board received the resignation, effective immediately, of
Mr. Ron Hadani as our President and Chief Executive Officer and as a member of
the Board. Mr. Hadani resigned due to personal reasons and his resignation was
not caused by any disagreement with us or the management or the Board. In
connection with Mr. Hadani’s resignation, we have offered Mr. Hadani certain
severance payments and other benefits.
 
 On
November 9, 2009, the Board appointed Mr. Warren Bielke, age 62, a current
member of the Board to serve, effective immediately, as Interim Chief Executive
Officer (“Interim CEO”), until the earlier of his resignation or such time as a
Chief Executive Officer is selected by the Board. Mr. Bielke will continue to
serve as a member on the Board. Mr. Bielke has served as a member of the Board
since 2005, served on the Audit Committee until April 2009 and, until his
appointment as Interim CEO, served as a consultant to us managing our sales and
marketing efforts. Mr. Bielke served as a consultant to us pursuant to a
Consulting Agreement between Mr. Bielke and us effective April 7, 2009 and filed
with the SEC as an exhibit to the Annual Report on Form 10-K for the fiscal year
ended March 31, 2009. This Consulting Agreement will be terminated in connection
with his role as Interim CEO.
 
 In
connection with Mr. Bielke’s position as Interim CEO, we entered into an
Employment Agreement, effective November 9, 2009, with Mr. Bielke, pursuant to
which he will be entitled to receive a base salary of $255,000 per year, a
performance-based incentive compensation as determined by the Compensation
Committee of the Board, and certain other benefits. Upon entering into the
Employment Agreement and with respect to each three month period of employment,
Mr. Bielke will be granted an immediately vested option to purchase 100,000
shares of our common stock in accordance with our 2007 Stock Incentive
Plan.
 
 On
November 9, 2009, we issued a press release announcing the resignation of Mr.
Hadani and the appointment of Mr. Bielke as Interim CEO.





23


Item 3.  Quantitative
and Qualitative Disclosures About Market Risk





We are a
smaller reporting company, as defined in Rule 12b-2 of the Exchange Act,
and are not required to provide the information required by this
item.





Item 4.  Controls
and Procedures






Disclosure
Controls and Procedures





We have
evaluated, under the supervision and with the participation of our senior
management, including our Interim CEO and Chief Financial Officer (“CFO”), the
effectiveness of the design and operation of our disclosure controls and
procedures as of September 30, 2009. Based upon the foregoing, our Interim CEO
and CFO concluded that our disclosure controls and procedures were effective as
of September 30, 2009.




Changes
in Internal Controls Over Financial Reporting






There
have been no changes in our internal controls over financial reporting during
the three months ended September 30, 2009 that have materially affected, or are
reasonably likely to materially affect our internal controls over financial
reporting.








24




PART
II—OTHER INFORMATION





Item 1.  Legal
Proceedings




None




Item 1A.  Risk
Factors




There
have been no material changes from the information discussed in Part I, Item 1A.
Risk Factors, on page 22 of our Annual Report on Form 10-K for the year ended
March 31, 2009, except for the
information discussed below. You should carefully consider the risks and
uncertainties we discussed on our Form 10-K and the risks described below in
this quarterly report before deciding to invest in, or retain, shares of our
common stock. These are not the only risks and uncertainties that we face.
Additional risks and uncertainties that we do not currently know about or that
we currently believe are immaterial, or that we have not predicted, may also
harm our business operations or adversely affect us. If any of these risks or
uncertainties actually occurs, our business, financial condition, operating
results or liquidity could be materially harmed.





We
have a history of operating losses and we may not achieve or maintain
profitability in the future





We have
incurred substantial operating losses since our inception and there can be no
assurance that we will achieve a profitable level of operations in the future.
We anticipate a negative cash flow during fiscal years 2010 and 2011, because of
spending for research and development, increasing our global network of
independent sales representatives and distributors, investing in a direct sales
force for the North American market, general business operations and capital
expenditures. As of September 30, 2009, we had cash and cash equivalents,
including short- term investments, totaling approximately $5.1 million. We
expect that our current balance of cash, short-term investments, and capital
available under the $5.0 million revolving loan agreement with our Chairman,
which was signed on November 9, 2009, will be sufficient to fund our operations
until September 30, 2010 (see Note 8. Subsequent Events).  However, if
our performance expectations fall short or our expenses increase, we will need
to either secure additional financing or reduce expenses or a combination
thereof, and in such instance, the failure to do so would have a material
adverse impact on our financial condition.  There can be no assurance
that any contemplated external financing will be available on terms acceptable
to us, if at all.





Our
failure to maintain our relationships with our key distributors on acceptable
terms would have a material adverse effect on our results of operations and
financial condition





We have
no assurance that any distributor will continue to purchase our products at the
same levels as in prior years, will purchase our new products (such as our
videoscopes) or that such relationship will continue on favorable terms, if at
all. For our ENT sales to the ENT market, we depend on a single worldwide
distributor, Medtronic ENT. In the first half of fiscal 2010, Medtronic
accounted for 45% of our total sales and 58% of our medical segment’s sales. Our
exclusive distribution agreement with Medtronic has expired and as of September
30, 2009, we are still negotiating a new agreement with them. During the
negotiation period, Medtronic has continued to market our ENT and TNE products
sold to the ENT market, and to purchase those products from us on terms
acceptable to us and on terms substantially similar to those in effect under our
agreement with them. There can be no assurance that we will be able to renew the
agreement on satisfactory terms. The loss of Medtronic as a customer or
distributor would have an adverse material negative effect on our financial
condition and future prospects. For our industrial segment sales, we rely on a
worldwide network of independent distributors. There is no assurance that we
will succeed in expanding our distribution network in the
short-term.





Item 2.  Unregistered
Sales of Equity Securities and Use of Proceeds




N/A




Item 3.  Defaults
Upon Senior Securities




N/A




25


Item 4.  Submission
of Matters to a Vote of Stockholders




Our 2009
Annual Meeting of Stockholders was held on September 3, 2009 for the purpose of
electing three Class III Directors to serve a three-year term and to ratify the
appointment of BDO Seidman, LLP as our independent registered public
accountants.





David W.
Anderson, Warren Bielke, and Lothar Koob were elected to serve as Class III
Directors. Votes cast for the election of directors were as
follows:




Election of Class III
    DirectorsDavid
      W. Anderson
              For:
              21,186,905
              
              Withheld:
              833,588Warren
      Bielke
              For:
              19,025,302
              
              Withheld:
              2,995,191Lothar
      Koob
              For:
              21,186,840
              
              Withheld:
              833,653




The vote
on the ratification of the appointment of BDO Seidman, LLP as the independent
registered public accountants was as follows:




For:
              21,462,654
              
              Against:
              509,189Abstain:
              48,649


Katsumi
Oneda, Lewis C. Pell, and John J. Rydzewski continued to serve as members of our
Board of Directors after the annual meeting.





Item 5.  Other
Information





N/A





Item 6.  Exhibits





Exhibits10.45
            
            Loan
      Agreement between Lewis C. Pell and the Company, dated November 9,
      200910.46
            
            Common
      Stock Warrants of the Company issued to Lewis C. Pell, dated November 9,
      200910.47
            
            Employment
      Agreement between Warren Bielke and the Company, dated November 9,
      200931.1
            
            Certification
      of Chief Executive Officer pursuant to Rule 13a-15(e)/15d-15(e),
      promulgated under the Securities Exchange Act of 1934, as
      amended.31.2
            
            Certification
      of Chief Financial Officer pursuant to Rule 13a-15(e)/15d-15(e),
      promulgated under the Securities Exchange Act of 1934, as
      amended.32
            
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes
      Oxley Act of 2002.






26


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 the undersigned thereunto
duly authorized.




VISION-SCIENCES, INC.Date:
      November 12, 2009
            /s/
      Warren Bielke
              Warren
      Bielke
              Interim
      Chief Executive Officer (Duly Authorized Officer)Date:
      November 12, 2009
            /s/
      Katherine L. Wolf
              Katherine
      L. Wolf
              Chief
      Financial Officer
              (Principal
      Financial Officer and
              Principal
      Accounting Officer)







27




VISION-SCIENCES, INC.




EXHIBIT
INDEX




Exhibit
            
            Description
      of Exhibit3.1(1)
            
            Amended
      and Restated Certificate of Incorporation of the Company, as amended to
      date3.2(20)
            
            By-laws,
      as amended to date*10.1(3)
            
            1990
      Stock Option Plan, as amended*10.2(17)
            
            2003
      Director Option Plan, as amended*10.3(4)
            
            2000
      Stock Incentive Plan*10.3.1(12)
            
            2007
      Stock Incentive Plan, as amended*10.5(2)
            
            Form
      of Vision-Sciences, Inc.’s Invention, Non-Disclosure and
      Non-Competition Agreement for employees*10.6(15)
            
            Letter
      Agreement between the Company and Ron Hadani dated January 24,
      200310.9(2)
            
            Registration
      Rights Agreement dated as of February 28, 1992 among the Registrant
      and the persons listed therein10.10(1)
            
            Piggyback
      Registration Rights Agreement, dated January 2, 2001, between the
      Company and the individuals and entities listed therein10.11(9)
            
            Supply
      Agreement dated March 16, 1992 between the Registrant and Pentax
      Corporation (formerly known as Asahi Optical Co., Ltd.) and
      amendment dated October 1, 200210.12(13)
            
            Termination
      Agreement between Pentax Corporation and Vision-Sciences, Inc. dated
      February 12, 200810.14(6)
            
            License
      Agreement between Vision-Sciences, Inc. and Advanced
      Polymers, Inc. dated June 10, 199310.15(7)
            
            Amendment
      to License Agreement between Vision-Sciences, Inc. and Advanced
      Polymers, Inc. dated April 5, 199410.16(8)
            
            Amendment
      to License Agreement between Vision-Sciences, Inc. and Advanced
      Polymers, Inc. dated April 5, 199510.17(8)
            
            Amendment
      to License Agreement between Vision-Sciences, Inc. and Advanced
      Polymers, Inc. dated April 5, 1996**10.19(5)
            
            License
      Agreement dated as of August 6, 1998 between
      Vision-Sciences, Inc. and Pentax Corporation (formerly Asahi
      Optical Co., Ltd.)10.21(4)
            
            Agreement
      of Lease between 30 Ramland Road LLC and Vision-Sciences, Inc.
      dated as of March 23, 2000.10.31(10)
            
            Asset
      Purchase Agreement dated as of January 16, 2007 by and between
      Medtronic Xomed, Inc. and the Company10.32(10)
            
            Amended
      and Restated Exclusive Distribution Agreement dated as of March 26,
      2007 by and between the Company and Medtronic
    Xomed, Inc.10.33(10)
            
            License
      Agreement dated as of March 26, 2007 by and between the Company and
      Medtronic Xomed, Inc.*10.35(15)
            
            Amendment
      dated April 4, 2007 to Employment Letter Agreement of Ron
      Hadani10.36(11)
            
            Merrill
      Lynch Loan Management Account Agreement (the “Agreement”) between
      Vision-Sciences, Inc. and Merrill Lynch Bank USA (“Bank”) and
      accompanying Commitment Letter from the Bank.10.38(15)
            
            Third
      Amendment to Lease between 30 Ramland Road, LLC and the Company
      dated as December 26, 2006.10.39(14)
            
            Development
      and Supply Agreement between Vision-Sciences, Inc. and
      SpineView, Inc. dated June 19, 2008*
      10.40(18)
            
            Employment
      Letter between Katherine L. Wolf and the Company, effective September 16,
      200810.41
      (18)
            
            Consulting
      Agreement between NYC Advisors LLC and the Company, effective October 1,
      200810.42(19)
            
            Surrender
      and Acceptance Agreement between Ramland Realty Associates L.L.C. and the
      Company dated December 31, 2008.10.43(21)
            
            Consulting
      Agreement between Warren Bielke and the Company, effective April 7,
      2009.10.44(21)
            
            Fourth
      Amendment to Lease between 30 Ramland Road, LLC and the Company
      dated as April 12, 2009.10.45
            
            Loan
      Agreement between Lewis C. Pell and the Company, dated November 9,
      200910.46
            
            Common
      Stock Warrants of the Company issued to Lewis C. Pell, dated November 9,
      2009*10.47
            
            Employment
      Agreement between Warren Bielke and the Company, dated November 9,
      200921.1(21)
            
            Subsidiaries
      of the Company23.1
            
            Consent
      of BDO Seidman, LLP31.1
            
            Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of
      1934, as amended.31.2
            
            Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of
      1934, as amended.32
            
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to
      18 U.S.C. Section 1350, as adopted pursuant to Section 906
      of the Sarbanes-Oxley Act of 2002.


28


*
            Management
      contract or compensatory plan or arrangement filed as an exhibit to this
      Form pursuant to Items 15(a) and 15(b) of
      Form 10-K.




**
            Confidential
      treatment granted as to certain portions, which portions have been deleted
      and filed separately with the Securities and Exchange
      Commission.




(1)
            Incorporated
      by reference to the Annual Report on Form 10-K for the fiscal year
      ended March 31, 2001.(2)
            Incorporated
      by reference to the Registration Statement on Form S-1 (File
      No. 33-53490).(3)
            Incorporated
      by reference to the Annual Report on Form 10-K for the fiscal year
      ended March 31, 1994.(4)
            Incorporated
      by reference to the Annual Report on Form 10-K for the fiscal year
      ended March 31, 2000.(5)
            Incorporated
      by reference to the Current Report on Form 8-K dated August 20,
      1998.(6)
            Incorporated
      by reference to the Quarterly Report on Form 10-Q for the quarter
      ended June 30, 1993.(7)
            Incorporated
      by reference to the Quarterly Report on Form 10-Q/A for the quarter
      ended June 30, 1994.(8)
            Incorporated
      by reference to the Annual Report on Form 10-K for the fiscal year
      ended March 31, 1996.(9)
            Incorporated
      by reference to the Quarterly Report on Form 10-Q/A for the quarter
      ended December 31, 2002.


(10)
            Incorporated
      by reference to the Proxy Statement dated March 6, 2007 filed with
      the Securities and Exchange Commission on March 7, 2007 on
      Schedule 14A.(11)
            Incorporated
      by reference to the Current Report on Form 8-K filed on
      January 24, 2008.


(12)
            Incorporated
      by reference to the Proxy Statement dated July 30, 2007 filed with
      the Securities and Exchange Commission on July 27, 2007 on
      Schedule 14A.(13)
            Incorporated
      by reference to the current report on Form 8-K filed on
      February 15, 2008.(14)
            Incorporated
      by reference to the current report on Form 8-K filed on June 23,
      2008.(15)
            Incorporated
      by reference to the Annual Report on Form 10-K for the fiscal year ended
      March 31, 2008.(16)
            Incorporated
      by reference to the current report on Form 8-K filed on September 16,
      2008.(17)
            Incorporated
      by reference Registration Statement on Form S-8, filed on October 10,
      2008.(18)
            Incorporated
      by reference to the Quarterly Report on Form 10-Q for the quarter ended
      September 30, 2008.(19)
              (20)
              (21)
            Incorporated
      by reference to the current report on Form 8-K filed on January 6,
      2009.
              Incorporated
      by reference to the current report on Form 8-K filed on July 15,
      2009.
              Incorporated
      by reference to the Annual Report on Form 10-K filed for the fiscal year
      ended March 31, 2009.






29