**SECURITIESAND EXCHANGE COMMISSIONWASHINGTON, D. C. 20459**

**FORM 10-Q**

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

**FOR THEQUARTER ENDED June 30, 2007**

**COMMISSIONFILE NUMBER 0-20970**

**VISION-SCIENCES,INC.**(Exact name of registrant as specified in its charter)

| **Delaware**                               | ** ** | **13-3430173**          |
|--------------------------------------------|------------|-------------------------|
| (State or other  jurisdiction of           |       | (IRS Employer           |
| incorporation or  organization)            |       | Identification  Number) |
|                                       |       |                    |
| **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 yearif changed since last report)

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

Yes  x                      No  o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.

Large acceleratedfiler o    Acceleratedfiler o    Non-accelerated filer x

Indicate by checkmark whether the registrant is a shell company (as defined by Rule 12b-2 of theExchange Act).

Yes  o                      No  x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of July 31, 2007.
| Common Stock, par value of $.01 | ** ** | **35,253,031**      |
|---------------------------------|------------|---------------------|
| (Title of Class)                |       | (Number of  Shares) |

 

 

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**VISION-SCIENCES,INC.TABLE OF CONTENTS**
| Part I.  | Financial  Information                                                                               |   |   |
|----------|------------------------------------------------------------------------------------------------------|--------|--------|
|     |                                                                                                 |   |   |
|     | Item 1. Financial  Statements                                                                        |   | 3      |
|     |                                                                                                 |   |   |
|     | Consolidated  Balance Sheets                                                                         |   | 3      |
|     |                                                                                                 |   |   |
|     | Consolidated  Statements of Operations                                                               |   | 4      |
|     |                                                                                                 |   |   |
|     | Consolidated  Statement of Stockholders’ Equity                                                 |   | 5      |
|     |                                                                                                 |   |   |
|     | Consolidated  Statements of Cash Flows                                                               |   | 6      |
|     |                                                                                                 |   |   |
|     | Notes to  Consolidated Financial Statements                                                          |   | 7      |
|     |                                                                                                 |   |   |
|     | Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations |   | 18     |
|     |                                                                                                 |   |   |
|     | Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                  |   | 31     |
|     |                                                                                                 |   |   |
|     | Item 4. Controls  and Procedures                                                                     |   | 32     |
|     |                                                                                                 |   |   |
| Part II. | Other Information                                                                                    |   | 33     |
|     |                                                                                                 |   |   |
|     | Item  1A. Risk Factors                                                                               |   | 33     |
|     |                                                                                                 |   |   |
|     | Item  6. Exhibits                                                                                    |   | 33     |
|     |                                                                                                 |   |   |
|     | Signatures                                                                                           |   | 34     |
|     |                                                                                                 |   |   |
|     | Exhibits                                                                                             |   |   |

 

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**PART I - FINANCIAL INFORMATION**

**Item 1: FINANCIAL STATEMENTS**

**VISION-SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                            | ** ** | **June 30, 2007** | ** ** | **March 31, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                            | ** ** | **(Unaudited)**             | ** ** | ** **                   | ** ** |
| ASSETS                                                                                                |       |                        |       |                         |       |
| Current assets:                                                                                       |       |                        |       |                         |       |
| Cash and cash  equivalents                                                                            |       | $                           | 15,057,422 |                         | $          | 28,955,497 |   |
| Short term  investments                                                                               |       | 9,631,499                   |       | —                       |       |
| Accrued interest  receivable                                                                          |       | 217,003                     |       | —                       |       |
| Accounts  receivable, net of allowance for doubtful accounts of $180,700 and $129,600,  respectively  |       | 1,243,054                   |       | 1,230,285                    |       |
| Inventories                                                                                           |       | 2,818,210                   |       | 2,102,757                    |       |
| Prepaid expenses  and deposits                                                                        |       | 399,920                     |       | 111,282                      |       |
| Total current  assets                                                                                 |       | 29,367,108                  |       | 32,399,821                   |       |
| Property and equipment,  at cost:                                                                     |       |                        |       |                         |       |
| Machinery and  equipment                                                                              |       | 4,056,190                   |       | 3,713,074                    |       |
| Furniture and  fixtures                                                                               |       | 345,709                     |       | 307,961                      |       |
| Leasehold improvements                                                                                |       | 591,196                     |       | 591,196                      |       |
|                                                                                                  |       | 4,993,095                   |       | 4,612,231                    |       |
| Less-accumulated  depreciation and amortization                                                       |       | 4,110,252                   |       | 4,071,537                    |       |
|                                                                                                  |       | 882,843                     |       | 540,694                      |       |
|                                                                                                  |       |                        |       |                         |       |
| Equity investment                                                                                     |       | 917,745                     |       | —                       |       |
| Other assets, net of  accumulated amortization of $ 67,700 and $66,200, respectively             |       | 60,907                      |       | 62,393                       |       |
| Total assets                                                                                          |       | $                           | 31,228,603 |                         | $          | 33,002,908 |   |
|                                                                                                  |       |                        |       |                         |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                            |       |                        |       |                         |       |
| Current liabilities:                                                                                  |       |                        |       |                         |       |
| Current portion  of note payable                                                                      |       | $                           | 2,854      |                         | $          | 3,785 |   |
| Accounts payable                                                                                      |       | 797,993                     |       | 591,166                      |       |
| Accrued expenses                                                                                      |       | 1,315,206                   |       | 1,443,434                    |       |
| Income taxes  payable                                                                                 |       | —                      |       | 549,000                      |       |
| Total current  liabilities                                                                            |       | 2,116,053                   |       | 2,587,385                    |       |
|                                                                                                  |       |                        |       |                         |       |
| Stockholders’ equity:                                                                            |       |                        |       |                         |       |
| Preferred stock,  $.01 par value -                                                                    |       |                        |       |                         |       |
| Authorized –  5,000,000                                                                          |       |                        |       |                         |       |
| Issued and  outstanding –none-                                                                   |       | —                      |       | —                       |       |
| Common stock, $.01 par  value-                                                                        |       |                        |       |                         |       |
| Authorized -  50,000,000 shares                                                                       |       |                        |       |                         |       |
| Issued and  outstanding - 35,253,031 shares at June 30, 2007 and 35,243,931 shares at  March 31, 2007 |       | 352,529                     |       | 352,438                      |       |
| Additional  paid-in capital                                                                           |       | 76,624,136                  |       | 76,483,273                   |       |
| Accumulated  deficit                                                                                  |       | (47,864,115                 | )          | (46,420,188                  | )          |
| Total  stockholders’ equity                                                                      |       | 29,112,550                  |       | 30,415,523                   |       |
| Total liabilities and  stockholders’ equity                                                      |       | $                           | 31,228,603 |                         | $          | 33,002,908 |   |

 

See accompanyingnotes to consolidated financial statements.

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##### **VISION-SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS****(Unaudited)**

| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **June 30,**                | ** ** |
| ** **                                                            | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Net sales                                                             |       | $                                | 2,430,438  |   | $ | 2,007,073 |   |
| Cost of sales                                                         |       | 1,487,046                        |       | 1,519,071 |   |
|                                                                  |       |                             |       |   |   |
| Gross profit                                                          |       | 943,392                          |       | 488,002 |   |
|                                                                  |       |                             |       |   |   |
| Selling, general  and administrative expense                          |       | 1,747,288                        |       | 1,081,809 |   |
| Research and  development expense                                     |       | 835,273                          |       | 610,204 |   |
| Loss from operations                                                  |       | (1,639,169                       | )          | (1,204,011 | ) |
|                                                                  |       |                             |       |   |   |
| Interest income                                                       |       | 279,057                          |       | 48,391 |   |
| Interest expense                                                      |       | —                           |       | (485 | ) |
| Other income  (expense), net                                          |       | (1,560                           | )          | (4,280 | ) |
| Loss in equity  investment                                            |       | (82,255                          | )          | — |   |
|                                                                  |       |                             |       |   |   |
| Net loss                                                              |       | $                                | (1,443,927 | ) | $ | (1,160,385 | ) |
|                                                                  |       |                             |       |   |   |
| Basic and  diluted net loss per common share                          |       | $                                | (0.04      | ) | $ | (0.03 | ) |
|                                                                  |       |                             |       |   |   |
| Shares used in  computing basic and diluted net loss per common share |       | 35,249,431                       |       | 35,152,430 |   |

 

See accompanyingnotes to consolidated financial statements.

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**VISION-SCIENCES,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY(Unaudited)**
| ** **                                     | ** ** | **Common Stock**      | ** ** | ** **               | ** ** | ** **                      | ** ** | **Total**                | ** ** |
|------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|---------------------------------|------------|--------------------------|------------|
| ** **                                     | ** ** | **Number  of Shares** | ** ** | **$.01  Par Value** | ** ** | **Additional  Paid-in-Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** |
|                                           |       |                       |       |                     |       |                            |       |                     |       |   |   |
| Balance, March  31, 2007                       |       | 35,243,931                 |       | $                        | 352,438    |                            | $          | 76,483,273               |       | $ | (46,420,188 | ) | $ | 30,415,523 |   |
| Exercise of  stock options, net                |       | 9,100                      |       | 91                       |       | 8,699                           |       |                     |       | 8,790 |   |
| Compensation  expense related to stock options |       |                       |       |                     |       | 132,164                         |       |                     |       | 132,164 |   |
| Net loss                                       |       |                       |       |                     |       |                            |       | (1,443,927               | )          | (1,443,927 | ) |
|                                           |       |                       |       |                     |       |                            |       |                     |       |   |   |
|  Balance, June 30, 2007                   |       | 35,253,031                 |       | $                        | 352,529    |                            | $          | 76,624,136               |       | $ | (47,864,115 | ) | $ | 29,112,550 |   |

 

See accompanyingnotes to consolidated financial statements.

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**VISION-SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                    | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**      | ** ** |
| Cash flows from  operating activities:                                        |       |                             |       |                             |       |
| Net loss                                                                      |       | $                                | (1,443,927 | )                                | $          | (1,160,385 | ) |
| Adjustments to reconcile net loss to net cash used  for operating activities: |       |                             |       |                             |       |
| Depreciation and amortization                                                 |       | 40,200                           |       | 102,304                          |       |
| Stock-based compensation                                                      |       | 132,164                          |       | 112,471                          |       |
| Loss in equity investment                                                     |       | 82,255                           |       | —                           |       |
| Changes in assets and liabilities:                                            |       |                             |       |                             |       |
| Accrued interest receivable                                                   |       | (217,003                         | )          | —                           |       |
| Accounts receivable                                                           |       | (12,769                          | )          | 713,115                          |       |
| Inventories                                                                   |       | (715,453                         | )          | (494,882                         | )          |
| Prepaid expenses and deposits                                                 |       | (288,638                         | )          | 4,273                            |       |
| Accounts payable                                                              |       | 206,827                          |       | (223,214                         | )          |
| Accrued expenses                                                              |       | (128,228                         | )          | 83,566                           |       |
| Income taxes payable                                                          |       | (549,000                         | )          | —                           |       |
|                                                                          |       |                             |       |                             |       |
| Net cash used for operating activities                                        |       | (2,893,572                       | )          | (862,752                         | )          |
|                                                                          |       |                             |       |                             |       |
| Cash flows used  for investing activities                                     |       |                             |       |                             |       |
|                                                                          |       |                             |       |                             |       |
| Purchase of short term investments                                            |       | (9,631,499                       | )          | —                           |       |
| Purchase of property and equipment, net                                       |       | (380,863                         | )          | (144,358                         | )          |
| Purchase of equity investment                                                 |       | (1,000,000                       | )          | —                           |       |
|                                                                          |       |                             |       |                             |       |
| Net cash used for investing activities                                        |       | (11,012,362                      | )          | (144,358                         | )          |
|                                                                          |       |                             |       |                             |       |
| Cash flows  provided by (used for) financing activities:                      |       |                             |       |                             |       |
| Payments on note payable                                                      |       | (931                             | )          | (6,530                           | )          |
| Payments of acceptances payable to a bank, net                                |       | —                           |       | (38,191                          | )          |
| Exercise of stock options, net                                                |       | 8,790                            |       | 19,398                           |       |
| Net cash provided by (used for) financing activities                          |       | 7,859                            |       | (25,323                          | )          |
|                                                                          |       |                             |       |                             |       |
| Net decrease in  cash and cash equivalents                                    |       | (13,898,075                      | )          | (1,032,433                       | )          |
| Cash and cash  equivalents, beginning of period                               |       | 28,955,497                       |       | 6,138,148                        |       |
| Cash and cash  equivalents, end of period                                     |       | $                                | 15,057,422 |                             | $          | 5,105,715 |   |
|                                                                          |       |                             |       |                             |       |
| Supplemental  disclosure of cash flow information:                            |       |                             |       |                             |       |
| Cash paid during  the period for interest                                     |       | $                                | —     |                             | $          | 485 |   |

 

See accompanying notes toconsolidated financial statements.

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**VISION-SCIENCES, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1.****                                      Basisof Presentation**

The consolidatedfinancial statements included herein have been prepared by Vision-Sciences,Inc. and subsidiaries (the “Company”) in accordance with generally acceptedaccounting principles in the United States of America, without audit, pursuantto the rules and regulations of the Securities and Exchange Commission andinclude, in the opinion of management, all adjustments (consisting only ofnormal and recurring adjustments) that the Company considers necessary for afair presentation of such information. Certain information and footnote disclosures normally included infinancial statements have been condensed or omitted pursuant to such rules andregulations.  The Company believes,however, that its disclosures are adequate to make the information presentednot misleading.  These consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in the Company’slatest annual report to stockholders. The results for the interim periods presented are not necessarilyindicative of results to be expected for the full fiscal year. Our fiscalyear-end is on March 31 of each year, and is herein referred to as FY 06, FY 07and FY 08, respectively. All amounts in the financial footnotes, except forshare and per share data, are reported in (000’s), unless otherwise indicated.Q1 07 refers to the period from April 1, 2006 to June 30, 2006; and Q1 08refers to the period from April 1, 2007 to June 30, 2007.

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

The accompanyingconsolidated financial statements reflect the application of certain accountingpolicies described below:

a.                                       *Principles of Consolidation*: The accompanying consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries.  All material intercompanyaccounts and transactions have been eliminated in consolidation.

b**.****                                     ***Cash Equivalents*: The Company classifies investments withoriginal maturities of ninety days or less, consisting of commercial paper anda money market account at a bank, as cash equivalents. Cash equivalents arestated at amortized cost, which approximates market value*.*

c.             *Short Term Investments*:The Company classifies investments with original maturities of greater than90 days in Government Securities and high grade Commercial Paper as ShortTerm Investments. The Company intends to hold these investments to maturity.The following table summarizes these securities classified as held to maturity:

|                       | ** ** | **June 30, 2007** | ** ** | **March 31, 2007** | ** ** |
|-----------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **            | ** ** | **Fair Value**         | ** ** | **Cost**                     | ** ** | **Fair Value** | ** ** | **Cost** | ** ** |
| Held to maturity      |       |                        |       |                         |       |   |   |   |   |
| Less than one year:   |       |                        |       |                         |       |   |   |   |   |
| Government Securities |       | $                           | 7,738      |                         | $          | 7,697 |   | $ | — |   | $ | — |   |
| Commercial paper      |       | 1,956                       |       | 1,934                        |       |   |   |   |   |
| Total                 |       | $                           | 9,694      |                         | $          | 9,631 |   | $ | — |   | $ | — |   |

 

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

|                 | ** ** | **June 30,** | ** ** | **March 31,** | ** ** |
|-----------------|------------|-------------------|------------|--------------------|------------|
| ** **      | ** ** | **2007**          | ** ** | **2007**           | ** ** |
| ** **      | ** ** | ** **        | ** ** | **(audited)**      | ** ** |
| Raw materials   |       | $                 | 2,002      |               | $          | 1,447 |   |
| Work-in-process |       | 277               |       | 273                |       |
| Finished goods  |       | 539               |       | 383                |       |
|            |       | $                 | 2,818      |               | $          | 2,103 |   |

 

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Raw materials include components purchased from independent suppliers.Most purchased components are available form multiple sources. Work-in-processand finished goods inventories consist of material, labor, and manufacturingoverhead.

e.                                       *Depreciation and Amortization*: The Company provides fordepreciation and amortization using the straight-line method in amounts thatallocate the cost of the assets to operations over their estimated useful livesas follows:
|                               | ** ** | **Estimated**        | ** ** |
|-------------------------------|------------|----------------------|------------|
| **Asset Classification** | ** ** | **Useful Life** | ** ** |
| Machinery and  Equipment      |       | 3-7 Years            |       |
| Furniture and Fixtures        |       | 5 Years              |       |

 

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

f.                                         *Basic and Diluted Net Loss Per Common Share*: Basic anddiluted net loss per common share is based on the weighted average number ofcommon shares outstanding.  For theperiods ended June 30, 2007 and 2006, shares of common stock issuable pursuantto outstanding stock options have not been considered, as their effect would beantidilutive.

g.                                      *Revenue Recognition*: The following must occur before theCompany recognizes revenue: (1) persuasive evidence of an arrangement exists,(2) delivery has occurred or services have been rendered, (3) the price isfixed or determinable, (4) collectibility is reasonably assured.  The Company recognizes revenue when titlepasses to the customer, generally upon shipment of products.

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h.                                      *Foreign Currency Transactions*: The Company charges foreigncurrency exchange gains or losses, in connection with its purchases of productsfrom foreign vendors to operations.

i.                                          *Income Taxes*: The Company accounts for income taxes underthe liability method and deferred tax assets or liabilities are computed basedon the differences between the financial statement and income tax bases of assetsand liabilities as measured by the enacted tax rates.  The Company has recorded a valuationallowance equal to its net deferred tax asset due to the uncertainty ofrealizing the benefit of this asset.

j.                                          *Stock-based Compensation:*Effective April 1, 2006 theCompany began accounting for compensation expense related to stock options inaccordance with SFAS No. 123 (Revised 2004) *Share-Based Payment*(“SFAS123R”).  Prior to April 1, 2006, theCompany accounted for stock options according to Accounting Principles Board (“APB”)Opinion 25, *Accounting for Stock Issued to Employees.*

The Company has adoptedthe modified prospective transition method and consequently has notretroactively adjusted results from prior periods.  Under this transition method, compensationcost associated with stock options now includes: (i) amortization related tothe remaining unvested portion of all stock options outstanding at March 31,2006, based on the fair value determined on the grant date in accordance withthe original provisions of SFAS 123, and (ii) amortization related to all stockoption awards granted subsequent to March 31, 2006, based upon the fair valueestimated in accordance with SFAS 123R. The compensation expense forstock-based compensation awards under SFAS 123R is recognized over the vestingperiod of the options, and includes an estimate for forfeitures.

In accordance with SFAS123R, the Company recorded $132 and $112 of stock-based compensation expense inthe statement of operations for Q1 08 and Q1 07, respectively, in the followingexpense categories:
|                                        | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** |
|----------------------------------------|------------|----------------|------------|----------------|------------|
| Cost of Goods  Sold                    |       | $              | 13         |           | $          | 14 |   |
| Selling, General  & Administrative |       | 102            |       | 86             |       |
| Research &  Development            |       | 17             |       | 12             |       |
| Total                                  |       | $              | 132        |           | $          | 112 |   |

 

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At June 30, 2007, thetotal unamortized stock-based compensation is approximately $910.  The Company will expense that amount overperiods ending through June 30, 2013. The Company does not expect to realize any tax benefits from futuredisqualifying dispositions, if any, since it currently has a full valuationallowance against its deferred tax asset.

In the three monthsended June 30, 2007, the Company granted options to purchase a total of1,011,250 shares of the Company’s Common Stock. A total of 650,000 of these options were issued pending shareholdersapproval of the 2007 Stock Option Plan (the “2007 Plan”). Consequently, theexpense for these options will be recorded only after shareholder approval ofthe 2007 plan. A total of 361,250 of these options were granted from the Company’s2000 Stock Option Plan (the “2000 Plan”). The fair value of these optionsmeasured at the option grant date was approximately $275, determined using theBlack-Scholes option-pricing model. This amount is reduced by an estimatedforfeiture rate and is being recorded as an expense over the vestingperiod.  The assumptions used in theBlack-Scholes option-pricing model in the period by the Company were asfollows:
|                                         | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| Risk-free  interest rate                |       | 4.55                        | %          |
| Expected  dividend yield                |       | —                      |       |
| Expected life                           |       | 6.25 – 6.75 years      |       |
| Expected  volatility                    |       | 69 – 70                | %          |
| Weighted average value  grant per share |       | $                           | 0.76       |   |
|                                         |            |                             |            |  |

 

We account for optionsissued to employees and non-employees in accordance with the provisions of SFAS123R. We grant options with vesting periods ranging from immediate to sixyears. We use the simplified method of calculating the expected option term,which averages an award’s weighted average vesting period and its contractualterm.  The contractual term of ouroptions is ten years. The risk-free rate is based upon the daily Treasury yieldcurve for a period approximately equal to the expected option term. We usedhistorical data to estimate the expected price volatility and forfeiture rate.The expected dividend yield is 0%, based on our history of not payingdividends.

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k.                                       *New Accounting Standards:*

InJuly 2006, the Financial Accounting Standards Board (“FASB’) issued FIN 48, *Accounting for Uncertainty in Income Taxes-an**Interpretation of FASB Statement No. 109*, which seeks toreduce the significant diversity in practice associated with certain aspects ofmeasurement and recognition in accounting for income taxes. FIN 48 prescribes arecognition threshold and measurement attribute for financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. It also provides guidance on de-recognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. The provisions of FIN 48 are effective for fiscal years beginningafter December 15, 2006. Upon adoption, the cumulative effect of any changes innet assets resulting from the application of FIN 48 will be recorded as anadjustment to retained earnings. We adopted FIN 48 effective April 1, 2007, and the adoption of FIN 48did not have a material impact on our results of operations, financial positionor cash flow.

InFebruary 2006, the FASB issued SFAS 155, *Accountingfor Certain Hybrid Financial Instruments* which amends SFAS 133,*Accounting for Derivative Instruments and HedgingActivities* and SFAS 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*.  SFAS 155 simplifies the accounting forcertain derivatives embedded in other financial instruments by allowing them tobe accounted for as a whole if the holder elects to account for the wholeinstrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions ofSFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired,issued or subject to a re-measurement event occurring in fiscal years beginningafter September 15, 2006 and is therefore required to be adopted by theCompany in the first quarter of its fiscal year ended March 31, 2008. We adoptedSFAS 155 effective April 1, 2007, and the adoption of SFAS 155 did not have amaterial impact on our results of operations, financial position or cash flow.

InSeptember 2006, the FASB issued SFAS 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans*.This statement requires public entities with defined benefit pension plans andother postretirement plans to fully recognize, as an asset or a liability, theover funded or under funded status of its benefit plans in its 2006 balancesheet. SFAS 158 did not have an impact on our consolidated financial statementsas we have no defined benefit pension or other postretirement plans.

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In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements* to provide guidance on theconsideration of the effects of prior year misstatements in quantifying currentyear misstatements for the purpose of a materiality assessment. Under SAB No.108, companies should evaluate a misstatement based on its impact on thecurrent year income statement, as well as the cumulative effect of correctingsuch misstatements that existed in prior years existing in the current year’sending balance sheet. SAB No. 108 is effective for fiscal years ending afterNovember 15, 2006. The adoption of SAB No. 108 did not have an impacton our financial position and results of operations.

In September 2006, theFASB issued SFAS 157 *Fair Value Measurements*.SFAS 157 establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  The standard applies whenever other standards require (orpermit) assets or liabilities to be measured at fair value.  The standarddoes not expand the use of fair value in any new circumstances.  SFAS 157is effective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years. Earlierapplication is encouraged. The Company has not yet determined the effect theadoption of SFAS 157 will have on its financial position and results ofoperations.

In June 2006, the FASBratified the consensus on EITF Issue No. 06-03, *How TaxesCollected from Customers and Remitted to Governmental Authorities Should BePresented in the Income Statement.* The scope ofEITF Issue No. 06-03 includes any tax assessed by a governmental authoritythat is directly imposed on a revenue-producing transaction between a sellerand a customer and may include, but is not limited to, sales, use, value added,Universal Service Fund (“USF”) contributions and some excise taxes. TheTask Force affirmed its conclusion that entities should present these taxes inthe income statement on either a gross or a net basis, based on theiraccounting policy, which should be disclosed pursuant to APB OpinionNo. 22, *Disclosure of Accounting Policies.*If such taxes are significant, and are presented on a gross basis, the amountsof those taxes should be disclosed. The consensus on Issue No. 06-03 iseffective for interim and annual reporting periods beginning afterDecember 15, 2006. The adoption of EITF No. 06-03 did not have animpact on our results of operations.

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**3.             StockOption Plans**

The Company’s initialstock option plan (the “1990 Plan”) allowed it to grant key employees andconsultants incentive and non-statutory stock options at the fair value of thestock on the date of grant.  Optionsbecame exercisable at varying dates ranging up to five years from the date ofgrant. The Board of Directors had authorized the issuance of options for thepurchase of up to 4,375,000 shares of common stock under the 1990 Plan.

This plan expired in 2001and was replaced with the 2000 Plan. The terms of the 2000 Plan aresubstantially the same as the 1990 Plan. The Board of Directors andshareholders have authorized the issuance of options for the purchase of up to4,500,000 shares of Common Stock under the 2000 Plan, of which 5,905 sharesremain available for future grants. The Company grants options to bothemployees and non-employee consultants with vesting periods ranging fromimmediate to four years. For options granted in the current year, we havechosen to employ the simplified method of calculating the option term, whichaverages an award’s weighted average vesting period and its contractualterm.The contractual term of our options is ten years.

The Board of Directorshas recently approved the establishment of the 2007 Plan, pending shareholdersapproval. The shareholders are expected to vote on the 2007 Plan in the nextannual meeting, currently scheduled for August 21, 2007.

A summary of the stock option activity for the threemonths ended June 30, 2007 is as follows:
| ** **                  | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average Remaining  Contractual Term** | ** ** |
|-----------------------------|------------|--------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| Outstanding  March 31, 2007 |       | 4,687,800                      |       | $                                              | 1.52       |                                                            | 5.9 years  |   |
| Granted                     |       | 361,250                        |       | 1.10                                           |       |                                                            |       |
| Exercised                   |       | (9,100                         | )          | .97                                            |       |                                                            |       |
| Canceled                    |       | (92,000                        | )          | 1.19                                           |       |                                                            |       |
| Outstanding June  30, 2007  |       | 4,947,950                      |       | $                                              | 1.45       |                                                            | 6.1 years  |   |
| Exercisable June 30,  2007  |       | 3,623,075                      |       | $                                              | 1.48       |                                                            |       |   |

 

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The following tablesummarizes information about stock options outstanding and exercisable at June30, 2007:
| ** **                          | ** ** | **Outstanding**            | ** ** | **Exercisable**                                                      | ** ** |
|-------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Number  of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|                                |       |                       |       |                                                                 |       |   |   |   |   |   |   |
| $  .79 - 1.05             |       | 1,083,450                  |       | 5.7                                                                  |       | $ | 1.03 |   | 987,450 |   | $ | 1.02 |   |
| 1.06 - 1.31                         |       | 1,303,250                  |       | 6.6                                                                  |       | 1.12 |   | 798,000 |   | 1.13 |   |
| 1.32 - 1.88                         |       | 2,157,750                  |       | 5.8                                                                  |       | 1.54 |   | 1,521,750 |   | 1.58 |   |
| 2.05 - 2.28                         |       | 150,000                    |       | 7.6                                                                  |       | 2.13 |   | 100,000 |   | 2.17 |   |
| 2.70 - 3.69                         |       | 128,500                    |       | 6.9                                                                  |       | 3.51 |   | 109,625 |   | 3.62 |   |
| 4.00 - 4.30                         |       | 125,000                    |       | 6.9                                                                  |       | 4.18 |   | 106,250 |   | 4.17 |   |
|                                |       | 4,947,950                  |       | 6.1                                                                  |       | $ | 1.45 |   | 3,623,075 |   | $ | 1.48 |   |

 

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In July 2003, the Companyadopted, and the stockholders approved, a 2003 Director Option Plan (the “2003Plan”). The terms of the 2003 Plan include automatic grants of 4,000 shares toeach outside director on each date on which an annual meeting of thestockholders of the Company is held, provided that such outside director doesnot hold on such date any outstanding options to purchase Common Stock of theCompany’s 1993 Plan, which options are not fully exercisable. Options grantedunder the 2003 Plan are 100% vested on the date of grant. If the Company’sannual meeting of stockholders is held in August of each year, and the numberof outside directors were unchanged, the Company would be required to grantoptions to purchase 16,000 shares in each August of 2007, 2008 and 2009.

A summary of the 2003 Plan activity is as follows:
|                             | ** ** | **Number  of Shares** | ** ** | **Exercise  Price Range** | ** **   | **Weighted  Average  Exercise Price** | ** ** |
|-----------------------------|------------|----------------------------|------------|--------------------------------|--------------|--------------------------------------------|------------|
| Outstanding  March 31, 2007 |       | 88,000                     |       | $                              | 1.00 - $2.10 |                                       | $          | 1.41 |   |
| Granted                     |       | —                     |       | —                         |         | —                                     |       |
| Exercised                   |       | —                     |       | —                         |         | —                                     |       |
| Canceled                    |       | —                     |       | —                         |         | —                                     |       |
| Outstanding June  30, 2007  |       | 88,000                     |       | $                              | 1.00 - $2.10 |                                       | $          | 1.41 |   |
| Exercisable June 30,  2007  |       | 88,000                     |       | $                              | 1.00 - $2.10 |                                       | $          | 1.41 |   |

 

The followingtable summarizes information about director stock options outstanding and exercisableat June 30, 2007:
|                                     | ** ** | **Outstanding**            | ** ** | **Exercisable**                                                      | ** ** |
|-------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|                                |       |                       |       |                                                                 |       |   |   |   |   |   |   |
| $ 1.00 – 1.30             |       | 40,000                     |       | 3.9                                                                  |       | $ | 1.15 |   | 40,000 |   | $ | 1.15 |   |
|    1.49 – 1.50       |       | 36,000                     |       | 4.1                                                                  |       | 1.50 |   | 36,000 |   | 1.50 |   |
|    2.06 – 2.10       |       | 12,000                     |       | 2.7                                                                  |       | 2.03 |   | 12,000 |   | 2.03 |   |
|                                |       | 88,000                     |       | 4.6                                                                  |       | $ | 1.41 |   | 88,000 |   | $ | 1.41 |   |

 

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**4.             SegmentInformation**

Up until the end of ourfiscal year ended March 31, 2007, (FY 07), the Company had three reportablesegments: medical, industrial and corporate. The corporate segment consisted ofcertain administrative expenses applicable to the Company as a whole. As ofApril 1, 2007 (FY 08), we consolidated the corporate segment into the medicaland industrial segments. The medical segment designs, manufactures and sellsEndoSheaths and endoscopes to users in the health care industry. The industrialsegment designs, manufactures and sells borescopes to a variety of users,primarily in the aircraft engine manufacturing and aircraft engine maintenanceindustries.

In March 2007, wecompleted the license and sale to Medtronic Xomed, Inc. (“Medtronic”), awholly-owned subsidiary of Medtronic, Inc., of certain assets with respect toour ENT sheath business. This transaction resulted in a thorough review of ourbusiness, including how we evaluate and report our results of operations. Inorder to enable the Chief Executive Officer to make operating and financialdecisions about allocating resources within the Company and assessing itsperformance, as mentioned above, effective for FY 08, we are operating undertwo reportable segments, medical and industrial. All expenses formerly reportedunder the corporate segment are allocated at the rate of 95% to the medicalsegment and 5% to the industrial segment. In addition, we have changed the methodology of inter-segment costallocations between the medical and the industrial segments. As part of our businessreview, we examined the resources allocated between departments and changed theallocations accordingly. These changes affect certain expenses such as Cost ofGoods Sold (“COGS”), Research and Development (“R&D”) and Sales, Marketingand Administration (“SG&A”).

We have reclassified ourFY 07 segment information according to Statement of Financial AccountingStandard 131 (“FAS 131”) to reflect the change in reportable segments. AllExpenses reported during FY 07 under the corporate segment, were allocated atthe rate of 95% to the medical segment and 5% to the industrial segment.However, we have determined that it is impractical to restate FY 07inter-segment allocations.

FAS 131 requires that ifan enterprise has changed the structure of its internal organization in amanner that causes the composition of its reportable segments to change, and ifsegment information for earlier periods, including interim periods, is notrestated to reflect the change, the enterprise shall disclose in the year in whichthe change occurs segment information for the current period under both the oldbasis and the new basis of segmentation, unless it is impracticable to do so.We have determined that it is impractical for us to report our new allocationmethodology under the old and new basis, and we are reporting under the newbasis.

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The two segments follow the accounting policiesdescribed in the summary of significant accounting policies. The Companyevaluates segment performance based upon operating income.  Identifiable assets are those used directlyin the operations of each segment and general corporate assets, such as cashand marketable securities are allocated to each segment. Management’s view ofthe Company’s segments are provided in the following tables:
| **Three months ended June 30,** | ** ** | **Medical** | ** ** | **Industrial** | ** ** | **Adjustments** | ** ** | **Total**  | ** ** |
|-----------------------------------------------------|------------|-------------|------------|----------------|------------|-----------------|------------|------------|------------|
| **2007  (Q1 08)**                                   | ** ** | ** **  | ** ** | ** **     | ** ** | ** **      | ** ** | ** ** | ** ** |
| Sales to  external customers                        |       | $           | 1,832      |           | $          | 598             |       | $          | —     |   | $ | 2,430 |   |
| Operating income  (loss)                            |       | (1,654      | )          | 15             |       | —          |       | (1,639     | )          |
| Interest income  (expense), net                     |       | 279         |       | —         |       | —          |       | 279        |       |
| Depreciation and  amortization                      |       | 31          |       | 9              |       | —          |       | 40         |       |
| Other  significant non-cash items:                  |       |        |       |           |       |            |       |       |       |
| Stock-based compensation                            |       | 129         |       | 3              |       | —          |       | 132        |       |
| Loss in equity investment                           |       | 82          |       | —         |       | —          |       | 82         |       |
| Expenditures for  fixed assets                      |       | 381         |       | —         |       | —          |       | 381        |       |
| Total assets                                        |       | 31,172      |       | 1,277          |       | (1,220          | )          | 31,229     |       |
| ** **                                          | ** ** | ** **  | ** ** | ** **     | ** ** | ** **      | ** ** | ** ** | ** ** |
| **2006  (Q1 07)**                                   | ** ** | ** **  | ** ** | ** **     | ** ** | ** **      | ** ** | ** ** | ** ** |
| Sales to  external customers                        |       | $           | 1,352      |           | $          | 655             |       | $          | —     |   | $ | 2,007 |   |
| Operating income  (loss)                            |       | (1,046      | )          | (158           | )          | —          |       | (1,204     | )          |
| Interest income  (expense), net                     |       | 46          |       | 2              |       | —          |       | 48         |       |
| Depreciation and  amortization                      |       | 96          |       | 6              |       | —          |       | 102        |       |
| Other  significant non-cash items:                  |       |        |       |           |       |            |       |       |       |
| Stock-based compensation                            |       | 91          |       | 21             |       | —          |       | 112        |       |
| Expenditures for  fixed assets                      |       | 133         |       | 11             |       | —          |       | 144        |       |
| Total assets                                        |       | 8,863       |       | 2,354          |       | (918            | )          | 10,299     |       |

 

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

## **Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**Executive Summary**

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of The PrivateSecurities Litigation Reform Act of 1995. Examples of forward-lookingstatements include statements about expectations about future financialresults, future products and future sales of new and existing products, futureexpenditures, and capital resources to meet anticipated requirements.  Without limiting the foregoing, the words “believes”,“anticipates”, “plans”, “expects”, and similar expressions are intended toidentify forward-looking statements. These forward-looking statements involverisks and uncertainties, and our actual results may differ significantly fromthose discussed in the forward-looking statements. Factors that might causesuch a difference include, but are not limited to, the availability of capitalresources, the availability of third-party reimbursement, governmentregulation, the availability of supplies, competition, technologicaldifficulties, the completion of obligations under our contract with MedtronicXomed, Inc., general economic conditions and other risks detailed in our mostrecent Annual Report on Form 10-K and any subsequent periodic filings made withthe Securities and Exchange Commission. We do not undertake an obligation toupdate our forward-looking statements to reflect future events orcircumstances.

Our fiscal year-end is onMarch 31 of each year, and is herein referred to as FY 06, FY 07 and FY 08,respectively. Q1 07 refers to the period from April 1, 2006 to June 30, 2006;and Q1 08 refers to the period from April 1, 2007 to June 30, 2007.

Wedesign, develop, manufacture and market products for endoscopy – the science ofusing an instrument, known as an endoscope – to provide minimally invasiveaccess to areas not readily visible to the human eye. We operate in tworeporting segments, medical and industrial.

#### *MedicalSegment*

*The medical segment* designs,manufactures and sells our Slide-On® EndoSheath® Systems (“EndoSheath” or “Slide-OnEndoSheath” or “Sheath”), which consists of our Slide-On EndoSheath steriledisposable covers and our endoscopes. The insertion tube, which the sheathcovers, is the part of the endoscope that enters the patient’s body. The use ofa Sheath gives health-care providers economic advantages, as it allows them toavoid the burdensome cleaning required of endoscopes, reduces repair costs to endoscopescaused by the exposure to harsh chemicals used in the cleaning process, andallows health-care providers to avoid investing in multiple endoscopes. Thevarious EndoSheaths enable physicians preferred configuration of the endoscopefor specific procedures. For example, specific models of our Ear-Nose-Throat (“ENT”)EndoSheaths have channels, which help to improve the efficiency of healthcareproviders by allowing them to perform procedures in their offices. Theseprocedures would otherwise have to be performed in hospitals, using specialendoscopes that have channels. Often, the reimbursement rates are higher forphysicians when they perform procedures in their offices. In other fields likeUrology, our EndoSheaths come with various size channels, which unlike

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conventional flexibleendoscopes, allow the healthcare provider to customize the insertion tube tothe procedure (i.e. diagnostic cystoscopy, or therapeutic cystoscopy, whichrequires a larger channel). In addition, the EndoSheath is a sterile device,providing patients with a contaminant-free insertion tube for eachprocedure.The EndoSheath reduces the risk of cross-contamination from the reuseof conventional flexible endoscopes, which are difficult to clean anddisinfect.

*The industrial segment* designs,manufactures and markets flexible endoscopes, called borescopes. In addition,the industrial segment manufactures all the flexible endoscopes which aremarketed through the medical segment. The industrial segment markets areprimarily aircraft maintenance, jet engine manufacturing, defense and otherspecialized industries.

#### *Sales Distribution – Medical Segment*

The end users of our disposable EndoSheaths, flexibleendoscopes and related products are otolaryngologists (ENT doctors), urologistsand gastroenterologists in hospitals, medical clinics and physicians’ offices.Since September 2003 we have been distributing all of our products for the ENTmarkets in the U.S.A. and Canada through Medtronic ENT (“MENT”), under the MENT Agreement. As part of thelicense and sale of the ENT sheath business to MENT during March 2007, MENTwill also now distribute, market and sell our ENT endoscope line worldwide, ona co-branded basis, through MENT’s global sales force.

FromDecember 2004 to May 2006, we distributed all of our urology market products inthe U.S.A. and Canada through Medtronic USA, Inc. (the Medtronic Gastroenterology/Urology business,or “MGU”). In May 2006 we assumed the distribution of our urologyproducts and started building our own global independent network of salesrepresentatives and various distributor organizations. We periodically evaluatethe effectiveness of our sales channels, and may change them if we believe adifferent method will benefit our business and strategy.

*Sales Distribution -**Industrial Segment*

Our borescopes are sold directly by our Machidasubsidiary and through a global network of independent sales representatives.

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*NewProducts and Markets*

Ourplans for product development in FY 08 include the design of a new family ofvideo scopes with a miniature digital camera mounted on the distal end of theinsertion tube, and design and cost improvements to our existing family offiberscopes for the medical segment. In addition, we intend to release a newline of video borescopes for the industrial market. We also plan to work onimprovements to our manufacturing processes that should result in lower coststo produce our endoscopes and EndoSheaths.

InApril 2007, we executed a definitive investment agreement under which Vision-Sciencesacquired a strategic interest in Minos Medical, Inc. (“Minos’’). Minos is aprivately held California based development stage medical device companyconcentrating in the emerging field of N.O.T.E.S. (Natural OrificeTrans-luminal Endoscopy Surgery). N.O.T.E.S. is a new frontier in surgery,focusing on using natural orifices to enter the body to facilitateincision-less surgical procedures. We invested $1 million in cash and haveagreed to expend $165 in development costs in collaboration with Minos, inorder to exploit certain surgical procedures. We accounted for this transactionon our Balance Sheet as an Equity Investment.

Vision-Sciences isfocusing on the development of new products and technologies, looking toacquire related technologies, and to enter new markets which the Company hasidentified.  N.O.T.E.S. is one of ourtargeted fields, and this investment is our Company’s first publicly announcedstep towards positioning us in the forefront of this new field. N.O.T.E.S.represents the next generation of surgical procedures, going beyond minimallyinvasive laparoscopic surgery to achieve incision-less surgery. We areconfident that Minos will be a valuable strategic partner for Vision-Sciencesas we pursue a leading position in the emerging N.O.T.E.S. field.

In addition, we are atvarious stages of, exploration of opportunities in, and development of productsfor the medical fields of Gynecology and Gastroenterology, among others.

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Critical AccountingPolicies and Estimates

This discussion and analysis of our financialcondition and results of operations is based upon our Consolidated FinancialStatements, which have been prepared in accordance with generally acceptedaccounting principles in the United States of America. See the Notes to the ConsolidatedFinancial Statements included elsewhere herein. Certain of our accountingpolicies require the application of judgment in selecting the appropriateassumptions for calculating financial estimates. By their nature thesejudgments are subject to an inherent degree of uncertainty. We periodicallyevaluate the judgments and estimates used for our critical accounting policiesto ensure that such judgments and estimates are reasonable for our interim andyear-end reporting requirements. These judgments and estimates are based uponour historical experience, current trends and information available from othersources, as appropriate.  If differentconditions result from those assumptions used in our judgment, the resultscould be materially different from our estimates. Our critical accountingpolicies include the following:

### *RevenueRecognition*

Werecognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, *Revenue Recognition in Financial Statements*and EITF 00-21, *Revenue Arrangements with Multiple Deliverables.* Thesepronouncements require that five basic criteria must be met before revenue canbe recognized: (1) persuasive evidence that an arrangement exists; (2) deliveryhas occurred or services rendered; (3) the fee is fixed and determinable; (4)collectibility is reasonably assured. The Company recognizes revenue when titlepasses to the customer, generally upon shipment of products.

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*Options Issued*

Effective April 1, 2006the Company began accounting for compensation expense related to stock optionsin accordance with SFAS No. 123 (Revised 2004) *Share-BasedPayment*(“SFAS 123R”). Prior to April 1, 2006, the Company accountedfor stock options according to Accounting Principles Board (“APB”) Opinion 25, *Accounting for Stock Issued to Employees.*

The Company has adoptedthe modified prospective transition method and consequently has notretroactively adjusted results from prior periods. Under this transitionmethod, compensation cost associated with stock options now includes: (i)amortization related to the remaining unvested portion of all stock optionsoutstanding at March 31, 2006, based on the fair value determined on the grantdate in accordance with the original provisions of SFAS 123, and (ii)amortization related to all stock option awards granted subsequent to March 31,2006, based upon the fair value estimated in accordance with SFAS 123R. Thecompensation expense for stock-based compensation awards under SFAS 123R isrecognized over the vesting period of the options, and includes an estimate forforfeitures.

In accordance with SFAS123R, the Company recorded $132 and $112 of stock-based compensation expense inthe statement of operations for Q1 08 and for Q1 07, respectively, in thefollowing expense categories:

|                                        | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** |
|----------------------------------------|------------|----------------|------------|----------------|------------|
| Cost of Goods  Sold                    |       | $              | 13         |           | $          | 14 |   |
| Selling, General  & Administrative |       | 102            |       | 86             |       |
| Research &  Development            |       | 17             |       | 12             |       |
| Total                                  |       | $              | 132        |           | $          | 112 |   |

 

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At June 30, 2007, thetotal unamortized stock-based compensation is approximately $910. The Companywill expense that amount over periods ending through June 30, 2013. The Companydoes not expect to realize any tax benefits from future disqualifyingdispositions, if any, due to its policy of recording valuation allowances equalto its deferred tax asset.

In the three months ended June 30, 2007, theCompany granted options to purchase a total of 1,011,250 shares of the Company’sCommon Stock. A total of 650,000 of these options were issued pendingshareholders approval of the 2007 Stock Option Plan (the “2007 Plan”).Consequently,the expense for these options will be recorded only after shareholder approvalof the 2007 Plan. A total of 361,250 of these options were granted from theCompany’s 2000 Stock Option Plan (the “2000 Plan”). The fair value of theseoptions measured at the option grant date was approximately $275, determinedusing the Black-Scholes option-pricing model. This amount is reduced by anestimated forfeiture rate and is being recorded as an expense over the vestingperiod. The assumptions used in the Black-Scholes option-pricing model in theperiod by the Company were as follows:
|                                         | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| Risk-free  interest rate                |       | 4.55                        | %          |
| Expected  dividend yield                |       | —                      |       |
| Expected life                           |       | 6.25 – 6.75 years      |       |
| Expected  volatility                    |       | 69 – 70                | %          |
| Weighted average value  grant per share |       | $                           | 0.76       |   |
|                                         |            |                             |            |  |

 

We account for optionsissued to non-employees and employees in accordance with the provisions of SFAS123R. We grant options with vesting periods ranging from immediate to sixyears. We use the simplified method of calculating the expected option term,which averages an award’s weighted average vesting period and its contractualterm. The contractual term of our options is ten years. The risk-free rate isbased upon the daily Treasury yield curve for a period approximately equal tothe expected option term. We used historical data to estimate the expectedprice volatility and forfeiture rate. The expected dividend yield is 0%, basedon our history of not paying dividends.

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*Income Taxes*

Underour income tax policy, we record the estimated future tax effects of temporarydifferences between the tax bases of assets and liabilities and amountsrecorded in the accompanying consolidated balance sheets, as well as operatingloss and tax credit carry-forwards.  Theevaluation of the recoverability of any tax assets recorded on the balancesheet is subject to significant judgment. We have provided valuation allowances for all our deferred tax assets todate.

**Results of Operations**

Net Sales

Net sales for the three months ended June 30, 2007, (Q1 08), were$2,430, an increase of $423, or 21%, compared to the three-month period endedJune 30, 2006 (Q1 07). During Q1 08, net sales of the medical segment increasedby $480, or 36%, to $1,832, and net sales of the industrial segment decreasedby $57, or 9%, to $598, compared to Q1 07. In the medical segment, we tracksales of endoscopes and EndoSheaths by market. We also track sales ofperipheral items that can be sold to more than one market.  Sales of other products include sales to the Gastrointestinal**(“GI”) and pulmonary markets, and sales of repairsand accessories. Sales by segment and category in Q1 08 and Q1 07 were as follows:
| Category         | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| ENT              |       | $              | 1,113      |           | $          | 1,032                    |       | $           | 81         |   | 8 | % |
| Urology          |       | 224            |       | 75             |       | 149                      |       | 199         | %          |
| Peripherals      |       | 117            |       | 69             |       | 48                       |       | 70          | %          |
| Other            |       | 378            |       | 176            |       | 202                      |       | 115         | %          |
| Total medical    |       | 1,832          |       | 1,352          |       | 480                      |       | 36          | %          |
| Total industrial |       | 598            |       | 655            |       | (57                      | )          | (9          | )%         |
| Total VSCI       |       | $              | 2,430      |           | $          | 2,007                    |       | $           | 423        |   | 21 | % |

 

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*MedicalSales – ENT Market*

Net sales to the ENTmarket include products for domestic and international customers as follows:
| **ENT Market** | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|---------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Domestic            |       | $              | 1,113      |           | $          | 532                      |       | $           | 581        |   | 109 | % |
| International       |       | 0              |       | 500            |       | (500                     | )          | (100        | )%         |
| Total ENT           |       | $              | 1,113      |           | $          | 1,032                    |       | $           | 81         |   | 8 | % |

 

We further delineateproducts sold to the domestic ENT market as follows:
| **Products**          | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|-----------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On  EndoSheaths |       | $              | 681        |           | $          | 403                      |       | $           | 278        |   | 69 | % |
| Endoscopes            |       | 432            |       | 129            |       | 303                      |       | 235         | %          |
| Total Domestic  ENT   |       | $              | 1,113      |           | $          | 532                      |       | $           | 581        |   | 109 | % |

 

Theprimary reason for the increase in sales of products to the domestic ENT marketwas a change in our customer base. We previously sold some of our productsdirectly to foreign distributors. As of Q1 08 we sell all ENT products for thedomestic and foreign markets directly to Medtronic. Usage of TNE endoscopes byENT physicians allows them to perform procedures in their offices thatcurrently are performed mainly by GI physicians in hospitals. Educating thismarket on the advantages of these procedures has proven more difficult than wehad anticipated. We expect these procedures will be more popular among ENTphysicians in the future, to diagnose and treat gastroenterology reflux disease(“GERD”), especially as the population ages. A TNE procedure allows patients toreceive topical anesthetics in a physician’s office, as opposed to the morecommon Trans Oral Esophagoscopy procedure that requires a patient to beconsciously sedated in a hospital. A patient who undergoes a TNE procedure canrecover more quickly than one who is consciously sedated. It is our view thatthese procedures will increase in the future because the inconvenience to thepatient is less and the total cost is less when they are done in an office.However, it will take time to educate and train the physicians and educate thepatient population on these advantages.

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Sales of our ENTSlide-On EndoSheath covers increased in Q1 08, compared to Q1 07, as Medtronic,our exclusive ENT distributor, increased its purchases from us, as part of theMedtronic Transition Agreement of March 26, 2007 that was entered into at thetime of the sale of the ENT business to Medtronic.

As a result of thesale of the ENT business to Medtronic, the success of our ENT product lines issubstantially dependent upon the success of the marketing and sales activitiesof Medtronic over which we have limited control.

We furtherdelineate products sold to the international ENT market as follows:
| **Products**          | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|-----------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On  EndoSheaths |       | $              | —     |           | $          | 481                      |       | $           | (481       | ) | (100 | )% |
| Endoscopes            |       | —         |       | 19             |       | (19                      | )          | (100        | )%         |
| Total  International  |       | $              | —     |           | $          | 500                      |       | $           | (500       | ) | (100 | )% |

 

The decrease innet sales to international distributors is due to the fact that as part of ourlicense and sales of our ENT business in March of 2007 to MENT, we terminatedall of our international ENT distributors, and granted MENT exclusive worldwidedistribution rights for our ENT products. We now ship our ENT products directlyto MENT, which distributes to both the U.S. and international markets.

*Medical Sales – Urology*

Theincrease in sales of urology products reflects our focus on this medicalsegment. In May 2006, we terminated our distribution agreement with MedtronicInc. (the “MGU Agreement”). We decided to explore other forms of distributionfor our Slide-On EndoSheath flexible cystoscopy System (“CST-2000” and “CST-2000A”,together referred to as “CST”), including utilizing a network of independentsales representatives. We are focused on developing this network and believethat it will take between 9 and 12 months to complete the build up of this newsales network. Although current performance reflects an increase in sales as aresult of these efforts, we will continually assess our progress in this area,and could abandon our efforts if they do not prove to be successful during thattime frame.

Webelieve the CST EndoSheath System can significantly enhance the practiceefficiency of urologists by allowing them to avoid the tedious andtime-consuming reprocessing of conventional cystoscopes, and presents thesignificant benefit of a sterile insertion tube for each patient. In addition,the use of our CST-2000A cystoscope with the Slide-On EndoSheath sterile,single-use cover avoids the need to reprocess endoscopes with harsh chemicals,one of which has been contraindicated for use on patients with bladder cancer.

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*MedicalSales – Peripherals and Other*

Salesof peripheral and other products increased in Q1 08, compared to Q1 07, dueprimarily to higher demand for our GI and pulmonary EndoSheaths. We have asmall installed base of users of these products, and we plan to continue tosupply them with EndoSheaths in FY 08. However, we do not plan to activelypromote these products. As a result, we expect the sales of these products maydecline during FY 08, compared to FY 07.

*IndustrialSegment*

Thedecrease in net sales of the industrial segment was due to lower demand in themarket for new fiberscopes and repairs to fiberscopes.

Gross Profit

Grossprofit was $943 in Q1 08, an increase of $455, compared to gross profit in Q107. Gross profit increased by approximately $262 in the medical segment, andincreased by approximately $193 in the industrial segment. Gross profit in themedical segment increased due to higher volume of domestic sales of ENTEndoSheath covers and a higher volume of ENT endoscopes, peripherals and otherproducts.  In the industrial segment, theincrease in gross profit was due primarily to an increase in efficiencyassociated with our manufacturing and quality control of endoscopes.

Operating Expenses

*Selling,General and Administrative Expenses*

The increase in selling,general and administrative (“SG&A”) expenses in Q1 08 was due primarily tohigher spending for personnel, including stock-based compensation, ofapproximately $270; higher spending on product promotion and travel related tomedical products of approximately $40; and higher costs for professional feesof approximately $170.

*Research and Development Expenses*

The increase in researchand development (“R&D”) expenses in Q1 08 was $225 as  compared to Q1 07. This increase was dueprimarily to additional spending for materials and personnel developing our newlines of videoscope and sheath products. We expect R&D expenses willcontinue to be higher in FY 08, compared to FY 07, as we increase our effortsto develop this new family of video scopes as well as other new products.

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Operating Income (Loss)

Operating income (loss)by segment was as follows ($000’s):
| Segment    | ** ** | **Q1 08** | ** ** | **Q1 07** | ** ** | **Change** | ** ** |
|------------|------------|----------------|------------|----------------|------------|------------|------------|
| Medical    |       | $              | (1,654     | )              | $          | (1,046     | )          | $ | (608 | ) |
| Industrial |       | 15             |       | (158           | )          | 173        |       |
| Total      |       | $              | (1,639     | )              | $          | (1,204     | )          | $ | (435 | ) |

 

Inthe medical segment, higher spending for SG&A and R&D resulted in anincrease to the operating loss for Q1 08. In the industrial segment, the highergross profit was the primary cause for the decrease in the operating loss in Q108.

Liquidity and CapitalResources

At June 30, 2007, ourprincipal source of liquidity was working capital of approximately $27.3 million,including $24.7 million in cash and short term investments.

Ourcash and cash equivalents decreased by approximately $13,898 in the threemonths ended June 30, 2007, due primarily to cash used for operations ofapproximately $2,894, cash used for investing activities of approximately $11,012,including a $1 million investment in MINOS, (see below) and the purchase ofshort term investments of $9,631, and cash provided by financing activity ofapproximately $8. We expect that our current balance of cash and cashequivalents will be sufficient to fund our operations for at least the nexttwelve months.

InApril 2007, we also executed a definitive investment agreement under whichVision-Sciences acquired a strategic interest in Minos Medical, Inc. (“Minos’’).Minos is a privately held California based development stage medical devicecompany concentrating in the emerging field of N.O.T.E.S. (Natural OrificeTrans-luminal Endoscopy Surgery). N.O.T.E.S. is a new frontier in surgery,focusing on using natural orifices to enter the body to facilitateincision-less surgical procedures. We invested $1 million in cash and haveagreed to expend $165 in development costs in collaboration with Minos toexploit a specific common surgical procedure in exchange for 30% of theirissued and outstanding capital stock, which is included in equity investments.We accounted for this transaction on our Balance Sheet as an Equity Investment.

Wehave incurred losses since our inception, and losses are expected to continueat least during FY 08.  We have fundedthe losses principally with the proceeds from public and private equityfinancings.

Weexpect total spending for property and equipment to be approximately $1,500,000for FY 08.

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We conduct ouroperations in certain leased facilities. These leases expire on various dates through August 31, 2010.  In addition, we have operating leases forcertain office equipment.  At June 30,2007, the minimum rent commitments are as follows:
| Fiscal Year | ** ** | **Rent Commitments** | ** ** |
|------------------|------------|---------------------------|------------|
| 2008             |       | $                         | 539        |   |
| 2009             |       | 385                       |       |
| 2010             |       | 283                       |       |
| 2011             |       | 88                        |       |
| Total            |       | $                         | 1,295      |   |

 

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

Recently IssuedAccounting Standards

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48, *Accounting for Uncertainty in Income Taxes-an**Interpretation of FASB Statement No. 109*, which seeks toreduce the significant diversity in practice associated with certain aspects ofmeasurement and recognition in accounting for income taxes. FIN 48 prescribes arecognition threshold and measurement attribute for financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return, and also provides guidance on de-recognition, classification,interest and penalties, accounting in interim periods, disclosure andtransition. The provisions of FIN 48 are effective for fiscal years beginningafter December 15, 2006. Upon adoption, the cumulative effect of any changes innet assets resulting from the application of FIN 48 will be recorded as anadjustment to retained earnings. The Company is currently evaluating theimpact, if any, that FIN 48 will have on its financial position and results ofoperations.

InFebruary 2006, the FASB issued SFAS 155, *Accountingfor Certain Hybrid Financial Instruments* which amends SFAS 133,*Accounting for Derivative Instruments and HedgingActivities* and SFAS 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*.SFAS 155 simplifies the accounting for certain derivatives embedded inother financial instruments by allowing them to be accounted for as a whole ifthe holder elects to account for the whole instrument on a fair valuebasis.  SFAS 155 also clarifies andamends certain other provisions of SFAS 133 and SFAS 140.  SFAS 155 is effective for all financialinstruments acquired, issued or subject to a re-measurement event occurring infiscal years beginning after September 15, 2006 and is therefore requiredto be adopted by the Company in the first quarter of its fiscal year endedMarch 31, 2008. The Company does not expect SFAS 155 to have an impact onits consolidated financial statements as it does not currently use anyfinancial derivative instruments.

InSeptember 2006, the FASB issued SFAS 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans*.This statement requires public entities with defined benefit pension plans andother postretirement plans to fully recognize, as an asset or a liability, theover funded or under funded status of its benefit plans in its 2006 balancesheet. SFAS 158 did not have an impact on our consolidated financial statementsas we have no defined benefit pension or other postretirement plans.

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In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements* to provide guidance on theconsideration of the effects of prior year misstatements in quantifying currentyear misstatements for the purpose of a materiality assessment. Under SAB No.108, companies should evaluate a misstatement based on its impact on thecurrent year income statement, as well as the cumulative effect of correctingsuch misstatements that existed in prior years existing in the current year’sending balance sheet. SAB No. 108 is effective for fiscal years ending afterNovember 15, 2006. The adoption of SAB No. 108 did not have an impact on ourfinancial position and results of operations.

InSeptember 2006, the FASB issued SFAS 157 *Fair Value Measurements*.SFAS 157 establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  The standard applies whenever other standards require (orpermit) assets or liabilities to be measured at fair value.  The standarddoes not expand the use of fair value in any new circumstances.  SFAS 157is effective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years. Earlierapplication is encouraged. The Company has not yet determined the effect theadoption of SFAS 157 will have on its financial position and results ofoperations.

InJune 2006, the FASB ratified the consensus on EITF Issue No. 06-03, *How Taxes Collected from Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement.* Thescope of EITF Issue No. 06-03 includes any tax assessed by a governmentalauthority that is directly imposed on a revenue-producing transaction between aseller and a customer and may include, but is not limited to, sales, use, valueadded, Universal Service Fund (“USF”) contributions and some excise taxes.The Task Force affirmed its conclusion that entities should present these taxesin the income statement on either a gross or a net basis, based on theiraccounting policy, which should be disclosed pursuant to APB OpinionNo. 22, *Disclosure of Accounting Policies.*If such taxes are significant, and are presented on a gross basis, the amountsof those taxes should be disclosed. The consensus on Issue No. 06-03 iseffective for interim and annual reporting periods beginning afterDecember 15, 2006. The adoption of EITF No. 06-03 did not have animpact on our results of operations.

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

Inthe normal course of business, we are subject to the risks associated withfluctuations in interest rates and changes in foreign currency exchange rates.

#### *Interest and Market Risk*

We currently invest our excess cash in a money market account at ourbank.  We have not used derivativefinancial instruments in our investment portfolio. We attempt to limit ourexposure to interest rate and credit risk by placing our investments withhigh-quality financial institutions and have established investment guidelinesrelative to diversification and maturities designed to maintain safety andliquidity.

Investmentsin both fixed-rate and floating-rate interest earning instruments carry adegree of interest rate risk.  Fixed-ratesecurities may have their fair market value adversely impacted due to a rise ininterest rates, while floating-rate securities may produce less income thanexpected if interest rates decline.  Duein part to these factors, our future investment income may fall short ofexpectations due to changes in interest rates, or we may suffer losses inprincipal if forced to sell securities which have seen a decline in marketvalue due to changes in interest rates.

#### *ForeignCurrency Exchange*

Weface exposure, due to purchases of raw materials from foreign suppliers, toadverse movements in the value of certain foreign currencies. This exposure maychange over time, and could have an adverse effect on our financialresults.  We may attempt to limit thisexposure by purchasing forward contracts, as required.  Most of our foreign exchange liabilities aresettled within 90 days of receipt of materials. At June 30, 2007, our liabilities relating to foreign currency were notmaterial.

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## **Item4.  CONTROLS AND PROCEDURES**

*a)**            Evaluation ofDisclosure Controls and Procedures.*

Basedon an evaluation of our disclosure controls and procedures (as defined in Rules13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934), the chiefexecutive officer and chief financial officer have concluded that ourdisclosure controls and procedures as of the end of the three months ended June30, 2007, are effective.

*b)**            Changes in InternalControls Over Financial Reporting.*

There were no changes inour internal controls over financial reporting that occurred during the fiscalquarter ended June 30, 2007 that have materially affected, or are reasonablelikely to materially affect, our internal controls over financial reporting.

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**PART II - OTHER INFORMATION**

**Item 1A.RISK FACTORS**

The risk factorsincluded in the Company’s Annual Report on Form 10-K for the fiscal year endedMarch 31, 2007 have not materially changed.

**Item6.  EXHIBITS**
| Exhibits | ** ** | ** **                                                                                                                                                                     |
|----------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |       |                                                                                                                                                                           |
| 31.1     |       | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a)/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)/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. §1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002. |

 

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##### **SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                              | VISION-SCIENCES, INC. |
|------------------------------|-----------------------|
|                         |                  |
|                         |                  |   |
|  Date:  August 14, 2007 |                  | /s/ Ron Hadani |   |
|                         |                  | Ron Hadani |
|                         |                  | President, CEO (Duly Authorized Officer) |
|                         |                  |   |
|                         |                  |   |
|  Date: August  14, 2007 |                  | /s/ Yoav M. Cohen |   |
|                         |                  | Yoav M. Cohen |
|                         |                  | Vice President Finance, Chief Financial Officer  (Principal Financial Officer and Principal Accounting  Officer) |
|                              |                       |  |  |  |

 

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