**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D. C. 20459**

**FORM 10-Q**
| **x**                                                 | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------|-----------------------------------------------------------------------------------------------|
| ** **                                            | ** **                                                                                    |
| **For the  quarterly period ended December 31, 2006** |
| ** **                                            |
| **OR**                                                |
| ** **                                            |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period               to              **

**COMMISSIONFILE NUMBER 0-20970**

**VISION-SCIENCES, INC.**

(Exact name ofregistrant 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’stelephone number, including area code)

**9 Strathmore Road, Natick MA01760**

(Former name, formeraddress, and

former fiscal yearif changed since last report)

Indicate by check markwhether 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 check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.

Large accelerated filer o  Acceleratedfiler o  Non-accelerated filer x

Indicate by check markwhether 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 February 6, 2007.
| **Common Stock, par value of $.01** |   | **35,172,728**      |
|-------------------------------------|--------|---------------------|
| (Title of Class)                    |   | (Number of  Shares) |

 

 

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

**TABLE OF CONTENTS**
|          | ** **            | ** **                                                                                  |
|----------|-----------------------|---------------------------------------------------------------------------------------------|
| Part I.  | Financial Information |                                                                                        |
|     |                  |                                                                                        |
|     | Item 1.               | Financial Statements                                                                        |   |
|     |                  |                                                                                        |   |
|     |                  | Consolidated Balance  Sheets                                                                |   |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statements of Operations                                                      |   |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statement of Stockholders’ Equity and Comprehensive Loss                 |   |
|     |                  |                                                                                        |   |
|     |                  | Consolidated  Statements of Cash Flows                                                      |   |
|     |                  |                                                                                        |   |
|     |                  | Notes to  Consolidated Financial Statements                                                 |   |
|     |                  |                                                                                        |   |
|     | Item 2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|     |                  |                                                                                        |   |
|     | Item 3.               | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
|     |                  |                                                                                        |   |
|     | Item 4.               | Controls and  Procedures                                                                    |   |
|     |                  |                                                                                        |   |
| Part II. | Other Information     |                                                                                        |
|     |                  |                                                                                        |
|     | Item 6.               | Exhibits                                                                                    |   |
|     |                  |                                                                                        |   |
|     | Signatures            |                                                                                        |
|     |                  |                                                                                        |
|     | Exhibits              |                                                                                        |

 

2

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**PART I - FINANCIAL INFORMATION**

**Item 1:FINANCIAL STATEMENTS**

**VISION-SCIENCES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                     | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                                                                                                     | ** ** | **2006**              | ** ** | **2006**           | ** ** |
| ** **                                                                                                                                     | ** ** | **(Unaudited)**       | ** ** | ** **         | ** ** |
| ASSETS                                                                                                                                         |       |                  |       |               |       |
| Current Assets:                                                                                                                                |       |                  |       |               |       |
| Cash and cash  equivalents                                                                                                                     |       | $                     | 2,549,819  |               | $          | 6,138,148 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $127,067 and $145,402,  respectively                                           |       | 1,432,600             |       | 1,767,913          |       |
| Inventories, net                                                                                                                               |       | 2,196,752             |       | 2,384,993          |       |
| Prepaid expenses  and other current assets                                                                                                     |       | 247,520               |       | 59,532             |       |
| Total current  assets                                                                                                                          |       | 6,426,691             |       | 10,350,586         |       |
| Property and Equipment,  at cost:                                                                                                              |       |                  |       |               |       |
| Machinery and  equipment                                                                                                                       |       | 5,171,388             |       | 4,747,964          |       |
| Furniture and  fixtures                                                                                                                        |       | 271,620               |       | 250,865            |       |
| Leasehold  improvements                                                                                                                        |       | 588,795               |       | 582,631            |       |
|                                                                                                                                           |       | 6,031,803             |       | 5,581,460          |       |
| Less-Accumulated  depreciation and amortization                                                                                                |       | 4,808,172             |       | 4,489,529          |       |
|                                                                                                                                           |       | 1,223,631             |       | 1,091,931          |       |
|                                                                                                                                           |       |                  |       |               |       |
| Other assets, net of  accumulated amortization of $64,754 and $60,127, respectively                                                            |       | 63,878                |       | 68,505             |       |
| Total assets                                                                                                                                   |       | $                     | 7,714,200  |               | $          | 11,511,022 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                     |       |                  |       |               |       |
| Current Liabilities:                                                                                                                           |       |                  |       |               |       |
| Acceptances  payable to a bank                                                                                                                 |       | $                     | 9,952      |               | $          | 61,536 |   |
| Current portion  of note payable                                                                                                               |       | 10,708                |       | 26,431             |       |
| Accounts payable                                                                                                                               |       | 487,199               |       | 892,398            |       |
| Accrued expenses                                                                                                                               |       | 1,220,441             |       | 1,028,146          |       |
| Total current  liabilities                                                                                                                     |       | 1,728,300             |       | 2,008,511          |       |
|                                                                                                                                           |       |                  |       |               |       |
| Long-term portion of  note payable                                                                                                             |       | —                |       | 4,193              |       |
|                                                                                                                                           |       |                  |       |               |       |
| Stockholders’ Equity:                                                                                                                     |       |                  |       |               |       |
| Common stock,  $.01 par value—                                                                                                            |       |                  |       |               |       |
| Authorized—50,000,000  shares Issued and outstanding—35,166,478 shares at December 31, 2006 and  35,148,427 shares at March 31, 2006 |       | 351,664               |       | 351,483            |       |
| Additional  paid-in capital                                                                                                                    |       | 76,078,613            |       | 75,678,615         |       |
| Accumulated  deficit                                                                                                                           |       | (70,444,377           | )          | (66,531,780        | )          |
| Total  stockholders’ equity                                                                                                               |       | 5,985,900             |       | 9,498,318          |       |
| Total liabilities and  stockholders’ equity                                                                                               |       | $                     | 7,714,200  |               | $          | 11,511,022 |   |

 

See accompanyingnotes to consolidated financial statements.

3

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**
| ** **                                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                            | ** ** | **December 31,**            | ** ** | **December 31,**           | ** ** |
| ** **                                                            | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                             |       | $                                | 2,215,615  |                            | $          | 3,330,041 |   | $ | 6,513,993 |   | $ | 8,164,551 |   |
| Cost of sales                                                         |       | 1,922,092                        |       | 2,445,318                       |       | 5,335,946 |   | 6,175,340 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                                          |       | 293,523                          |       | 884,723                         |       | 1,178,047 |   | 1,989,211 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Selling, general  and administrative expenses                         |       | 1,209,500                        |       | 1,343,478                       |       | 3,472,969 |   | 3,507,814 |   |
| Research and  development expenses                                    |       | 513,765                          |       | 597,930                         |       | 1,724,789 |   | 1,537,588 |   |
| Loss from operations                                                  |       | (1,429,742                       | )          | (1,056,685                      | )          | (4,019,711 | ) | (3,056,191 | ) |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Interest income                                                       |       | 27,831                           |       | 56,237                          |       | 117,669 |   | 143,117 |   |
| Interest expense                                                      |       | (270                             | )          | (731                            | )          | (1,126 | ) | (2,549 | ) |
| Other income  (expense), net                                          |       | (2,549                           | )          | (1,190                          | )          | (9,429 | ) | 3,610 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                              |       | $                                | (1,404,730 | )                               | $          | (1,002,369 | ) | $ | (3,912,597 | ) | $ | (2,912,013 | ) |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Basic and  diluted net loss per common share                          |       | $                                | (0.04      | )                               | $          | (0.03 | ) | $ | (0.11 | ) | $ | (0.08 | ) |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Shares used in  computing basic and diluted net loss per common share |       | 35,166,330                       |       | 35,128,478                      |       | 35,161,713 |   | 35,089,761 |   |

 

See accompanyingnotes to consolidated financial statements.

4

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

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**(Unaudited)**
| ** **                                     | ** ** | **Common Stock** | ** ** | ** **         | ** ** | ** **          | ** ** | **Total**       | ** ** |
|------------------------------------------------|------------|-----------------------|------------|--------------------|------------|---------------------|------------|-----------------|------------|
| ** **                                     | ** ** | **Number**            | ** ** | **$.01**           | ** ** | **Additional**      | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                     | ** ** | **of Shares**    | ** ** | **Par Value** | ** ** | **Paid-in-Capital** | ** ** | **Deficit**     | ** ** | **Equity** | ** ** |
|                                           |       |                  |       |               |       |                |       |            |       |   |   |
| Balance, March  31, 2006                       |       | 35,148,427            |       | $                  | 351,483    |                | $          | 75,678,615      |       | $ | (66,531,780 | ) | $ | 9,498,318 |   |
| Exercise of  stock options, net                |       | 18,051                |       | 181                |       | 19,395              |       |            |       | 19,576 |   |
| Compensation  expense related to stock options |       |                  |       |               |       | 380,603             |       |            |       | 380,603 |   |
| Net loss                                       |       |                  |       |               |       |                |       | (3,912,597      | )          | (3,912,597 | ) |
|                                           |       |                  |       |               |       |                |       |            |       |   |   |
| Balance December 31,  2006                     |       | 35,166,478            |       | $                  | 351,664    |                | $          | 76,078,613      |       | $ | (70,444,377 | ) | $ | 5,985,900 |   |

 

See accompanyingnotes to consolidated financial statements.

5

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                    | ** ** | **Nine Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                    | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
| Cash flows from  operating activities:                                        |       |                            |       |                            |       |
| Net loss                                                                      |       | $                               | (3,912,597 | )                               | $          | (2,912,013 | ) |
| Adjustments to reconcile net loss to net cash used  for operating activities: |       |                            |       |                            |       |
| Depreciation and amortization                                                 |       | 323,271                         |       | 328,498                         |       |
| Stock-based compensation                                                      |       | 380,603                         |       | 388,316                         |       |
| Changes in assets and liabilities:                                            |       |                            |       |                            |       |
| Accounts receivable                                                           |       | 335,313                         |       | (300,759                        | )          |
| Inventories                                                                   |       | 188,240                         |       | (392,345                        | )          |
| Prepaid expenses and deposits                                                 |       | (187,988                        | )          | (11,483                         | )          |
| Accounts payable                                                              |       | (405,198                        | )          | 212,122                         |       |
| Accrued expenses                                                              |       | 192,294                         |       | (136,859                        | )          |
| Net cash used for operating activities                                        |       | (3,086,062                      | )          | (2,824,523                      | )          |
|                                                                          |       |                            |       |                            |       |
| Cash flows used  for investing activities:                                    |       |                            |       |                            |       |
| Purchase of property and equipment, net                                       |       | (450,344                        | )          | (318,112                        | )          |
|                                                                          |       |                            |       |                            |       |
| Net cash used for investing activities                                        |       | (450,344                        | )          | (318,112                        | )          |
|                                                                          |       |                            |       |                            |       |
| Cash flows  provided by (used for) financing activities:                      |       |                            |       |                            |       |
| Payments on note payable for computer equipment                               |       | (19,915                         | )          | (18,493                         | )          |
| Payments of acceptances payable to a bank, net                                |       | (51,584                         | )          | 24,266                          |       |
| Proceeds from the sale of common stock, net                                   |       | —                          |       | 55,869                          |       |
| Exercise of stock options, net                                                |       | 19,576                          |       | 145,565                         |       |
| Net cash (used for) provided by financing activities                          |       | (51,923                         | )          | 207,207                         |       |
| Net decrease in  cash and cash equivalents                                    |       | (3,588,329                      | )          | (2,935,428                      | )          |
| Cash and cash  equivalents, beginning of period                               |       | 6,138,148                       |       | 9,868,586                       |       |
| Cash and cash  equivalents, end of period                                     |       | $                               | 2,549,819  |                            | $          | 6,933,158 |   |
| Supplemental  Disclosure of Cash Flow Information:                            |       |                            |       |                            |       |
| Cash paid during the  period for interest                                     |       | $                               | 1,126      |                            | $          | 2,549 |   |

 

6

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

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

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

The consolidated financial statementsincluded herein have been prepared by Vision-Sciences, Inc. and itssubsidiaries (referred to herein as “we,” “our,” “us” or the “Company”) inaccordance with generally accepted accounting principles in the United Statesof America (“GAAP”), without audit, pursuant to the rules and regulations ofthe Securities and Exchange Commission and include, in the opinion ofmanagement, all adjustments (consisting only of normal and recurringadjustments) that the Company considers necessary for a fair presentation ofsuch information.  Certain informationand footnote disclosures normally included in financial statements have beencondensed or omitted pursuant to such rules and regulations.  The Company believes, however, that itsdisclosures are adequate to make the information presented not misleading.  These consolidated financial statements shouldbe read in conjunction with the audited consolidated financial statements andnotes thereto included in the Company’s latest annual report tostockholders.  The results for theinterim periods presented are not necessarily indicative of results to be expectedfor the full fiscal year.

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

The accompanying consolidated financialstatements reflect the application of certain                        accounting policies described below:

a.                                       *Principles of Consolidation*: The accompanying consolidated financialstatements 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 with originalmaturities of ninety days or less, consisting of commercial paper and a moneymarket account at a bank, as cash equivalents. Cash equivalents are stated at amortized cost, which approximates marketvalue*.*

c.                                       *Inventories*: Inventories are stated at the lower of cost or market using thefirst-in, first-out (FIFO) method and consist of the following:
|                 | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-----------------|------------|-----------------------|------------|--------------------|------------|
| ** **      | ** ** | **2006**              | ** ** | **2006**           | ** ** |
| ** **      | ** ** | **(unaudited)**       | ** ** | **(audited)**      | ** ** |
|            |       |                  |       |               |       |
| Raw materials   |       | $                     | 1,363,856  |               | $          | 1,600,652 |   |
| Work-in-process |       | 372,961               |       | 143,803            |       |
| Finished goods  |       | 459,935               |       | 640,538            |       |
|            |       | $                     | 2,196,752  |               | $          | 2,384,993 |   |

 

Work-in-process and finished goodsinventories consist of material, labor, and manufacturing overhead.

7

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

d.                                      *Depreciation and Amortization*: The Company provides for depreciation andamortization using the straight-line method in amounts that allocate the costof the assets to operations over their estimated useful lives as follows:
|                               | ** ** | **Estimated**        | ** ** |
|-------------------------------|------------|----------------------|------------|
| **Asset Classification** | ** ** | **Useful Life** | ** ** |
| Machinery and Equipment       |       | 3-5 Years            |       |
| Furniture and  Fixtures       |       | 5 Years              |       |

 

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

e.                                       *Basic and Diluted Net Loss PerCommon Share*: Basic anddiluted net loss per common share is based on the weighted average number ofcommon shares outstanding.  Shares ofcommon stock issuable pursuant to outstanding stock options have not beenconsidered, as their effect would be antidilutive.

f.                                         *RevenueRecognition*: The following must occur before the Companyrecognizes revenue: (1) persuasive evidence of an arrangement exists, (2)delivery has occurred or services have been rendered, (3) the price is fixed ordeterminable, (4) collectibility is reasonably assured and (5) the fair valueof undelivered elements, if any, exists. To date the Company has not entered into any multiple elementarrangements.  The Company recognizesrevenue when title passes to the customer, generally upon shipment of productsF.O.B. its plants.  Since September 2003,the Company’s medical segment has distributed all of its products for theEar-Nose-Throat (“ENT”) market in the United States and Canada through anagreement (the “Medtronic Agreement”) with Medtronic ENT, Inc. (“MENT”).  The Medtronic Agreement does not provide forany contingencies, nor provide any terms related to product acceptance orwarranty that are different from the normal terms provided by the Company toits other customers.

The initial term of theMedtronic Agreement was three years. Thereafter, it provided for an automaticrenewal for successive one-year periods, unless terminated by either party uponadvance written notice.  Neither partyprovided such notice, so on September 2006, the Medtronic Agreement was renewedfor an additional one year (for additional information, please see Note 5, *subsequent events,* paragraph a).

From December 2004 to May 1, 2006, theCompany’s medical segment distributed all of its products for the urologymarket in the United States and Canada through Medtronic USA, Inc. (theMedtronic Gastroenterology/Urology business, or “MGU”) as part of a separateexclusive agreement (the “MGU Agreement”). The MGU Agreement continued in full force and effect until March 31,2006, renewable thereafter annually, unless terminated by either party.  In May 2006, the Company and MGU terminatedthe MGU Agreement.  Subsequent to May 1,2006, the Company has been developing its own worldwide independent salesrepresentative organization to distribute its products to the urology market.

8

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The Company’s medical segment distributes itsproducts for the pulmonary and gastro-intestinal (“GI”) markets and the Urologymarket through a network of independent domestic sales representatives.  The Company’s medical segment distributes allits products outside the United States and Canada through a network ofindependent international distributors.

The Company’s industrial segment distributesall its products using direct sales personnel and a network of independentsales representatives.

g.                                      *Foreign Currency Transactions*: In accordance with Statement of FinancialAccounting Standard (“SFAS”) No. 52, *Foreign CurrencyTranslation,* the Company charges foreign currency exchange gains orlosses, in connection with its purchases of products from foreign vendors, tooperations.

h.                                      *Income Taxes*: The Company accounts for income taxes underthe liability method in accordance with SFAS No. 109, *Accountingfor Income Taxes*(“SFAS 109”). Under SFAS 109, deferred tax assets or liabilities are computed basedupon the differences between the financial statement and income tax bases ofassets and 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.

i.                                          *Stock-based Compensation:*Effective April 1, 2006 the Company beganaccounting for compensation expense related to stock options granted toemployees and directors in accordance with SFAS No. 123 (Revised 2004) *Share-Based Payment*(“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 adopted the modifiedprospective transition method provided for under SFAS 123R, and consequentlyhas not retroactively 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 for stock-based compensation awards under SFAS123R is recognized over the vesting period of the options, and includes anestimate for forfeitures.

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The Company continues to account forcompensation expense related to stock options granted to non-employees inaccordance with EITF 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods and Services*(“EITF 96-18”).  According to the provisions of EITF 96-18,the Company determines the fair value of options granted to non-employees usingthe Black-Scholes option-pricing model on the measurement date which is eitherthe date a commitment for performance is reached, or when performance has beencompleted, depending upon the facts and circumstances of the option.  The fair value of the options valued at themeasurement date is expensed over the vesting period of the options.  This method approximates the same periods theexpense would be recognized had the Company paid cash for the services.  The Company does not account for the fairvalue of options granted, in which the quantity and terms are known up front,prior to the measurement date, as the services are not rendered prior to thosedates.  The Company accounts for the fairvalue of options granted, in which the quantity and terms are not known up front,when the services are performed.

In accordance withSFAS 123R and EITF 96-18, the Company recorded $136,754 and $380,603 ofstock-based compensation expense in the statement of operations for the threeand nine months ended December 31, 2006, respectively in the following expensecategories:
|                     | ** ** | **Three Months  Ended**    | ** ** | **Nine Months  Ended** | ** ** |
|---------------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** **          | ** ** | **December 31, 2006** | ** ** |
| Cost of Goods  Sold |       | $                               | 15,018     |                        | $          | 45,053 |   |
| SG&A            |       | 97,044                          |       | 288,498                     |       |
| R&D             |       | 24,692                          |       | 47,052                      |       |
| Total               |       | $                               | 136,754    |                        | $          | 380,603 |   |

 

On December 31, 2006**,** the total unamortized stock-based compensation isapproximately $932,000.  The Company willexpense that amount over the period ending December 31, 2010.  The Company does not expect to realize anytax benefits from future disqualifying dispositions, if any, due to its policyof recording valuation allowances equal to its deferred tax asset.

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In the three and ninemonths ended December 31, 2005, the Company recorded compensation expense of$288,947 and $388,316 for non-qualified stock options in the statement ofoperations in the following expense categories:
|            | ** ** | **Three Months  Ended**    | ** ** | **Nine Months  Ended** | ** ** |
|------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** ** | ** ** | **December 31, 2005** | ** ** |
|       |       |                            |       |                        |       |
| SG&A   |       | $                               | 284,325    |                        | $          | 383,475 |   |
| R&D    |       | 4,622                           |       | 4,841                       |       |
| Total      |       | $                               | 288,947    |                        | $          | 388,316 |   |

 

*EmployeesOptions:*In the nine months ended December 31,2006****(“9M 07”), the Company granted optionsto purchase 350,000 shares of the Company’s common stock to employees.  The fair value of these options measured atthe option grant dates was approximately $314,000, determined using theBlack-Scholes option-pricing model, and is being recorded as an expense overthe four year vesting period.  Theassumptions used in the Black-Scholes option-pricing model in the period by theCompany were as follows:
|                                         | ** ** | **Nine Months Ended  December 31, 2006** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------|------------|
| Risk-free  interest rate                |       | 4.51%-4.96                                                   | %          |
| Expected  dividend yield                |       | —                                                       |       |
| Expected life                           |       | 6.25 years                                                   |       |
| Expected  volatility                    |       | 67%-69                                                       | %          |
| Weighted average value  grant per share |       | $                                                            | 1.35       |   |
|                                         |            |                                                              |            |  |

 

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*NonEmployees Options*: In August2006, the Company granted options to purchase 100,000 shares of the Company’scommon stock to a non-employee.  The fairvalue of these options measured at the option grant dates was approximately$107,000, determined using the Black-Scholes option-pricing model, and is beingrecorded as an expense over the four year vesting period.  The assumptions used in the Black-Scholesoption-pricing model in the period by the Company were as follows:
|                                         | ** ** | **Nine Months Ended  December 31, 2006** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------|------------|
| Risk-free  interest rate                |       | 4.91                                                         | %          |
| Expected  dividend yield                |       | —                                                       |       |
| Expected life                           |       | 6.25 years                                                   |       |
| Expected  volatility                    |       | 69                                                           | %          |
| Weighted average value  grant per share |       | $                                                            | 1.60       |   |
|                                         |            |                                                              |            |  |

 

*DirectorsOptions:*In August 2006, the Company grantedoptions to purchase 16,000 shares of the Company’s common stock to outsidemembers of the board of directors.  Thefair value of these options measured at the option grant dates wasapproximately $15,160, determined using the Black-Scholes option-pricing model,and was recorded as an expense in the three months ended September 30, 2006, asthe options were 100% vested upon grant. The assumptions used in the Black-Scholes option-pricing model in theperiod by the Company were as follows:
|                                         | ** ** | **Nine Months Ended  December 31, 2006** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------|------------|
| Risk-free  interest rate                |       | 4.91                                                         | %          |
| Expected  dividend yield                |       | —                                                       |       |
| Expected life                           |       | 5.50 years                                                   |       |
| Expected  volatility                    |       | 69                                                           | %          |
| Weighted average value  grant per share |       | $                                                            | 1.49       |   |
|                                         |            |                                                              |            |  |

 

12

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Weaccount for options issued in accordance with the provisions of SFAS 123R.  We grant options with vesting periods rangingfrom immediate to four years.  Foroptions granted to employees in the current year, we have chosen to employ thesimplified method of calculating the expected option term, which averages anaward’s weighted average vesting period and its contractual term.  The contractual term of our options is tenyears.  The risk-free rate is based uponthe daily Treasury yield curve for a period approximately equal to the expectedoption term.  We used historical data toestimate the expected price volatility and forfeiture rate.  The expected dividend yield is 0%, based onour history of not paying dividends and on the fact that we are prohibited frompaying dividends under our bank agreement.

SFAS 123R requires the presentation of proforma information for the comparative period prior to the adoption, as if theCompany had accounted for all its employee stock options under the fair valuemethod of the original SFAS 123.  Thefollowing table illustrates the effect on net loss and loss per share if theCompany had applied the fair value recognition provisions of SFAS 123 to stock-basedemployee compensation in the prior year.
|                                                       | ** ** | **Three Months  Ended  December 31, 2005** | ** ** | **Nine Months  Ended  December 31, 2005** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Net loss – as  reported                          |       | $                                                         | (1,002,369 | )                                                        | $          | (2,912,013 | ) |
| Stock-based  employee compensation – as reported |       | 242,559                                                   |       | 249,153                                                  |       |
| Pro forma  stock-based employee compensation          |       | (494,452                                                  | )          | (760,114                                                 | )          |
| Net loss - pro  forma                                 |       | $                                                         | (1,254,262 | )                                                        | $          | (3,422,974 | ) |
|                                                  |       |                                                      |       |                                                     |       |
| Net loss per  share – as reported                |       | $                                                         | (.03       | )                                                        | $          | (.08 | ) |
| Stock-based  employee compensation – as reported |       | —                                                    |       | —                                                   |       |
| Pro forma  stock-based employee compensation          |       | (.01                                                      | )          | (.02                                                     | )          |
| Net loss per share -  pro forma                       |       | $                                                         | (.04       | )                                                        | $          | (.10 | ) |

 

13

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Inthe nine months ended December 31, 2005, the Company granted options topurchase 1,031,500 shares of the Company’s common stock.  The fair value of these options measured atthe option grant dates were approximately $1,476,000, determined using theBlack-Scholes option-pricing model, and were not recorded as an expense overthe vesting period, as the Company was not accounting for options under SFAS123R.

The assumptions usedin the Black-Scholes option-pricing model in the period by the Company were asfollows:
|                                         | ** ** | **Nine Months Ended  December 31, 2005** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------|------------|
| Risk-free  interest rate                |       | 3.33-4.07                                                    | %          |
| Expected  dividend yield                |       | —                                                       |       |
| Expected life                           |       | 5 years                                                      |       |
| Expected  volatility                    |       | 66%-72                                                       | %          |
| Weighted average value  grant per share |       | $                                                            | 1.36       |   |
|                                         |            |                                                              |            |  |

 

j.                                                *Recently Issued AccountingStandards*

In July 2006, the Financial AccountingStandards Board (“FASB”) issued FIN 48, *Accounting for Uncertaintyin Income Taxes-an**Interpretation of FASBStatement No. 109*, which seeks to reduce the significant diversityin practice associated with certain aspects of measurement and recognition inaccounting for income taxes. FIN 48 prescribes a recognition threshold and measurementattribute for financial statement recognition and measurement of a tax positiontaken or expected to be taken in a tax return, and also provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. The provisions of FIN 48 are effective forfiscal years beginning after December 15, 2006. Upon adoption, the cumulativeeffect of any changes in net assets resulting from the application of FIN 48will be recorded as an adjustment to retained earnings. The Company iscurrently evaluating the impact, if any, that FIN 48 will have on its financialposition and results of operations.

14

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In February 2006, the FASBissued SFAS 155, *Accounting for CertainHybrid Financial Instruments* which amends SFAS 133, *Accounting for Derivative Instruments and Hedging Activities*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. TheCompany does not expect SFAS 155 to have an impact on its consolidatedfinancial statements as it does not currently use any financial derivativeinstruments.

In September 2006, the FASB issuedSFAS 158, *Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans*. This statement requirespublic entities with defined benefit pension plans and other postretirementplans to fully recognize, as an asset or a liability, the overfunded orunderfunded status of its benefit plans in its 2006 balance sheet. The Companydoes not expect SFAS 158 to have an impact on its consolidated financialstatements as it has no defined benefit pension or other postretirement plans.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No.108, *Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements* to provide guidance on the consideration of the effectsof prior year misstatements in quantifying current year misstatements for thepurpose of a materiality assessment. Under SAB No. 108, companies shouldevaluate a misstatement based on its impact on the current year incomestatement, as well as the cumulative effect of correcting such misstatementsthat existed in prior years existing in the current year’s ending balancesheet. SAB No. 108 is effective for fiscal years ending after November 15,2006. The Company does not expect the adoption of SAB No. 108 to have animpact on its financial position and results of operations.

15

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In September 2006, the FASBissued 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 FASB ratified the consensuson EITF Issue No. 06-03, *How Taxes Collectedfrom Customers and Remitted to Governmental Authorities Should Be Presented inthe Income Statement.* The scope of EITF Issue No. 06-03includes any tax assessed by a governmental authority that is directly imposedon a revenue-producing transaction between a seller and a customer and mayinclude, but is not limited to, sales, use, value added, Universal Service Fund(“USF”) contributions and some excise taxes. The Task Force affirmed itsconclusion that entities should present these taxes in the income statement oneither a gross or a net basis, based on their accounting policy, which shouldbe disclosed pursuant to APB Opinion No. 22, *Disclosure of Accounting Policies.* If such taxes aresignificant, and are presented on a gross basis, the amounts of those taxesshould be disclosed. The consensus on Issue No. 06-03 will be effectivefor interim and annual reporting periods beginning after December 15,2006. The Company is currently evaluating the impact of EITF No. 06-03. Should the Company need to change the manner in which it records grossreceipts, it is not expected that the change will have a material impact ontotal operating revenue and expenses and operating income and net income wouldnot be affected.

16

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**3.     Stock Option Plans**

The Company had a stock option plan (the “1990Plan”) under which it could grant employees and non-employees stock options atthe fair value of the stock on the date of grant.  The Board of Directors had authorized theissuance of options for the purchase of up to 4,375,000 shares of common stockunder the 1990 Plan, of which 872,087 were retired as of the expiration of the1990 Plan.  Options for the purchase of1,435,750 shares of common stock under the 1990 Plan remain outstanding atDecember 31, 2006.

The Company has a stock option plan (the “2000Plan”) under which it grants key employees and consultants stock options at thefair value of the stock on the date of grant. Options become exercisable at varying dates ranging up to five yearsfrom the date of grant.  The Board ofDirectors and shareholders have authorized the issuance of options for thepurchase of up to 4,500,000 shares of common stock under the 2000 Plan, ofwhich 798,358 shares remain available for future grant.  Options for the purchase of 3,049,300 sharesof common stock under the 2000 Plan remain outstanding at December 31,2006.  The Company grants options to bothemployees and non-employee consultants.

A summary of the stockoption activity for 9M 07 is as follows:
| ** **                     | ** ** | **Number of Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average Remaining  Contractual Term (years)** | ** ** |
|--------------------------------|------------|--------------------------------|------------|------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
|                           |       |                           |       |                                           |       |                                                                         |       |
| Outstanding March 31,  2006    |       | 4,367,351                      |       | $                                              | 1.52       |                                                                         | 6.08       |   |
| Granted                        |       | 450,000                        |       | 1.41                                           |       |                                                                         |       |
| Exercised                      |       | (18,051                        | )          | 1.08                                           |       |                                                                         |       |
| Canceled                       |       | (314,250                       | )          | 2.14                                           |       |                                                                         |       |
| Outstanding December  31, 2006 |       | 4,485,050                      |       | $                                              | 1.47       |                                                                         | 5.71       |   |
| Exercisable December 31, 2006  |       | 3,527,050                      |       | $                                              | 1.44       |                                                                         |       |   |

 

The total intrinsic value ofoptions exercised in 9M 07 was $11,882.

The following table summarizes information about stock optionsoutstanding and exercisable on December 31, 2006:
|                                | ** ** | ** **            | ** ** | **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** | ** ** |
|                           |       |                  |       |                                                       |       |                                  |       |   |   |   |   |
| $                              | 0.79-1.05  |                  | 1,151,050  |                                                       | 6.21       |                                  | $          | 1.02 |   | 1,148,550 |   | $ | 1.02 |   |
| 1.06-1.32                      |       | 1,227,750             |       | 5.57                                                       |       | 1.15                                  |       | 902,750 |   | 1.14 |   |
| 1.34-1.67                      |       | 1,502,750             |       | 4.62                                                       |       | 1.57                                  |       | 1,138,000 |   | 1.61 |   |
| 1.73-2.25                      |       | 300,000               |       | 8.24                                                       |       | 1.90                                  |       | 90,000 |   | 1.89 |   |
| 2.28-2.90                      |       | 73,500                |       | 7.39                                                       |       | 2.44                                  |       | 57,750 |   | 2.35 |   |
| 3.25-4.30                      |       | 230,000               |       | 7.34                                                       |       | 3.95                                  |       | 190,000 |   | 3.89 |   |
|                           |       | 4,485,050             |       | 5.71                                                       |       | $                                     | 1.47       |   | 3,527,050 |   | $ | 1.44 |   |
|                                |            |                       |            |                                                            |            |                                       |            |  |  |  |  |  |  |  |

 

17

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The aggregate intrinsicvalue of all outstanding and exercisable options at December 31, 2006 isnegative, as the closing price of the Company’s common stock on December 31,2006 is less than the weighted average price of the outstanding and exercisableoptions.

The Company has a 2003Director Option Plan (the “2003 Plan”) under which it may grant up to 200,000non-statutory stock options to non-employee directors of the Company at thefair value of the stock on the grant date. 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 granted under the 2003 Plan are 100%vested on the date of grant.  The Companygranted options to purchase 16,000 shares to the outside directors on August 3,2006.  The Company expects to makesimilar grants at the annual meetings in each of 2007, 2008 and 2009.

A summary of the 2003 Plan activity is asfollows:
|                                | ** ** | **Number  of Shares** | ** ** | **Exercise  Price Range** | ** **  | **Weighted  Average  Exercise Price** | ** ** |
|--------------------------------|------------|----------------------------|------------|--------------------------------|-------------|--------------------------------------------|------------|
| Outstanding March 31,  2006    |       | 72,000                     |       | $                              | 1.0 - $2.10 |                                       | $          | 1.39 |   |
| Granted                        |       | 16,000                     |       | 1.49                           |        | 1.49                                       |       |
| Exercised                      |       | —                     |       | —                         |        | —                                     |       |
| Canceled                       |       | —                     |       | —                         |        | —                                     |       |
| Outstanding December  31, 2006 |       | 88,000                     |       | 1.00 - 2.10                    |        | 1.41                                       |       |
| Exercisable December 31, 2006  |       | 88,000                     |       | 1.00 - 2.10                    |        | 1.41                                       |       |
|                                |            |                            |            |                                |             |                                            |            |  |  |

 

The following table summarizes information about director stock optionsoutstanding and exercisable on December 31, 2006:
|                                     | ** **       | ** **                 | ** ** | **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     |                                                        | 4.44       |                                   | $          | 1.15 |   | 40,000 |   | $ | 1.15 |   |
| 1.49 – 1.92                    |             | 40,000                     |       | 5.01                                                        |       | 1.54                                   |       | 40,000 |   | 1.54 |   |
| 2.06 – 2.10                    |             | 8,000                      |       | 8.65                                                        |       | 2.08                                   |       | 8,000 |   | 2.08 |   |
|                                |             | 88,000                     |       | 5.08                                                        |       | $                                      | 1.41       |   | 88,000 |   | 1.41 |   |
|                                     |                  |                            |            |                                                             |            |                                        |            |  |  |  |  |  |  |  |

 

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**4.     Segment Information**

TheCompany has three reportable segments – medical, industrial and corporate.  The medical segment designs, manufactures andsells disposable Slide-On® EndoSheaths® (“EndoSheaths”) and sells endoscopes tousers in the healthcare industry.  Theindustrial segment designs, manufactures and sells borescopes to a variety ofusers, primarily in the aircraft engine manufacturing and aircraft enginemaintenance industries.  In addition, theindustrial segment manufactures and repairs endoscopes for the medicalsegment.  The corporate segment consistsof certain administrative and business development activities applicable to theCompany as a whole.

All segments follow the accounting policiesdescribed in the summary of significant accounting policies.  The Company evaluates segment performancebased upon operating income. Identifiable assets are those used directly in the operations of eachsegment.  Corporate assets include cash,marketable securities and the assets of Vision-Sciences, Ltd.  Data regarding management’s view of the Company’ssegments are provided in the following tables ($000’s):

19

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| **Three months ended December 31,** | ** ** | **Medical** | ** ** | **Industrial** | ** ** | **Corporate** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|---------------------------------------------------------|------------|-------------|------------|----------------|------------|---------------|------------|-----------------|------------|-----------|------------|
| **2006**                                                |       |        |       |           |       |          |       |            |       |      |       |
| Sales to external  customers                            |       | $           | 1,535      |           | $          | 681           |       | $               | —     |      | $          | — |   | $ | 2,216 |   |
| Intersegment sales                                      |       | —      |       | 357            |       | —        |       | (357            | )          | —    |       |
| Operating income (loss)                                 |       | (716        | )          | (314           | )          | (400          | )          | —          |       | (1,430    | )          |
| Interest income  (expense), net                         |       | —      |       | —         |       | 28            |       | —          |       | 28        |       |
| Depreciation and  amortization                          |       | 102         |       | 9              |       | —        |       | —          |       | 111       |       |
| Other significant  non-cash items:                      |       |        |       |           |       |          |       |            |       |      |       |
| Stock-based  compensation                               |       | 47          |       | 31             |       | 59            |       | —          |       | 137       |       |
| Expenditures for fixed  assets                          |       | 105         |       | 16             |       | —        |       | —          |       | 121       |       |
| ** **                                              |       |        |       |           |       |          |       |            |       |      |       |
| **2005**                                                |       |        |       |           |       |          |       |            |       |      |       |
| Sales to external  customers                            |       | $           | 2,531      |           | $          | 799           |       | $               | —     |      | $          | — |   | $ | 3,330 |   |
| Intersegment sales                                      |       | —      |       | 831            |       | —        |       | (831            | )          | —    |       |
| Operating income (loss)                                 |       | (581        | )          | 21             |       | (497          | )          | —          |       | (1,057    | )          |
| Interest income  (expense), net                         |       | —      |       | —         |       | 56            |       | —          |       | 56        |       |
| Depreciation and  amortization                          |       | 118         |       | 4              |       | —        |       | —          |       | 122       |       |
| Other significant  non-cash items:                      |       |        |       |           |       |          |       |            |       |      |       |
| Stock-based  compensation                               |       | 61          |       |           |       | 228           |       | —          |       | 289       |       |
| Expenditures for fixed  assets                          |       | 109         |       | 10             |       | —        |       | —          |       | 119       |       |
| ** **                                              |       |        |       |           |       |          |       |            |       |      |       |
| Nine months ended  December 31,                         |       |        |       |           |       |          |       |            |       |      |       |
| **2006**                                                |       |        |       |           |       |          |       |            |       |      |       |
| Sales to external  customers                            |       | $           | 4,474      |           | $          | 2,040         |       | $               | —     |      | $          | — |   | $ | 6,514 |   |
| Intersegment sales                                      |       | —      |       | 1,271          |       | —        |       | (1,271          | )          | —    |       |
| Operating income (loss)                                 |       | (2,258      | )          | (571           | )          | (1,191        | )          | —          |       | (4,020    | )          |
| Interest income  (expense), net                         |       | —      |       | —         |       | 118           |       | —          |       | 118       |       |
| Depreciation and  amortization                          |       | 301         |       | 22             |       | —        |       | —          |       | 323       |       |
| Other significant  non-cash items:                      |       |        |       |           |       |          |       |            |       |      |       |
| Stock-based  compensation                               |       | 114         |       | 75             |       | 192           |       | —          |       | 381       |       |
| Expenditures for fixed  assets                          |       | 384         |       | 66             |       | —        |       | —          |       | 450       |       |
| Total assets                                            |       | 4,496       |       | 1,777          |       | 2,589         |       | (1,148          | )          | 7,714     |       |
|                                                    |       |        |       |           |       |          |       |            |       |      |       |
| **2005**                                                |       |        |       |           |       |          |       |            |       |      |       |
| Sales to external  customers                            |       | $           | 6,147      |           | $          | 2,018         |       | $               | —     |      | $          | — |   | $ | 8,165 |   |
| Intersegment sales                                      |       | —      |       | 2,247          |       | —        |       | (2,247          | )          | —    |       |
| Operating income (loss)                                 |       | (1,929      | )          | (6             | )          | (1,121        | )          | —          |       | (3,056    | )          |
| Interest income  (expense), net                         |       | —      |       | —         |       | 141           |       | —          |       | 141       |       |
| Depreciation and  amortization                          |       | 300         |       | 28             |       | —        |       | —          |       | 328       |       |
| Other significant  non-cash items:                      |       |        |       |           |       |          |       |            |       |      |       |
| Stock-based  compensation                               |       | 154         |       | —         |       | 234           |       | —          |       | 388       |       |
| Expenditures for fixed  assets                          |       | 292         |       | 26             |       | —        |       | —          |       | 318       |       |
| Total assets                                            |       | 3,832       |       | 2,058          |       | 7,019         |       | (402            | )          | 12,507    |       |

 

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**Note 5    SubsequentEvents**

*a)**           **Sale of a business line toMedtronic Xomed Inc.*

On January 16, 2007, weentered into an Asset Purchase Agreement (the “Agreement”) with MedtronicXomed, Inc., a wholly-owned subsidiary of Medtronic, Inc. (“Medtronic”).  Pursuant to the Agreement, the Company willsell to Medtronic its two (2) existing manufacturing lines for the production of EndoSheath® products (“theassets”), free and clear of all liens.

Under the terms of theAgreement, Medtronic will pay us up to $34.0 million, of which $27.0 millionwill be payable at closing, plus up to an additional $4.0 million will be paidupon the achievement of certain post-closing milestones related to thetransition of manufacturing capability to Medtronic, and an additional $3.0million will be payable approximately 15 months after closing, assuming we havecomplied with its obligations under the Asset Purchase Agreement, and thatMedtronic has not made any claims based on our representations and warrantiesunder the Asset Purchase Agreement. Based on the sale price, we expect to record a gain on the sale of theseassets.

Since the assets are notavailable for immediate sale in its present condition, the Company has enteredinto a Transition Services Agreement. The agreement provides, among otherthings, that within the first 90 days after the closing of the transaction, wehave to modify and then validate the 2 manufacturing lines.

In addition, as part of this transaction,Medtronic and Vision-Sciences amended their existing distribution relationshippursuant to which Medtronic has been distributing Vision-Sciences’ ENTEndoscope and EndoSheath® products in the US and Canada since 2004.  Under the amended Distribution Agreement,Medtronic will have the right to distribute, market and sell EndoSheath®Products on a worldwide basis. The EndoSheath® products will initially besupplied by Vision-Sciences until Medtronic has established its ownmanufacturing capacity for EndoSheath® products. In addition, Medtronic willnow distribute, market and sell Vision-Sciences’ ENT endoscope productsworldwide, on a co-branded basis, through Medtronic’s dedicated sales force.

*b)**           **Termination of our bankagreement.*

In February 2007, we terminated our bankagreement. We plan to use leasing arrangements for future capital equipment,and we have negotiated payment terms with our foreign vendors; therefore,reducing our cost and eliminating the need for banker’s acceptances.

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## **Item 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF**

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

**Executive Summary**

ThisQuarterly Report on Form 10-Q contains forward-looking statements within themeaning of The Private Securities Litigation Reform Act of 1995.  Examples of forward-looking statements includestatements about expectations of future financial results, future products andfuture sales of new and existing products, future expenditures, and capitalresources to meet anticipated requirements. Without limiting the foregoing, the words “believes”, “anticipates”, “plans”,“expects”, and similar expressions are intended to identify forward-lookingstatements.  These forward-lookingstatements involve risks and uncertainties, and our actual results may differsignificantly from those discussed in the forward-looking statements. Factorsthat might cause such a difference include, but are not limited to, theavailability of capital resources, the availability of third-partyreimbursement, government regulation, the availability of supplies,competition, technological difficulties, the continuation of our contract withMENT, general economic conditions and other risks detailed in our most recentAnnual Report on Form 10-K and any subsequent periodic filings made with theSecurities and Exchange Commission.  Wedo not undertake an obligation to update our forward-looking statements toreflect future events or circumstances.

Wedevelop, manufacture and sell flexible endoscope and sheath products for themedical and industrial markets.  Weoperate in three reporting segments, medical, industrial and corporate.

#### *Medical Segment*

Themedical segment supplies flexible endoscopes and disposable Slide-On®EndoSheath® systems (“EndoSheaths”) to the ENT, urology, GI and pulmonarymarkets.  Healthcare providers use EndoSheathsto cover the insertion tube of flexible endoscopes, such as ENT endoscopes,Trans-Nasal Esophagoscopes (“TNE”), cystoscopes, sigmoidoscopes andbronchoscopes.  We have designed theEndoSheaths to allow the health-care providers to process patients economicallyby permitting the providers to minimize reprocessing the endoscopes betweenprocedures.  In addition, the EndoSheathsensure a sterile insertion tube for each patient procedure.

Ourstrategy in the medical segment is comprised of three components: a) improvesales distribution and customer service and support, b) lower manufacturingcosts and c) increase the number of new product offerings.

#### *Sales Distribution*

Since September 19, 2003, we have been distributing all of our productsfor the ENT market in the United States and Canada through MENT, as part of theMedtronic Agreement. Under the Medtronic Agreement, we have granted MENTexclusive distribution rights in the United States and Canada to market andsell our ENT and TNE EndoSheaths and endoscopes to ENT practitioners.  MENT fulfilled certain minimum purchaserequirements for the initial twelve-month period of the term.

The initial term of the Medtronic Agreement was three years.Thereafter, it provided for an automatic renewal for successive one-yearperiods, unless terminated by either party upon advance written notice.  Neither party provided such notice, so inSeptember 2006, the Medtronic Agreement was renewed for an additional year (foradditional information, please refer to Note 5, paragraph a).

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#### We believe themarketing and sales capabilities of MENT have facilitated and will continue tofacilitate the introduction of new products to the ENT market by allowingquicker market acceptance of these products than if we marketed them ourselves.  As a result of this agreement, the success ofour endoscopes ENT product line is substantially dependent upon the success ofthe marketing and sales activities of MENT, over which we have limited control.

In December 2004, we signed the MGU Agreement with MGU, granting MGUthe exclusive right to distribute our new cystoscope with Slide-On® EndoSheath®system to urologists in the United States and Canada.  The term of the MGU Agreement was throughMarch 31, 2006, renewable for successive one-year periods unless either partynotified the other party in writing at least 90 days prior to the end of anyterm that it did not want to renew. In May 2006, we and MGU mutually terminatedthe MGU Agreement, due to lower sales than we expected, and a change in strategyby MGU.  MGU decided to put greater focuson therapy products and narrow its overall uro-diagnostics product offerings,which included our products.  We thendecided to explore other forms of distribution for our flexible cystoscope andSlide-On® EndoSheath® system, including through a network of independent salesrepresentatives. We have retained our own international network of distributorsfor all our medical product lines. We are in the process of establishing anetwork of independent sales representatives for the domestic urology market,and we are also increasing our international network of independentdistributors. We expect developing this network will take between nine andtwelve months.  We will continuallyassess our progress in this area, and could amend or abandon our efforts ifthey do not prove to be successful during that time frame.

#### *Cost Reduction*

During this fiscal year ended March 31, 2007 (“FY 07”), we arecontinuing the efforts begun in the previous fiscal year to reduce the cost ofmaterials and labor across our endoscope and EndoSheath product lines.

#### *New Products*

InNovember 2006, we released to market our new cystoscope, the CST-2000A,addressing improvements requested by our customers.  During the fourthquarter of FY 07, we will be releasing our redesigned cystoscope sheath, whichincorporates improvements making the product easier to use.  Our productdevelopment efforts for our new family of videoscopes, with a miniature digitalcamera mounted at the distal end of the insertion tube, continue ontrack.  We expect to release the first of this product family during thefiscal year ended March 31, 2008  (“FY 08”). Inaddition, we are continuing our efforts in the areas of design and costimprovements to our disposable sheaths for our TNE and urology endoscopes.

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*Industrial Segment*

Theindustrial segment designs, manufactures and sells flexible endoscopes, termedborescopes, for industrial users, and manufactures and repairs flexibleendoscopes for the medical segment.  Theindustrial segment users consist primarily of companies in the aircraft enginemanufacturing and maintenance markets, the defense market and a variety ofspecialized industrial markets.

#### *Corporate Segment*

Thecorporate segment consists of certain administrative and business developmentactivities applicable to the Company as a whole.

**CriticalAccounting Policies 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 theConsolidated Financial Statements included elsewhere herein. Certain of ouraccounting policies require the application of judgment in selecting theappropriate assumptions for calculating financial estimates.  By their nature these judgments are subjectto an inherent degree of uncertainty. We periodically evaluate the judgmentsand estimates used for our critical accounting policies to ensure that suchjudgments and estimates are reasonable for our interim and year-end reportingrequirements. These judgments and estimates are based upon our historicalexperience, current trends and information available from other sources, asappropriate. If different conditions result from those assumptions used in ourjudgment, the results could be materially different from our estimates.  Our critical accounting policies include thefollowing:

### *Revenue Recognition*

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 and (5) the fair value of undeliveredelements, if any, exists.  Determinationof criterion (4) is based on management’s judgment regarding the collectibilityof invoices for products and services delivered to customers.  Should changes in conditions cause managementto determine these criteria are not met for certain future transactions,revenue recognized for any reporting period could be adversely affected.

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*OptionsIssued*

We account for optionsissued to non-employees and employees in accordance with the provisions of SFAS123R.  We use the Black-Scholesoption-pricing model for determining the value of options issued, and weexpense that value over the vesting period of the options.  We grant options with vesting periods rangingfrom immediate to four years.  For thefirst three quarters of fiscal 07, we have chosen to employ the simplifiedmethod of calculating the expected option term, which averages an award’sweighted average vesting period and its contractual term.  The contractual term of our options is tenyears.  The options granted to employeesand consultants in the first three quarters of fiscal 07 vest at a rate of 25%per year for the first four years.  Theoptions granted to members of the board of directors are 100% vested upongrant.  The risk-free rate is based uponthe daily Treasury yield curve for a period approximately equal to the expectedoption term.  We used historical data toestimate the expected price volatility and forfeiture rate.  The expected dividend yield is 0%, based onour history of not paying dividends.

*IncomeTaxes*

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 carryforwards.  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.

**Resultsof Operations**

NetSales

*Three-monthPeriod Ended December 31, 2006 (“Q3 07”) Compared to the Three-month PeriodEnded December 31, 2005 (“Q3 06”) ($000’s)*

Netsales for Q3 07 were $2,216, a decrease of $1,114, or 33%, compared to Q306.  During Q3 07, net sales of themedical segment decreased by $996, or 39%, to $1,535, and net sales of theindustrial segment decreased by $118 or 15%, to $681, compared to Q3 06.  In the medical segment, we track sales ofendoscopes and EndoSheaths by market.  Wealso track sales of peripheral items that can be sold to more than onemarket.  Sales of other products includesales to the GI and pulmonary markets and sales of repairs and accessories.Sales by segment and category in Q3 07 and Q3 06 were as follows ($000’s):

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| **Category**     | ** ** | **Q3 07** | ** ** | **Q3 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| ENT              |       | $              | 1,255      |           | $          | 1,650                    |       | $           | (395       | ) | (24 | )% |
| Urology          |       | 92             |       | 457            |       | (365                     | )          | (80         | )%         |
| Peripherals      |       | 21             |       | 268            |       | (247                     | )          | (92         | )%         |
| Other            |       | 167            |       | 156            |       | 11                       |       | 7           | %          |
| Total medical    |       | $              | 1,535      |           | $          | 2,531                    |       | $           | (996       | ) | (39 | )% |
| Total industrial |       | 681            |       | 799            |       | (118                     | )          | (15         | )%         |
| Total Company    |       | $              | 2,216      |           | $          | 3,330                    |       | $           | (1,114     | ) | (33 | )% |

 

*MedicalSales – ENT Market*

Netsales to the ENT market include products for domestic and internationalcustomers as follows ($000’s):
| **ENT Market** | ** ** | **Q3 07** | ** ** | **Q3 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|---------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Domestic            |       | $              | 625        |           | $          | 790                      |       | $           | (165       | ) | (21 | )% |
| International       |       | 630            |       | 860            |       | (230                     | )          | (27         | )%         |
| Total ENT           |       | $              | 1,255      |           | $          | 1,650                    |       | $           | (395       | ) | (24 | )% |

 

Wefurther delineate products sold to the domestic ENT market as follows ($000’s):
| **Products**         | ** ** | **Q3 07** | ** ** | **Q3 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On EndoSheaths |       | $              | 377        |           | $          | 384                      |       | $           | (7         | ) | (2 | )% |
| Endoscopes           |       | 248            |       | 406            |       | (158                     | )          | (39         | )%         |
| Total Domestic ENT   |       | $              | 625        |           | $          | 790                      |       | $           | (165       | ) | (21 | )% |

 

The primary reason for the decrease in sales to thedomestic ENT market was lower demand for our scopes from MENT.  Sales of our ENT Slide-On Endo Sheath (“ENT SOS”) decreased slightly in Q3 07 compared to Q3 06by $7, sheath products are being ordered as a result of having  more of our endoscopes in the market.

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As a result of the current and future Medtronic Agreement, the successof our ENT product lines is substantially dependent upon the success of themarketing and sales activities of MENT over which we have limited control.

Wefurther delineate products sold to the international ENT market as follows($000’s):
| Products                 | ** ** | **Q3 07** | ** ** | **Q3 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On  EndoSheaths    |       | $              | 507        |           | $          | 559                      |       | $           | (52        | ) | (9 | )% |
| Endoscopes               |       | 123            |       | 301            |       | (178                     | )          | (59         | )%         |
| Total  International ENT |       | $              | 630        |           | $          | 860                      |       | $           | (230       | ) | (27 | )% |

 

Thedecrease in net sales to international distributors is primarily due to thefact that in Q3 07, we lost the services of our Director of International Salesand have replaced our Vice President of Sales and Marketing.  Since we have anticipated the new distributionagreement announced on January 16, 2007, we did not rebuild our internationalsales force. As announced on January 16, 2007, all international sales of ourENT products will be handled by Medtronic as soon as the announced transactioncloses (see Note  5, subsequent events,paragraph a).

*MedicalSales – Urology*

Thedecrease in sales of urology products reflects our new efforts to build anindependent sales representative organization after the cancellation of the MGUAgreement. In May 2006, we and MGU mutually terminated the MGU Agreement, dueto lower sales than we expected, and a change in strategy by MGU.  MGU decided to put greater focus on therapyproducts and narrow its overall uro-diagnostics product offerings, whichincluded our products.  We then decidedto explore other forms of distribution for our flexible cystoscope and Slide-OnEndoSheath system.  We are still in theprocess of establishing a network of independent sales representatives for thedomestic urology market, and we are also increasing our network of independentdistributors for the international urology market.  We expect developing these networks will takebetween nine and twelve months.  We willcontinually assess our progress in this area, and could modify or abandon ourefforts if they do not prove to be successful during that time frame.

*MedicalSales – Peripherals and Other*

Salesof peripheral and other products declined substantially in Q3 07, compared toQ3 06, due primarily to lower demand for our GI and pulmonary EndoSheaths.  We have a small installed base of users ofthese products, and we plan to continue to supply them with EndoSheaths in FY07.  However, we do not plan to promotethese products.  As a result, we expectsale of these products will continue to decline during FY 07, compared to thefiscal year ended March 31, 2006 (“FY 06”). In addition, we experienced lowerdemand for light sources and other accessories.

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*IndustrialSegment*

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

*9M 07 Compared to the Nine Months Ended December 31, 2005 (“9M06”) (000’s)*

*Sales*

Netsales for 9M 07 were $6,514, a decrease of $1,651, or 20%, compared to netsales of $8,165 in 9M 06.  In 9M 07,sales of the medical segment were $4,474, a decrease of $1,673 or 27%, comparedto net sales of $6,147 in 9M 06.  In 9M07, sales of the industrial segment were $2,040, an increase of $22, or 1%,compared to net sales of $2,018 in 9M 06. Net sales by category were as follows ($000’s):

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| **Category**     | ** ** | **9M 07** | ** ** | **9M 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| ENT              |       | $              | 3,550      |           | $          | 4,093                    |       | $           | (543       | ) | (13 | )% |
| Urology          |       | 308            |       | 959            |       | (651                     | )          | (68         | )%         |
| Peripherals      |       | 111            |       | 339            |       | (228                     | )          | (67         | )%         |
| Other            |       | 505            |       | 756            |       | (251                     | )          | (33         | )%         |
| Total medical    |       | $              | 4,474      |           | $          | 6,147                    |       | $           | (1,673     | ) | (27 | )% |
| Total industrial |       | 2,040          |       | 2,018          |       | 22                       |       | 1           | %          |
| Total Company    |       | $              | 6,514      |           | $          | 8,165                    |       | $           | (1,651     | ) | (20 | )% |

 

Salesto the ENT market include products for the domestic and international customersas follows ($000’s):
| **ENT Market** | ** ** | **9M 07** | ** ** | **9M 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|---------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Domestic            |       | $              | 1,907      |           | $          | 1,984                    |       | $           | (77        | ) | (4 | )% |
| International       |       | 1,643          |       | 2,109          |       | (466                     | )          | (22         | )%         |
| Total ENT           |       | $              | 3,550      |           | $          | 4,093                    |       | $           | (543       | ) | (13 | )% |

 

Wefurther delineate products sold to the domestic ENT market as follows ($000’s):
| **Products**          | ** ** | **9M 07** | ** ** | **9M 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|-----------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On  EndoSheaths |       | $              | 1,275      |           | $          | 813                      |       | $           | 462        |   | 57 | % |
| Endoscopes            |       | 632            |       | 1,171          |       | (539                     | )          | (46         | )%         |
| Total Domestic  ENT   |       | $              | 1,907      |           | $          | 1,984                    |       | $           | (77        | ) | (4 | )% |

 

Theprimary reason for the increase in sales of ENT EndoSheaths to the domesticmarket was higher demand from MENT, offset partially by lower demand for ENTand TNE endoscopes.

Wefurther delineate products sold to the international ENT market as follows($000’s):
| **Products**             | ** ** | **9M 07** | ** ** | **9M 06** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|--------------------------|------------|----------------|------------|----------------|------------|--------------------------|------------|-------------|------------|
| Slide-On  EndoSheaths    |       | $              | 1,359      |           | $          | 1,501                    |       | $           | (142       | ) | (9 | )% |
| Endoscopes               |       | 284            |       | 608            |       | (324                     | )          | (53         | )%         |
| Total  International ENT |       | $              | 1,643      |           | $          | 2,109                    |       | $           | (466       | ) | (22 | )% |

 

Theprimary cause for the lower sales of  bothEndoSheaths and endoscopes in the 9M 07, compared to 9M 06 was lower demandfrom our foreign distributors, mainly as a result of our Director ofInternational Sales leaving the Company. Due to the more unpredictable nature of the sales cycle of endoscopes wecannot expect demand will recover fully in FY 07 to where it was in FY 06.However, the new distribution agreement with Medtronic announces on January 16,2007 should help in increasing our sales of our ENT endoscopes during FY 08.

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*MedicalSales – Urology Market*

Thedecrease in sales of urology products reflects the cancellation of the MGUAgreement, which required us to build and train a network of independent salesrepresentatives in the domestic market. We believe we will continue to showprogress in the domestic and international markets from the distributors whoare selling the urology line and from additional distributors with whom weintend to establish agreements.  However,there can be no assurance that we will be able to establish these agreements onterms satisfactory to us.

*Industrial Segment*

Theincrease in sales to the industrial market in 9M 07 was due primarily to higherdemand for new borescopes.  However, thiswill continue to be a difficult market for us until we are able to provide amore competitive product line to this market.

GrossProfit

*Q3 07Compared to Q3 06*

Grossprofit was $294 in Q3 07, a decrease of $591, compared to gross profit in Q306.  Gross profit decreased by $267 inthe medical segment, and decreased by $324 in the industrial segment. Grossprofit in the medical segment decreased due to higher fixed costs based on thedrop in sales volume.  In the industrialsegment, the decrease in gross profit was due primarily to an increase inoverhead costs associated with production problems and improving ourmanufacturing and quality control of endoscopes.

*9M 07Compared to 9M 06*

Grossprofit was $1,178 in 9M 07, a decrease of $811, compared to gross profit in 9M06. Gross profit decreased by $177 in the medical segment and decreased by $634in the industrial segment. The causes of the changes were the same as notedabove.

OperatingExpenses

*Selling,General and Administrative Expenses*

*Q3 07Compared to Q3 06*

Theincrease in selling, general and administrative (“SG&A”) expenses in Q3 07of $150 was due primarily to higher spending for payroll, consulting fees, andprofessional fees related to moving corporate headquarters from Natick, MA toOrangeburg, NY.

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*9M 07Compared to 9M 06*

Theincrease in SG&A expenses in 9M 07 of $349 was due primarily to higherspending for payroll, consulting fees, and professional fees related to movingcorporate headquarters from Natick, MA to Orangeburg, NY.

*Researchand Development Expenses*

Theincrease in research and development (“R&D”) expenses in Q3 07, compared toQ3 06 and for 9M 07, compared to 9M 06 was due primarily to additional spendingfor materials and personnel hired to work on the development of our newvideoscope line.  We expect R&Dexpenses will continue to be higher in FY 07, compared to FY 06, as weaccelerate our efforts to develop this new family of videoscopes.

OperatingIncome (Loss)

Operatingloss by segment was as follows ($000’s):
| Segment    | ** ** | **Q3 07** | ** ** | **Q3 06** | ** ** | **Change** | ** ** | **9M 07** | ** ** | **9M 06** | ** ** | **Change** | ** ** |
|------------|------------|----------------|------------|----------------|------------|------------|------------|----------------|------------|----------------|------------|------------|------------|
| Medical    |       | $              | (716       | )              | $          | (581       | )          | $              | (135       | )              | $          | (2,258     | )          | $ | (1,929 | ) | $ | (329 | ) |
| Industrial |       | (314           | )          | 21             |       | (335       | )          | (571           | )          | (6             | )          | (565       | )          |
| Corporate  |       | (400           | )          | (497           | )          | 97         |       | (1,191         | )          | (1,121         | )          | (70        | )          |
| Total      |       | $              | (1,430     | )              | $          | (1,057     | )          | $              | (373       | )              | $          | (4,020     | )          | $ | (3,056 | ) | $ | (964 | ) |

 

Inthe medical segment, higher spending for SG&A and R&D, and lower grossprofit, resulted in an increased operating loss for Q3 07 and 9M 07.  In the industrial segment, the lower grossprofit caused an increase in the operating loss in Q3 07 and 9M 07.  In the corporate segment, lower charges forstock compensation resulted in a decreased loss in Q3 07 and 9M 07.

Liquidityand Capital Resources

On December 31, 2006,our principal source of liquidity was working capital of $4,698, including$2,550 in cash and cash equivalents.  OnDecember 31, 2006, we had acceptances payable to a bank totaling $10.  We have pledged $125 to support theseacceptances.

In July 2006, we renewed our bank agreement, which is subject torenewal in July 2007. This bank agreement includes a revolving line of creditunder which we may borrow up to $250,000, including any outstanding letters ofcredit and banker’s acceptances. Borrowings under these loan arrangements would bear interest at theprime rate, and would be collateralized by our assets.  In addition, we have an equipment line withthe bank, providing for us to borrow up to $750,000 for the purchase of newequipment until July 31, 2007. At that time, any borrowings under the equipmentline would become payable as a note, over a three-year period, at the bank’sprime rate.  Alternatively, we couldarrange for other financing of the equipment at that time, and repay anyamounts drawn down under that line. The agreement also stipulates that we havethe greater of $2.0 million, or one-half of our cash and cash

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equivalents, on deposit or invested at the bank. In 9M 07, we did notutilize the equipment line (please refer to Note 5, see subsequent events,paragraph b).

Ourcash and cash equivalents decreased by $3,588 in the nine months ended December31, 2006, due primarily to cash used for operations of $3,086, cash used forinvesting activities of $450, and cash used for financing of $52.  We expect that our current balance of cashand cash equivalents and the definitive deal signed with Medtronic Xomedannounced on January 16, 2007 (please refer to Note 5, paragraph a) will besufficient to fund our operations for the next twelve months.

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.

**ContractualObligations**

Weconduct our operations in certain leased facilities.  These leases expire on various dates throughAugust 31, 2010.  In addition, we haveoperating leases for certain office equipment. These leases expire on various dates through June 2007.  The following chart summarizes ourcontractual obligations as of September 30, 2006.
| **Contractual Obligation** | ** ** | **Total** | ** ** | **Due within 1 Year** | ** ** | **Due in 1-3 years** | ** ** | **Due in 3-5 Years** | ** ** |
|---------------------------------|------------|-----------|------------|--------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Operating leases                |       | $         | 857,584    |                                 | $          | 338,112                             |       | $                                   | 410,219    |   | $ | 109,253 |   |
| Capital lease                   |       | 10,451    |       | 10,451                               |       | —                              |       | —                              |       |
|                                 |            |           |            |                                      |            |                                     |            |                                     |            |  |  |  |  |

 

**Off-BalanceSheet Arrangements**

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.

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**RecentlyIssued Accounting Standards**

In July 2006, the FASBissued FIN 48, *Accounting for Uncertainty in IncomeTaxes-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 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. TheCompany does not expect SFAS 155 to have an impact on its consolidatedfinancial statements as it does not currently use any financial derivativeinstruments.

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, theoverfunded or underfunded status of its benefit plans in its 2006 balancesheet. The Company does not expect SFAS 158 to have an impact on itsconsolidated financial statements as it has no defined benefit pension or otherpostretirement plans.

In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No.108, *Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements* to provide guidance on the consideration of the effectsof prior year misstatements in quantifying current year misstatements for thepurpose of a materiality assessment. Under SAB No. 108, companies shouldevaluate a misstatement based on its impact on the current year incomestatement, as well as the cumulative effect of correcting such misstatementsthat existed in prior years existing in the current year’s ending balancesheet. SAB No. 108 is effective for fiscal years ending after November 15,2006.  The Company has not determined the effect the adoption of SAB No.108 will have on its financial position and results of operations.

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InSeptember 2006, the FASB issued SFAS 157 *FairValue Measurements*. SFAS 157 establishes a framework for measuringfair value in generally accepted accounting principles, and expands disclosuresabout fair value measurements.  The standard applies whenever otherstandards require (or permit) assets or liabilities to be measured at fairvalue.  The standard does not expand the use of fair value in any newcircumstances.  SFAS 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years.  Earlier application is encouraged. The Company hasnot yet determined the effect the adoption of SFAS 157 will have on itsfinancial position and results of operations.

InJune 2006, the FASB ratified the consensus on EITF Issue No. 06-03, *How Taxes Collected from Customers and Remitted toGovernmental Authorities 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 AccountingPolicies.* If such taxes are significant, and are presented on agross basis, the amounts of those taxes should be disclosed. The consensus onIssue No. 06-03 will be effective for interim and annual reporting periodsbeginning after December 15, 2006. The Company is currently evaluating theimpact of EITF No. 06-03.  Should the Company need to change the manner inwhich it records gross receipts, it is not expected that the change will have amaterial impact on total operating revenue and expenses and operating incomeand net income would not be affected.

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## **Item3.  QUANTITATIVE AND QUALITATIVEDISCLOSURESABOUT 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.

#### **Interestand Market Risk**

Wecurrently invest our excess cash in a money market account at our bank.  We have not used derivative financialinstruments in our investment portfolio. We attempt to limit our exposure to interest rate and credit risk byplacing our investments with high-quality financial institutions and haveestablished investment guidelines relative to diversification and maturitiesdesigned to maintain safety and liquidity.

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 market valuedue to changes in interest rates.

#### **ForeignCurrency Exchange**

Weface exposure, due to purchases of raw materials from foreign suppliers, toadverse movements in the value of foreign currencies against the US Dollar.This exposure may change over time, and could have a materially adverse effecton our financial results.  We may attemptto limit this exposure by purchasing forward contracts. Most of our foreignexchange liabilities are settled within 90 days of receipt of materials.  At December 31, 2006, our liabilitiesrelating to foreign currencies were approximately $35,000.

## **Item4.  CONTROLS AND PROCEDURES**

*a)**           **Evaluation of Disclosure Controlsand 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 quarter ended December31, 2006, are effective.

*b)**           **Changes in Internal Controls OverFinancial Reporting.*

There were no changes in our internal controls over financial reportingthat occurred during the fiscal quarter ended December 31, 2006 that havematerially affected, or are reasonable likely to materially affect, ourinternal controls over financial reporting.

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**PART II- OTHER INFORMATION**

**Item 6.  EXHIBITS**
|        | Exhibits | ** ** | ** **                                                                                                                                                                     |
|--------|----------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |     |       |                                                                                                                                                                           |
|   | 10.1     |       | Employment Letter, dated September 22, 2006, between  the Company and Yoav M. Cohen.                                                                                           |
|   |     |       |                                                                                                                                                                           |
|   | 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 theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.
|                                | VISION-SCIENCES, INC. |
|--------------------------------|-----------------------|
|                           |                  |
|                           |                  |
|  Date: February 14, 2007  |                  | /s/ Ron Hadani |   |
|                           |                  | Ron Hadani |
|                           |                  | President, CEO (Duly Authorized Officer) |
|                           |                  |   |
|                           |                  |   |
|  Date:  February 14, 2007 |                  | /s/ Yoav M. Cohen |   |
|                           |                  | Yoav M. Cohen |
|                           |                  | Vice President, Chief Financial Officer (Principal |
|                           |                  | Financial Officer and Principal Accounting   Officer) |
|                                |                       |  |  |  |

 

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