SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D. C. 20459
  FORM 10-Q
  (Mark One)x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended December 31, 2010oro
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from                          to
  COMMISSION FILE NUMBER 0-20970
  VISION-SCIENCES, INC.
 (Exact name of registrant as specified in its charter)
  Delaware
13-3430173(State or other jurisdiction of

incorporation or organization)
(IRS employer

identification number)40 Ramland Road South, Orangeburg, NY
10962(Address of principal executive offices)
(Zip code)
  (845) 365-0600
 (Registrant’s telephone number, including area code)
  (Former name, former address, and
 former fiscal year if changed since last report)
  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes x    No o
  Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate website, if any every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x  No  o
 
 Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, non-accelerated filer, or smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
  Large accelerated filer o
Accelerated filer o
Non-accelerated filer o

(Do not check if a smaller reporting company)
Smaller reporting company x
  Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).         Yes o    No x
  Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of February 9, 2011
  Common Stock, par value of $0.01
44,711,045(Title of Class)
(Number of Shares)
 1
 
 VISION-SCIENCES, INC.
 TABLE OF CONTENTS
  Part I.
Financial InformationItem 1.
Financial StatementsCondensed Consolidated Balance Sheets
3Condensed Consolidated Statements of Operations
4Condensed Consolidated Statement of Stockholders’ Equity (Deficit)
5Condensed Consolidated Statements of Cash Flows
6Notes to Condensed Consolidated Financial Statements
7Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15Item 3.
Quantitative and Qualitative Disclosures about Market Risk
27Item 4.
Controls and Procedures
27Part II.
Other InformationItem 1.
Legal Proceedings
28Item 1A.
Risk Factors
28Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
28Item 3.
Defaults Upon Senior Securities
28Item 4.
(Removed and Reserved)
29Item 5.
Other Information
29Item 6.
Exhibits
29Signatures
30
  2
 
 PART I—FINANCIAL INFORMATION
 Item 1: Financial Statements
  Vision-Sciences, Inc. and Subsidiaries
 Condensed Consolidated Balance Sheets
 (In thousands, except per share amounts)
  December 31,


March 31,2010


2010ASSETS

(unaudited)Current assets:Cash and cash equivalents

$
1,208


$
2,540Short-term investments


-



447Accounts receivable, net of allowance for doubtful accounts of $144and $347, respectively


1,647



1,147Inventories, net


5,996



4,175Prepaid expenses and other current assets


166



886Total current assets


9,017



9,195Machinery and equipment


4,440



3,584Furniture and fixtures


226



225Leasehold improvements


359



357Total property and equipment, at cost


5,025



4,166Less—accumulated depreciation and amortization


2,792



2,237Total property and equipment, net


2,233



1,929Other assets, net of accumulated amortization of $88 and $84,respectively


75



79Deferred debt cost, net of accumulated amortization of $132and $31, respectively


312



296Total assets

$
11,637


$
11,499LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITYCurrent liabilities:Capital lease obligations

$
65


$
55Accounts payable


1,903



867Accrued expenses


816



984Accrued compensation


679



1,107Advances from customers


3,669



-Total current liabilities


7,132



3,013Line of credit—related party


5,000



2,500Capital lease obligations, net of current portion


94



61Total liabilities


12,226



5,574Commitments and Contingencies (Note 6)Stockholders’ (deficit) equity:Preferred stock, $0.01 par value—Authorized—5,000 sharesissued and outstanding—none


-



-Common stock, $0.01 par value—Authorized—75,000 sharesissued and outstanding—37,711 sharesand 36,856 shares, respectively


377



369Additional paid-in capital


83,506



81,968Accumulated deficit


(84,472
)


(76,412
)Total stockholders’ (deficit) equity


(589
)


5,925Total liabilities and stockholders’ (deficit) equity

$
11,637


$
11,499
  See accompanying notes to condensed consolidated financial statements.
  3
  Vision-Sciences, Inc. and Subsidiaries
 Condensed Consolidated Statements of Operations
 (In thousands, except per share amounts)
 (Unaudited)
  Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Net sales

$
2,715


$
2,600


$
7,671


$
8,807Cost of sales


1,906



2,250



5,532



7,204Gross profit


809



350



2,139



1,603Selling, general, and administrative expenses


2,599



2,919



7,872



8,108Research and development expenses


655



659



1,984



2,342Loss from operations


(2,445
)


(3,228
)


(7,717
)


(8,847
)Interest income


1



14



4



85Interest expense


(91
)


(6
)


(235
)


(52
)Debt cost expense


(37
)


(12
)


(101
)


(12
)Other, net


-



-



(1
)


(28
)Loss before provision for income taxes


(2,572
)


(3,232
)


(8,050
)


(8,854
)Income tax provision


4



2



10



18Net loss

$
(2,576
)

$
(3,234
)

$
(8,060
)

$
(8,872
)Net loss per common share - basic and diluted

$
(0.07
)

$
(0.09
)

$
(0.22
)

$
(0.24
)Shares used in computing net lossper common share


36,955



36,855



36,904



36,853
  See accompanying notes to condensed consolidated financial statements.
  4
  Vision-Sciences, Inc. and Subsidiaries
 Condensed Consolidated Statements of Stockholders’ Equity (Deficit)
 (In thousands, except per share amounts)
 (Unaudited)
 
 TotalCommon Stock


Additional





Stockholders’Number


$0.01


Paid-in


Accumulated


Equityof Shares


Par Value


Capital


Deficit


(Deficit)Balance at March 31, 2009


36,818


$
368


$
80,031


$
(63,988
)

$
16,411Exercise of stock options


38



1



42



-



43Issuance of stock warrants


-



-



327



-



327Stock-based compensation expense


-



-



1,568



-



1,568Net loss


-



-



-



(12,424
)


(12,424
)Balance at March 31, 2010


36,856



369



81,968



(76,412
)


5,925Exercise of stock options


100



1



111



-



112Issuance of stock warrants


-



-



117



-



117Issuance of restricted stock awards


755



7



-



-



7Stock-based compensation expense


-



-



1,310



-



1,310Net loss


-



-



-



(8,060
)


(8,060
)Balance at December 31, 2010


37,711


$
377


$
83,506


$
(84,472
)

$
(589
)
    5
  Vision-Sciences, Inc. and Subsidiaries
 Condensed Consolidated Statements of Cash Flows
 (In thousands)
 (Unaudited)
  Nine Months EndedDecember 31,2010


2009Cash flows from operating activities:Net loss

$
(8,060
)

$
(8,872
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


559



494Stock-based compensation expense


1,310



1,177Issuance of restricted stock awards


7



-Provision for (recovery of) bad debt expenses


(152
)


52Debt cost expense


101



12Loss on sale of investments


-



34Changes in assets and liabilities:Accounts receivable


(348
)


522Inventories


(2,372
)


224Prepaid expenses and other current assets


720



(173
)Other assets


-



(23
)Accounts payable


1,036



(294
)Accrued expenses


(168
)


(22
)Accrued compensation


(428
)


131Advances from customers


3,669



-Net cash used in operating activities


(4,126
)


(6,738
)Cash flows from investing activities:Purchase of short-term investments


(149
)


(2,572
)Proceeds from short-term investment sales/maturities


596



8,310Purchase of property and equipment


(220
)


(601
)Net cash provided by investing activities


227



5,137Cash flows from financing activities:Advance on line of credit—related party


2,500



-Payments of capital leases


(45
)


(31
)Exercise of stock options


112



43Net cash provided by financing activities


2,567



12Net decrease in cash and cash equivalents


(1,332
)


(1,589
)Cash and cash equivalents from continuing operations, beginning of period

$
2,540


$
1,975Cash and cash equivalents from discontinued operations, beginning of period

$
-


$
8Cash and cash equivalents from discontinued operations, end of period

$
-


$
-Cash and cash equivalents from continuing operations, end of period

$
1,208


$
394Supplemental disclosure of cash flow information:Cash paid during the period for:Interest

$
58


$
-Income taxes

$
27


$
18Non-cash financing activities:Transfers of inventory to fixed assets for use as demonstration equipment

$
551


$
-Capital lease entered into for equipment purchase

$
88


$
-Issuance of stock warrants with line of credit—related party

$
117


$
221
  See accompanying notes to condensed consolidated financial statements.
  6
  Vision-Sciences, Inc. and Subsidiaries
 Notes to Condensed Consolidated Financial Statements
 (Unaudited, in thousands except per share amounts)
  Note 1.  Basis of Presentation
  Vision-Sciences, Inc. and its Subsidiaries (the “Company” – which may be referred to as “our”, “us” or “we”) have prepared the condensed consolidated financial statements included herein according to generally accepted accounting principles in the United States of America (“U.S. GAAP”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and include, in the opinion of management, all adjustments that we consider necessary for a fair presentation of such information.  We have condensed or omitted certain information and footnote disclosures normally included in financial statements pursuant to those rules and regulations. We believe, however, that our disclosures are adequate to make the information presented not misleading. The results for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year. Please read these condensed consolidated financial statements in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.
 
 Note 2.  The Company and Summary of Significant Accounting Policies
 
 Company Overview
 
 We design, develop, manufacture, and market products for endoscopy - the science of using an instrument, known as an endoscope to provide minimally invasive access to areas not readily visible to the human eye. Our products are sold throughout the world through direct sales representatives in the United States and independent distributors for the rest of the world. Our largest geographic markets are the United States and Europe. Pursuant to our agreement dated as of September 22, 2010, with the Endoscopy Division of Stryker Corporation (“Stryker”), we will supply to Stryker our flexible video and fiber cystoscopes and related EndoSheath products upon launch by Stryker of such products (the “Stryker Agreement”) (See Note 9. Advances from Customers for additional information).
 
 We were incorporated in Delaware, and are the successor to operations originally begun in 1987. Machida Incorporated (“Machida”), which became our wholly-owned subsidiary in December 1990, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. Another one of our subsidiaries, Vision Sciences Ltd., an Israeli corporation, was established in 1998, but has been inactive since the fiscal year ended March 31, 2002. We own the registered trademarks Vision Sciences®, Slide-On®, EndoSheath®, and The Vision System®. Not all products referenced in this report are approved or cleared for sale, distribution, or use.
 
 Liquidity and Capital Resources
 
 We have incurred losses since our inception, and losses are expected to continue through at least fiscal years 2011 and 2012. We have funded the losses principally with cash flow from operations, advances under a three-year $5.0 million revolving loan agreement (the “Loan”) with our Chairman, Lewis C. Pell (the “Lender”), proceeds from public and private equity financings, payments from Medtronic related to the sale of certain assets related to our ENT EndoSheath technology business, and the sale of other assets. We have also received an aggregate of $3.9 million of deposits from two customers (the “Prepayments”) in September 2010 to support anticipated orders, which are expected to ship by June 30, 2011 (the end of the first quarter of our fiscal year 2012). In addition, on January 18, 2011, we issued 7 million shares of our common stock at a purchase price of $1.50 per share to a number of investors in a private placement for aggregate proceeds of $10.5 million (see Note 10. Subsequent Event for additional information). We believe that our cash, including the Prepayments, and the $10.5 million of proceeds we received from the private placement will be sufficient to fund our working capital, capital expenditures, and future operating losses until March 31, 2012. However, if our performance expectations fall short (including regaining sales or profits historically generated from Medtronic and generating expected sales from Stryker and SpineView) or our expenses exceed expectations, we will need to either secure additional financing or reduce expenses or a combination thereof. Our failure to do so would have a material adverse impact on our prospects and financial condition. There can be no assurance that any contemplated external financing will be available on terms acceptable to us, if at all, or that we will be able to reduce our expenses.
  7
 
 Summary of Significant Accounting Policies
 
 Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable, based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are any differences (other than nominal differences) between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The accounting policies that reflect our more significant estimates, judgments, and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
 
 • Revenue recognition
 • Stock-based compensation expense
 • Allowances for doubtful accounts
 • Inventory obsolescence reserves
 • Other contingencies
 
 The accompanying condensed consolidated financial statements reflect the accounts of the Company. All significant inter-company accounts and transactions have been eliminated in consolidation.
 
 Accounting Standards Updates Not Yet Effective
 
 In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (“ASC Update 2010-06”), an update to ASC 820. This update provides amendments to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. ASC Update 2010-06 became effective for us with the reporting period beginning January 1, 2010, except for the disclosure on the roll forward activities for Level 3 measurements, which will become effective for us with the reporting period beginning April 1, 2011 (our fiscal year 2012). We do not expect that the provisions of the update will have a material effect on our results of operations, financial position, or liquidity.
 
 Note 3.  Basic and Diluted Net Loss per Common Share
 
 Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding. For all periods presented, the diluted net loss per common share is the same as basic net loss per common share, as the inclusion of other shares of stock issuable pursuant to stock options and warrants would be anti-dilutive. Stock options, warrants, and restricted stock of 8,078,221 shares and 7,056,582 shares as of December 31, 2010 and 2009, respectively, were excluded from the calculation of fully diluted loss per share as their inclusion would have been anti-dilutive due to the net loss.
 
 Note 4.  Inventories
 
 Inventories are stated at the lower of cost or market using the first-in, first-out (“FIFO”) method and consist of the following:
  December 31,


March 31,2010


2010Raw materials

$
4,520


$
3,330Work in process


787



269Finished goods


689



576$
5,996


$
4,175


Raw materials include components purchased from independent suppliers. Most purchased components are available from multiple sources, with the exception of certain key components which are supplied to us by key suppliers, with whom we have long-term supply arrangements, but no long-term supply agreements.
 
 Note 5.  Financial Instruments
 
 Short-Term Investments
 
 We classify investments with original maturities of greater than 90 days in certificates of deposit as short-term investments. We intend to hold these investments to maturity. Our short-term investments are carried at amortized cost in our condensed consolidated balance sheets.
  8
 
 The following table summarizes these securities classified as held to maturity.
  December 31, 2010


March 31, 2010Amortized


Fair


Amortized


FairHeld to maturity less than one year:

Cost


Value


Cost


ValueCertificates of deposit

$
-


$
-


$
447


$
446Total short-term investments

$
-


$
-


$
447


$
446
 
 Fair Value Measurements
 
 The carrying amounts reflected in our condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, accrued compensation, and capital lease obligations approximate fair value due to their short-term nature. The fair value of the line of credit is based on its demand value, which is equal to its carrying value.
 
 Note 6.  Commitments and Contingencies
 
 Line of Credit – Related Party
 
 On November 9, 2009, we entered into a Loan with the Lender. Any amounts drawn against the Loan (an “Advance”) accrue interest at an annual rate of 7.5%. The Lender received an availability fee equal to a per annum rate of 0.5% on the unused portion of the Loan calculated based on the difference between the average annual principal amount of the outstanding Advances under the Loan and the maximum advance of $5.0 million. The availability of advances under the Loan is subject to customary conditions. As of December 31, 2010, we had fully drawn down the Loan. Subject to the terms of the Loan, we will be required to prepay all amounts outstanding under the Loan upon a change of control of the Company. We were required to prepay part or all of the amounts outstanding if we secured other financing or consummate a sale or license of assets, in each case resulting in net proceeds to us of $5.0 million or greater. In connection with our recent private placement (see Note 10. Subsequent Event for additional information), we received a waiver from the Lender such that we will not be required to repay all or any portion of the Advances with the proceeds from this fund raising.
 
 In connection with the Loan, the Lender received  a five-year warrant (the “Initial Warrant Shares”) to purchase up to 272,727 shares of our common stock at an exercise price of $1.375 per share (representing 7.5% warrant coverage, or approximately 0.7% of our outstanding common stock at the time of the Loan), which immediately vested upon issuance. In addition, we issued a second five-year warrant (the “Additional Warrant Shares”) to purchase up to an additional 378,788 shares of our common stock at an exercise price of $1.65 per share (representing up to an additional 12.5% warrant coverage, or approximately 1.0% of our then outstanding common stock) which vests at the time that each Advance is made in an amount equal to (i) the product of the amount of the Additional Warrant Shares multiplied by (ii) a ratio, (A) the numerator of which is the amount of the new Advance and (B) the denominator of which is $5.0 million. A portion of the Additional Warrant Shares vested on the date of the $2.5 million Advance on March 29, 2010, the $2.0 million Advance on June 29, 2010, and the $0.5 million Advance on December 16, 2010. All warrants are fully vested as of December 31, 2010.
 
 The following table summarizes Advances taken on the Loan and warrant issuances:
  Number of


Fair Value ofAmount of


Warrant Shares


Warrant SharesMonth

Advance


Vested


on Date VestedDecember 2010

$0.5 million


37,879


$30 thousandJune 2010

$2.0 million


151,515


$87 thousandMarch 2010

$2.5 million


189,394


$106 thousandNovember 2009

n/a


272,727


$221 thousand
  On the date of issuance, the fair value of the Initial and Additional Warrant Shares was approximately $221 thousand and $249 thousand, respectively. We defer costs associated with securing a line-of-credit or revolving loan agreement over the applicable term. These costs are amortized as debt cost expense in our condensed consolidated statement of operations. Accordingly, we recorded the $221 thousand associated with the Initial Warrant Shares as a deferred debt cost asset with a corresponding amount as additional paid-in capital. The cost is being amortized on a straight-line basis over the three-year term of the Loan.
  9
 
 We recorded the fair value associated with the Additional Warrant Shares as a deferred debt cost asset with a corresponding amount as additional paid-in capital. The cost is being amortized over the remaining life of the Loan using the effective interest method. During the three and nine months ended December 31, 2010, we recorded approximately $37 thousand and $101 thousand, respectively, as debt cost expense related to the amortization of the deferred debt cost for the Initial and Additional Warrant Shares in our condensed consolidated statement of operations.
 
 At December 31, 2010, we had $5.0 million in outstanding borrowings under the Loan, which is reflected as line of credit – related party on our condensed consolidated balance sheet. The $5.0 million revolving loan expires in November 2012, at which time we must repay all borrowings under the Loan. During the three and nine months ended December 31, 2010, we recorded approximately $89 thousand and $227 thousand, respectively, as interest expense related to the availability fee and accrued interest on outstanding borrowings in our condensed consolidated statement of operations. At December 31, 2010, we had $0.2 million in accrued interest related to the Loan, which is included in accounts payable ($0.1 million) and accrued expenses ($0.1 million) on our condensed consolidated balance sheet.
 
 Note 7.  Stock-Based Awards
  Stock Option Plans
 
 We maintain the following equity incentive plans:
 
 ·
The 2000 Stock Incentive Plan (the “2000 Plan”), approved by stockholders in August 2000, authorized the issuance of up to 4,500,000 shares of common stock covering several different types of awards, including stock options, restricted shares, stock appreciation rights, and performance shares.
 ·
The 2007 Stock Incentive Plan (the “2007 Plan”), approved by stockholders in August 2007, authorized the issuance of up to 4,000,000 shares of common stock covering several different types of awards, including stock options, restricted shares, stock appreciation rights, and other stock-based awards. On July 12, 2010, our Board and on September 2, 2010, our stockholders approved an amendment to the 2007 Plan to increase the authorized shares issuable under the plan to 5,000,000 shares of common stock.
 ·
The 2003 Director Option Plan (the “2003 Plan”), approved by stockholders in July 2003 and amended in August 2008, authorized the issuance of up to 450,000 shares of common stock covering the annual automatic grant of 10,000 stock options per outside director per year. The 2003 Plan also provides for granting newly elected or appointed outside directors a one-time grant of 10,000 stock options.
 
 The stock option plans provide that options may be granted at an exercise price of 100% of fair market value of our common stock on the date of grant, may be exercised in full or in installments, at the discretion of our Board of Directors or its Compensation Committee, and must be exercised within ten years from date of grant. We recognize stock-based compensation expense on a straight-line basis over the requisite service period based on fair values, generally four years. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and included these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date.
 
 Stock-Based Compensation Expense
  We account for stock-based awards issued to employees in accordance with the provisions of ASC 718 (Topic 718, Compensation – Stock Compensation). We recognize stock-based compensation expense on a straight-line uniform basis over the service period of the award, which is generally four years for employees. Stock-based awards issued to consultants are accounted for in accordance with the provisions of ASC 718 and ASC 505-50 (Subtopic 50 “Equity-Based Payments to Non-Employees” of Topic 505, Equity). Options granted to consultants are periodically revalued as the options vest, and are recognized as an expense over the related period of service or the vesting period, whichever is longer.
 
 Stock-based compensation expense for the three and nine months ended December 31, 2010 and 2009 was recorded in our condensed consolidated statement of operations as follows:
  Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Cost of sales

$
48


$
85


$
185


$
288Selling, general, and administrative expenses


311



135



1,058



781Research and development expenses


19



41



67



108Total stock-based compensation expense

$
378


$
261


$
1,310


$
1,177
  10
 
 We estimated the fair value of the stock options granted on the date of grant using a Black-Scholes valuation model that used the weighted average assumptions noted in the following table. The risk-free interest rate assumption we use is based upon United States Treasury interest rates appropriate for the expected life of the awards. The expected life (estimated period of time that we expect employees, consultants and directors to hold their stock options) was estimated based on historical rates for two group classifications, (i) employees and consultants and (ii) outside directors. Expected volatility was based on historical volatility of our stock price for a period equal to the stock option’s expected life and calculated on a daily basis. The expected dividend rate is zero since we do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future. Under the provisions of ASC 718, members of the Board are considered employees for calculation of stock-based compensation expense.
  Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Risk-free interest rate


2.15
%


3.00
%


2.72
%


2.66
%Expected life (in years)


7.55



7.04



6.90



6.51Expected volatility


86
%


87
%


84
%


87
%Expected dividend yield


--



--



--



--
  The following table summarizes stock options activity for the nine months ended December 31, 2010:
  WeightedWeighted


AverageNumber


Exercise


Average


Remainingof Shares


Price Range


Exercise Price


Contractual LifeOutstanding at March 31, 2010


6,264,685


$
0.79 – $5.10


$
1.91



5.84Granted


687,500


$
0.96 – $1.39



1.07Exercised


(100,142
)

$
1.10 – $1.34



1.12Canceled


(180,464
)

$
0.97 – $4.88



1.53Outstanding at December 31,  2010


6,671,579


$
0.79 – $5.10


$
1.85



5.73Vested and expected to vest at December 31, 2010


5,892,365


$
0.79 – $5.10


$
1.76



5.43Exercisable at December 31, 2010


4,750,540


$
0.79 – $5.10


$
1.68



4.73
 At December 31, 2010, unrecognized stock-based compensation expense related to stock options was approximately $1.4 million and is expected to be recognized over a weighted average period of approximately 2.2 years.
 
 The weighted average fair value of options granted during the three months ended December 31, 2010 and 2009 was $0.98 and $0.96 per share, respectively. The weighted average fair value of options granted during the nine months ended December 31, 2010 and 2009 was $0.82 and $0.91 per share, respectively.
 
 The total intrinsic value (the excess of the market price over the exercise price) was approximately $1.1 million for stock options outstanding, $0.8 million for stock options exercisable, and $1.0 million for stock options vested and expected to vest as of December 31, 2010. The total intrinsic value for stock options exercised during the three months ended December 31, 2010 and 2009 was approximately $1 thousand. There were no stock options exercised during the three months ended September 30, 2009. The total intrinsic value for stock options exercised during the nine months ended December 31, 2010 and 2009 was approximately $22 thousand and $6 thousand, respectively.
 
 We do not expect to realize any tax benefits from future disqualifying dispositions, if any, because we currently have a full valuation allowance against our deferred tax assets.
  11
 
 Stock Warrants
 
 The following table summarizes stock warrants activity related to the Loan with the Lender for the nine months ended December 31, 2010:
  WeightedNumber


Averageof Shares


Exercise PriceNonvested at March 31, 2010


189,394


$
1.65Granted


-



–Vested


(189,394
)


1.65Forfeited


-



–Nonvested at December 31, 2010


-


$
1.65Vested at December 31, 2010


651,515


$
1.53
  At December 31, 2010, unrecognized debt cost expense related to the Initial and Additional Warrant Shares was approximately $312 thousand, which is expected to be recognized over a weighted average period of approximately 1.9 years.
 
 Restricted Stock
 
 We granted 755,127 shares of restricted stock to management during the nine months ended December 31, 2010. The restrictions for these restricted stock awards lapse after certain Company (revenue and loss from operations) and individual milestones are met followed by a three-year graded vesting schedule. If the Company milestones are not met, regardless of whether the individual meets his or her performance milestones, the restricted stock awards are forfeited.
 
 The following table summarizes restricted stock activity for the nine months ended December 31, 2010:
 
 WeightedNumber


Averageof Shares


Grant PriceNonvested at March 31, 2010


-



–Granted


755,127


$
0.97Vested


-



–Forfeited


-



–Nonvested at December 31, 2010


755,127


$
0.97Vested at December 31, 2010


-



–
 
 At December 31, 2010, unrecognized stock-based compensation expense related to nonvested awards was approximately $574 thousand, which is expected to be recognized over a weighted average period of approximately 3.2 years.
 
 Note 8. Segment Information
 
 We have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics.
 
 Our medical segment designs, manufactures and sells our advanced line of endoscopy-based products, including our state-of-the-art flexible endoscopes, and our Slide-On EndoSheath technology referred to as a sheath or EndoSheath disposable, for a variety of specialties and markets.
 
 Our industrial segment, through our wholly-owned subsidiary Machida, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities.  Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items.
 
 Management evaluates the revenue and profitability performance of each of our product lines to make operating and strategic decisions. We have no intersegment revenue.
  12
 
 The following table presents key financial highlights, by reportable segments:
 
 Three months ended December 31,

Medical


Industrial


Adjustments *


Consolidated2010Net sales to external customers

$
2,068


$
647


$
-


$
2,715Gross profit


620



189



-



809Operating loss


(2,404
)


(41
)


-



(2,445
)Interest expense, net


(90
)


-



-



(90
)Depreciation and amortization


175



9



-



184Stock-based compensation expense


357



21



-



378Total assets


11,299



2,622



(2,284
)


11,637Expenditures for fixed assets


159



-



-



1592009Net sales to external customers

$
1,842


$
758


$
-


$
2,600Gross profit


8



342



-



350Operating (loss) income


(3,324
)


96



-



(3,228
)Interest income, net


8



-



-



8Depreciation and amortization


184



5



-



189Stock-based compensation expense


239



22



-



261Total assets


11,631



2,570



(2,362
)


11,839Expenditures for fixed assets


162



8



-



170Nine months ended December 31,2010Net sales to external customers

$
5,909


$
1,762


$
-


$
7,671Gross profit


1,589



550



-



2,139Operating loss


(7,542
)


(175
)


-



(7,717
)Interest expense, net


(231
)


-



-



(231
)Depreciation and amortization


538



21



-



559Stock-based compensation expense


1,231



79



-



1,310Expenditures for fixed assets


220



-



-



2202009Net sales to external customers

$
6,695


$
2,112


$
-


$
8,807Gross profit


552



1,051



-



1,603Operating (loss) income


(9,194
)


347



-



(8,847
)Interest income, net


33



-



-



33Depreciation and amortization


479



15



-



494Stock-based compensation expense


1,085



92



-



1,177Expenditures for fixed assets


593



8



-



601
  December 31,* Adjustments

2010


2009Intercompany eliminations

$
(1,512
)

$
(1,397
)Investment in subsidiaries


(772
)


(965
)Total adjustments

$
(2,284
)

$
(2,362
)


13
  Note 9. Advances from Customers
 
 Exclusive Urology Supply Agreement with Stryker
 
 On September 22, 2010, we signed a three-year agreement under which we will become the exclusive supplier to Stryker of Stryker-branded flexible video and fiber cystoscopes. These cystoscopes will employ our patented slide-on EndoSheath technology, which will be co-branded Stryker and Vision-Sciences. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during calendar 2011. Stryker will initially have the exclusive rights to distribute products, including cystoscopes, urology EndoSheath technology, and ureteroscopes manufactured by us, in North and Latin America, South America, China and Japan and 12 months post-launch, throughout the rest of the world.
 
 Subject to the terms of the Stryker Agreement, Stryker agreed to pay us a prepayment of $5 million, of which we received $2.5 million at signing and $2.5 million is due on or before March 31, 2011. The initial $2.5 million was recorded as an advance from customer in our condensed consolidated balance sheet. During the nine months ended December 31, 2010, we recognized $0.1 million in revenue for delivery of cystocopes and EndoSheath technology. We will continue to apply the amounts due from Stryker for purchases of scopes and EndoSheath technology to the prior advance by Stryker and recognize the associated revenue in accordance with our revenue recognition policy until the remaining $2.4 million is exhausted. Stryker will thereafter continue to pay us for products supplied. The purchase price for the products is based on our cost to manufacture plus a margin specified in the Stryker Agreement. We will recognize revenue for products sold to Stryker in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us. There can be no assurance that Stryker will purchase an amount of products in order for us to retain all or any portion of the prepayment or that we will not be required to refund all or a portion of the prepayments to Stryker.  If we are required to refund any amounts paid to us, it will have a material adverse effect on our financial condition.
 
 SpineView Development and Supply Agreement
 
 On June 19, 2008, we entered into a Development and Supply Agreement with SpineView, Inc. (the “SpineView Agreement”), pursuant to which we were to develop and supply a CCD-based video endoscope to SpineView for use with SpineView’s products. In September 2010, we received a prepayment of $1.4 million from SpineView for the initial, firm stocking order of 50 SpineView spinoscope sytems. We recorded this prepayment as an advance from customer in our condensed consolidated balance sheet. During the nine months ended December 31, 2010, we recognized $0.1 million in revenue for delivery of SpineView spinoscope systems. We will continue to apply the amounts due from SpineView to the prior advance by SpineView for purchases of scopes and recognize the associated revenue until the remaining $1.3 million is exhausted. SpineView will thereafter continue to pay us for products supplied.
 
 Mr. Pell, our Chairman, is the Chairman of the SpineView board and an investor in SpineView. Messrs. Katsumi Oneda and John J. Rydzewski, members of our Board, are also investors in SpineView. Our policy with respect to transactions in which any of our directors or officers may have an interest, requires that such transaction (i) be on terms no less favorable to us than could be obtained from unaffiliated third parties and (ii) be approved by a majority of the uninterested, outside members of the Board.
 
 At a Board meeting held on May 29, 2008, the Board reviewed the terms of the final draft of the SpineView Agreement, outside of the presence of Messrs. Pell and Oneda. The remaining (uninterested) members of our Board determined that the SpineView Agreement was fair, properly negotiated, and would be at least as favorable to us as could have been obtained from unaffiliated third parties, and accordingly, after discussion, it was approved. Mr. Rydzewski was neither an investor in SpineView nor a member of our Board at that time, and has no other relationship with SpineView.
 
 Note 10. Subsequent Event
 
 On January 18, 2011, we issued 7 million shares of our common stock at a purchase price of $1.50 per share to a number of investors in a private placement for aggregate proceeds of $10.5 million. We intend to use the proceeds from the private placement for working capital and general corporate purposes. We granted the investors in this private placement piggy-back registration rights, whereby if we decide to file a registration statement relating to an offering of any of our equity securities, other than on Form S-4 or Form S-8, then the investors will have the right, after notice, to include their securities in that registration statement. The investors in this private placement have no right to otherwise require us to register the sale of their shares.
  14
 
 Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 Forward Looking Statements
 
 This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. Such factors include, but are not limited to, further weakening of economic conditions that could adversely affect the level of demand for our products; our ability to satisfactorily distribute our ENT endoscopes without an arrangement with Medtronic; our ability to sell products to Stryker in at least the amounts necessary to retain the prepayments received from Stryker; pricing pressures, including cost-containment measures which could adversely affect the price of, or demand for, our products; availability of parts on acceptable terms; our ability to design new products and the success of such new products; changes in foreign exchange markets; changes in financial markets and changes in the competitive environment. Examples of forward-looking statements include statements about expectations about future financial results, future products and future sales of new and existing products, future expenditures, and capital resources to meet anticipated requirements. Generally, words such as “expect” “believe”, “anticipate”, “may”, “will”, “plan”, “intend”, “estimate”, “could”, and other similar expressions are intended to identify forward-looking statements. The forward-looking statements are based on our future plans, strategies, projections and predictions and involve risks and uncertainties, and our actual results may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference could include the availability of capital resources; the availability of third-party reimbursement; government regulation; the availability of raw material components; our ability to satisfactorily distribute our ENT endoscopes without an arrangement with Medtronic; our dependence on certain distributors and customers; our ability to affect expected sales to Stryker; competition; technological difficulties; general economic conditions and other risks detailed in this Quarterly Report on Form 10-Q and any subsequent periodic filings we make with the Securities and Exchange Commission (“SEC”). While we believe the assumptions underlying such forward-looking statements are reasonable, there can be no assurance that future events or developments will not cause such statements to be inaccurate. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement. We do not undertake an obligation to update our forward-looking statements to reflect future events or circumstances.
 
 Registered Trademarks, Trademarks and Service Marks
 
 Vision-Sciences, Inc. owns the registered trademarks Vision Sciences®, Slide-On®, EndoSheath®, and The Vision System®. Not all products referenced in this report are approved or cleared for sale, distribution, or use.
 
 Executive Summary
 
 We design, develop, manufacture, and market products for endoscopy – the science of using an instrument, known as an endoscope - to provide minimally invasive access to areas not readily visible to the human eye. We operate in two segments, medical and industrial. Our medical segment designs, manufactures, and sells our advanced line of endoscopy-based products, including our state-of-the-art flexible fiber and video endoscopes and our Slide-On EndoSheath technology, for a variety of specialties and markets. Our industrial segment, through our wholly-owned subsidiary, Machida, Inc. (“Machida”), designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine-manufacturing and aircraft engine-maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities.
 
 Medical Segment Areas
 
 Within our medical segment we target four main areas for our fiber and video endoscopes and our EndoSheath technology: ENT (ear, nose, and throat), urology, gastroenterology (“GI”), and pulmonology. Within the ENT area, we manufacture ENT endoscopes and, for the past three fiscal years, had sold these scopes exclusively to Medtronic Xomed, Inc., the ENT subsidiary of Medtronic, Inc. (“Medtronic”) for use by ENT physicians. On February 11, 2010, we announced that Medtronic would no longer serve as the distributor for our ENT endoscopes effective April 1, 2010. Since April 1, 2010, we have sold our ENT endoscopes through our direct sales force in the U.S. and through distributors internationally. We manufacture our TNE (trans-nasal esophagoscopy) endoscopes and market them to ENT and GI physicians and bariatric surgeons. Within the urology area, we manufacture, market, and sell our cystoscopes and EndoSheath technology to urologists and other urology-gynecology related physicians. Pursuant to our agreement dated as of September 22, 2010, with the Endoscopy Division of Stryker Corporation (“Stryker”), we will supply to Stryker our flexible video and fiber cystoscopes and related EndoSheath products (the “Stryker Agreement”) (See Exclusive Urology Supply Agreement with Stryker section below for additional information). Within the GI area, we manufacture, market, and sell our TNE scopes and EndoSheath technology to GI physicians, primary care physicians, and others with a GI focus as part of their practice, in addition to bariatric surgeons. We manufacture, market, and sell our bronchoscope (an endoscope that allows detailed viewing of the lungs) and EndoSheath technology for bronchoscopy to pulmonologists, oncologists, thoracic surgeons, and other pulmonology-related physicians.
  15
 
 Value Proposition and Strategy
 
 We believe our technology delivers significant value to our customers – doctors, clinics and hospitals – through reduced capital, staff and service costs, and increased patient throughput, practice revenue, and profitability. Our EndoSheath technology allows our customers to buy fewer endoscopes to service their patients and enables them to schedule more patient appointments in a single day. Our single-use EndoSheath technology provides a sterile barrier between patients and our reusable endoscopes, eliminating the need for time-consuming reprocessing routines necessary with conventional endoscopes. Our endoscopes are therefore typically ready for the next procedure in ten minutes, unlike conventional endoscopes which may take from 45 minutes to a day to reprocess. We believe our EndoSheath technology is the solution to the challenges and problems with conventional flexible endoscopes.  By offering a technology that provides simpler and quicker endoscope reprocessing and sterility derived from use of a single-use disposable sheath, we have removed the limitations of conventional flexible endoscopy.
 
 Our current strategic focus is to transform ourselves from a research and development-focused company to a sales and marketing-driven Company, with the primary goal of increasing top-line revenue and margins.  We intend to do this by:
 
 ·
Growing our direct sales force in the U.S. and enhancing our international distribution network;
 ·
Expanding our downstream marketing efforts to end customers, including expanding our communications, advertising and branding;
 ·
Increasing our clinical study activity in order to have peer-reviewed papers published which outline the benefits of our products;
 ·
Targeting teaching hospitals and academic institutions as potential customers and reference and training centers;
 ·
Leveraging our existing technology platform to explore new potential products and procedures in markets where we currently sell; and
 ·
Exploring potential distribution arrangements with strategic partners.
 
 New Product Releases
 
 We continue to enhance our current family of videoscopes and improve and refine their manufacturing. With respect to our fiberscope line of products, in the first quarter of fiscal 2011, we launched our 4000 Series bronchoscope which is inserted down the mouth or nose into the lungs, providing visualization of the lungs and the ability to perform a variety of diagnostic and therapeutic procedures. In the first quarter of fiscal 2011, we launched our 2.8mm channel EndoSheath disposable for bronchoscopy to international pulmonology markets.
 
 Exclusive Urology Supply Agreement with Stryker
 
 On September 22, 2010, we signed a three-year agreement under which we will become the exclusive supplier to Stryker of Stryker-branded flexible video and fiber cystoscopes. These cystoscopes will employ our patented slide-on EndoSheath technology, which will be co-branded under the Stryker and Vision-Sciences names. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during calendar 2011. Stryker will initially have the exclusive rights to distribute products, including cystoscopes, urology EndoSheath technology, and ureteroscopes manufactured by us, in North and Latin America, South America, China and Japan and 12 months post-launch, throughout the rest of the world.
 
 Subject to the terms of the Stryker Agreement, Stryker agreed to pay us a prepayment of $5 million, of which we received $2.5 million at signing and $2.5 million is due on or before March 31, 2011. The initial $2.5 million was recorded as an advance from customer in our condensed consolidated balance sheet. During the nine months ended December 31, 2010, we recognized $0.1 million in revenue for delivery of cystocopes and EndoSheath technology to Stryker. We will continue to apply the amounts due from Stryker for purchases of scopes and EndoSheath technology to the prior advance made by Stryker and recognize the associated revenue in accordance with our revenue recognition policy until the remaining $2.4 million is exhausted. Stryker will thereafter continue to pay us for products supplied. The purchase price for the products will be based on our cost to manufacture plus a margin specified in the Stryker Agreement. We will recognize revenue for products sold to Stryker in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us. There can be no assurance that they will purchase an amount of products in order for us to retain all or any portion of the prepayment or that we will not be required to refund all or a portion of the prepayments to Stryker.  If we are required to refund any amounts paid to us, it will have a material adverse effect on our financial condition.
 
 Line of Credit – Related Party
 
 On November 9, 2009, we entered into a three-year $5.0 million revolving loan agreement (the “Loan”) with our Chairman, Lewis C. Pell (the “Lender”). Any amounts drawn against the Loan (an “Advance”) accrue interest at a per annum rate of 7.5%. The Lender received an availability fee equal to an annual rate of 0.5% on the unused portion of the Loan calculated based on the difference between the average annual principal amount of the outstanding Advances under the Loan and the maximum advance of $5.0 million. The availability of advances under the Loan is subject to customary conditions. As of December 31, 2010, we had fully drawn down the Loan. Subject to the terms of the Loan, we will be required to prepay all amounts outstanding under the Loan upon a change of control of the Company. We were required to prepay part or all of the amounts outstanding if we secured other financing or consummate a sale or license of assets, in each case resulting in net proceeds to us of $5.0 million or greater. In connection with our recent private placement (see Subsequent Event below for additional information), we received a waiver from the Lender such that we will not be required to repay all or any portion of the Advances with the proceeds from this fund raising.
  16
  In connection with the Loan, the Lender received  a five-year warrant (the “Initial Warrant Shares”) to purchase up to 272,727 shares of our common stock at an exercise price of $1.375 per share (representing 7.5% warrant coverage, or approximately 0.7% of our outstanding common stock), which immediately vested upon issuance. The second five-year warrant (the “Additional Warrant Shares”) to purchase up to an additional 378,788 shares of our common stock at an exercise price of $1.65 per share (representing up to an additional 12.5% warrant coverage, or approximately 1.0% of our outstanding common stock) vests at the time that each Advance is made in an amount equal to (i) the product of the amount of the Additional Warrant Shares multiplied by (ii) a ratio, (A) the numerator of which is the amount of the new Advance and (B) the denominator of which is $5.0 million. A portion of the Additional Warrant Shares vested on the date of the $2.5 million Advance on March 29, 2010, the $2.0 million Advance on June 29, 2010, and the $0.5 million Advance on December 16, 2010.
 
 On the date of issuance, the fair value of the Initial and Additional Warrant Shares was approximately $221 thousand and $249 thousand, respectively. We defer costs associated with securing a line-of-credit or revolving loan agreement over the applicable term. These costs are amortized as debt cost expense in our condensed consolidated statement of operations.
 
 At December 31, 2010, we had $5.0 million in outstanding borrowings under the Loan, which is reflected as line of credit – related party on our condensed consolidated balance sheet. The $5.0 million revolving loan expires in November 2012, at which time we must repay all borrowings under the Loan.
 
 SpineView Development and Supply Agreement
 
 On June 19, 2008, we entered into a Development and Supply Agreement with SpineView, Inc. (the “SpineView Agreement”), pursuant to which we were to develop and supply a CCD-based video endoscope to SpineView for use with SpineView’s products. In September 2010, we received a prepayment of $1.4 million from SpineView for the initial, firm stocking order of 50 SpineView spinoscope sytems. We recorded this prepayment as an advance from customer in our condensed consolidated balance sheet. During the nine months ended December 31, 2010, we recognized $0.1 million in revenue for delivery of SpineView spinoscope systems. We will continue to apply the payment to amounts due from SpineView for purchases of scopes and recognize the associated revenue until the remaining $1.3 million is exhausted. SpineView will thereafter continue to pay us for products supplied.
 
 Mr. Pell, our Chairman, is the Chairman of the SpineView board and an investor in SpineView. Messrs. Katsumi Oneda and John J. Rydzewski, members of our Board, are also investors in SpineView. Our policy with respect to transactions in which any of our directors or officers may have an interest, requires that such transaction (i) be on terms no less favorable to us than could be obtained from unaffiliated third parties and (ii) be approved by a majority of the uninterested, outside members of the Board.
 
 At a Board meeting held on May 29, 2008, the Board reviewed the terms of the final draft of the SpineView Agreement, outside of the presence of Messrs. Pell and Oneda. The remaining (uninterested) members of our Board determined that the SpineView Agreement was fair, properly negotiated, and would be at least as favorable to us as could have been obtained from unaffiliated third parties, and accordingly, after discussion, it was approved. Mr. Rydzewski was neither an investor in SpineView nor a member of our Board at that time, and has no other relationship with SpineView.
 
 Subsequent Event
 
 On January 18, 2011, we issued 7 million shares of our common stock at a purchase price of $1.50 per share to a number of investors in a private placement for aggregate proceeds of $10.5 million. We intend to use the proceeds from the private placement for working capital and general corporate purposes. We granted the investors in this private placement piggy-back registration rights, whereby if we decide to file a registration statement relating to an offering of any of our equity securities, other than on Form S-4 or Form S-8, then the investors will have the right, after notice, to include their securities in that registration statement. The investors in this private placement have no right to otherwise require us to register the sale of their shares.
  Results of Operations
 
 Three months ended December 31, 2010 compared to the three months ended December 31, 2009 (in thousands, except percentages)
 
 Net Sales
 
 Net sales increased $0.1 million, or 4%, in the third quarter of fiscal 2011 to $2.7 million compared to $2.6 million in the third quarter of fiscal 2010. During the third quarter of fiscal 2011, our medical segment’s net sales of $2.1 million increased by $0.2 million, or 12%, primarily attributable to higher sales of our endoscopes and EndoSheath disposables in the urology market ($0.4 million). Our industrial segment’s net sales of $0.6 million decreased by $0.1 million, or 15%, primarily attributable to lower borescope sales ($0.2 million).
  17
 
 In the medical segment, we track sales of endoscopes and EndoSheath disposables by market. We also track sales of peripherals and accessories which can be sold to more than one market. Sales by segment, market, and by category for the three months ended December 31, 2010 and 2009 were as follows:
 
 Three Months EndedDecember 31,Market/Category

2010


2009


Difference


PercentageENT and TNE

$
751


$
550


$
201



37
%Urology


827



444



383



86
%Bronchoscopy


70



94



(24
)


-26
%SpineView


-



225



(225
)


-100
%Repairs, peripherals, and accessories


420



529



(109
)


-21
%Total medical sales


2,068



1,842



226



12
%Borescopes


442



610



(168
)


-28
%Repairs


205



148



57



39
%Total industrial sales


647



758



(111
)


-15
%Net sales

$
2,715


$
2,600


$
115



4
%
 
 Medical Segment
  Medical Segment – ENT and TNE Markets
 
 Sales to the ENT and TNE markets include both our ENT and TNE endoscopes and EndoSheath disposables and were as follows:
 
 Three Months Ended

December 31,ENT/TNE Market

2010


2009


Difference


PercentageEndoscopes

$
728


$
541


$
187



35
%Slide-On EndoSheaths


23



9



14



156
%Total ENT/TNE market

$
751


$
550


$
201



37
%
 
 Net sales to the ENT and TNE markets increased $0.2 million, or 37%, in the third quarter of fiscal 2011 to $0.8 million compared to $0.6 million in the third quarter of fiscal 2010. The increase in net sales was primarily attributable to higher sales of our videoscopes ($0.2 million).
 
 Medical Segment – Urology Market
 
 Sales to the urology market include urology endoscopes and EndoSheath disposables and were as follows:
 
 Three Months Ended

December 31,Urology Market

2010


2009


Difference


PercentageEndoscopes

$
331


$
163


$
168



103
%Slide-On EndoSheaths


496



281



215



77
%Total urology market

$
827


$
444


$
383



86
%
 
 Net sales to the urology market increased $0.4 million, or 86%, in the third quarter of fiscal 2011 to $0.8 million compared to $0.4 million in the third quarter of fiscal 2010. The increase in net sales was primarily attributable to higher sales of our EndoSheath disposables ($0.2 million).
  18
 
 Medical Segment – Bronchoscopy Market
 
 Sales to the bronchoscopy market include bronchoscopy endoscopes and EndoSheath disposables and were as follows:
  Three Months Ended

December 31,Bronchoscopy Market

2010


2009


Difference


PercentageEndoscopes

$
37


$
74


$
(37
)


-50
%Slide-On EndoSheaths


33



20



13



65
%Total bronchoscopy market

$
70


$
94


$
(24
)


-26
%
  Net sales to the bronchoscopy market decreased $24 thousand, or 26%, in the third quarter of fiscal 2011 to $70 thousand compared to $94 thousand in the third quarter of fiscal 2010. The decrease in net sales was primarily attributable to lower sales of our videoscopes ($40 thousand).
 Medical Segment – Repairs, Peripherals, and Accessories
 
 Net sales of repairs, peripherals, and accessories decreased $0.1 million, or 21%, in the third quarter of fiscal 2011 to $0.4 million compared to $0.5 million in the third quarter of fiscal 2010. The decrease was primarily attributable to lower sales volume of peripherals and accessories for our ENT endoscopes due to the end of our distribution agreement with Medtronic ($0.1 million).
 Industrial Segment
 Net sales of industrial products of $0.6 million decreased $0.1 million, or 15%, in the third quarter of fiscal 2011 compared to $0.8 million in the third quarter of fiscal 2010. The decrease was primarily attributable to lower borescope sales ($0.2 million). This segment’s products are mature, and therefore, we expect future sales to remain relatively flat.
  Gross Profit (Net Sales Less Cost of Sales)
  Gross profit from our two reportable segments was as follows:
  Three Months Ended

December 31,Gross Profit

2010


2009


Difference


PercentageMedical

$
620


$
8


$
612



7650
%As percentage of net sales


30
%


0
%


30
%Industrial


189



342



(153
)


-45
%As percentage of net sales


29
%


45
%


-16
%Gross profit

$
809


$
350


$
459



131
%Gross margin percentage


30
%


13
%


17
%
  Gross profit increased $0.5 million, or 131%, in the third quarter of fiscal 2011 to $0.8 million from $0.4 million in the third quarter of fiscal 2010, primarily attributable to favorable manufacturing overhead absorption and a lower inventory reserve ($0.3 million). Gross margin percentage increased 17% in the third quarter of fiscal 2011 to 30% of net sales from 13% of net sales in the third quarter of fiscal 2010. The higher gross margin percentage was primarily attributable to favorable manufacturing overhead absorption and a lower inventory reserve in the third quarter of fiscal 2011 compared to the same period last year ($0.3 million, or 13% gross margin percentage impact).
  19
  Gross Profit – Medical Segment
 
 Gross profit in our medical segment increased $0.6 million, or 7,650%, in the third quarter of fiscal 2011 to $0.6 million from $8 thousand in the third quarter of fiscal 2010, primarily attributable to favorable manufacturing overhead absorption and a lower inventory reserve ($0.6 million). Gross margin percentage increased 30% in the third quarter of fiscal 2011 to 30% of net sales from 0% of net sales in the third quarter of fiscal 2010. The higher gross margin percentage was primarily attributable to favorable manufacturing overhead absorption and a lower inventory reserve in the third quarter of fiscal 2011 compared to the same period last year ($0.6 million, or 28% gross margin percentage impact on our medical segment gross profit).
 
 Gross Profit – Industrial Segment
 
 Gross profit in our industrial segment decreased $0.2 million, or 45%, in the third quarter of fiscal 2011 to $0.2 million from $0.3 million in the third quarter of fiscal 2010, primarily attributable to unfavorable manufacturing overhead absorption ($0.2 million). Gross margin percentage decreased 16% in the third quarter of fiscal 2011 to 29% of net sales from 45% of net sales in the third quarter of fiscal 2010. The lower gross margin percentage was primarily attributable to unfavorable manufacturing overhead absorption, partially offset by a favorable materials usage variance ($0.1 million, or 20% gross margin percentage impact on our industrial segment gross profit).
 
 Operating Expenses
 
 Total operating expenses decreased $0.3 million, or 9%, in the third quarter of fiscal 2011 to $3.3 million from $3.6 million in the third quarter of fiscal 2010. Selling, general, and administrative (“SG&A”) expenses decreased $0.3 million, or 11%, and research and development (“R&D”) expenses decreased $4 thousand, or 1%, compared to the same period last year.
 
 Operating expenses, by segment, were as follows:
  Three Months Ended

December 31,Operating Expenses

2010


2009


Difference


PercentageSG&A expensesMedical

$
2,369


$
2,673


$
(304
)


-11
%Industrial


230



246



(16
)


-7
%Total SG&A expenses


2,599



2,919



(320
)


-11
%R&D expensesMedical


655



659



(4
)


-1
%Industrial


-



-



-



-Total R&D expenses


655



659



(4
)


-1
%Total operating expenses

$
3,254


$
3,578


$
(324
)


-9
%
 
 SG&A Expenses – Medical Segment
 
 SG&A expenses in our medical segment decreased $0.3 million, or 11%, in the third quarter of fiscal 2011 to $2.4 million, primarily attributable to one-time termination costs for the former Chief Executive Officer (“CEO”) recorded in the third quarter of fiscal 2010, which was not repeated in the current fiscal year ($0.5 million). Partially offsetting this decrease was higher stock-based compensation expense in the third quarter of fiscal 2011 compared to the same period last year ($0.2 million).
 
 SG&A Expenses – Industrial Segment
 
 SG&A expenses in our industrial segment decreased $16 thousand, or 7%, in the third quarter of fiscal 2011 to $230 thousand, primarily attributable to lower computer expenses ($7 thousand).
 
 R&D Expenses – Medical Segment
 
 R&D expenses in our medical segment decreased $4 thousand, or 1%, in the third quarter of fiscal 2011 to $0.7 million.
 
 R&D Expenses – Industrial Segment
 
 There were no material R&D expenses incurred by our industrial segment during the third quarter of fiscal 2011 or 2010.
  20
 
 Other (Expense) Income
 
 Other (expense) income was as follows:
  Three Months EndedDecember 31,Other (Expense) Income

2010


2009


Difference


PercentageInterest income

$
1


$
14


$
(13
)


-93
%Interest expense


(91
)


(6
)


(85
)


-1417
%Debt cost expense


(37
)


(12
)


(25
)


-208
%Other expense

$
(127
)

$
(4
)

$
(123
)


-3075
%
 
 Interest Income
 
 Interest income decreased $13 thousand, or 93%, in the third quarter of fiscal 2011 primarily attributable to lower cash and short-term investments balances.
 
 Interest Expense
 
 Interest expense increased $85 thousand, or 1,417%, in the third quarter of fiscal 2011 primarily attributable to the interest associated with Advances of $5.0 million on the Loan.
 
 Debt Cost Expense
 
 Debt cost expense increased $25 thousand, or 208%, in the third quarter of fiscal 2011 primarily associated with the issuance of Additional Warrant Shares.
 
 Net Loss
 
 Net loss was as follows:
 
 Three Months EndedDecember 31,Net Loss

2010


2009


Difference


PercentageLoss before provision for income taxes

$
(2,572
)

$
(3,232
)

$
(660
)


-20
%Income tax provision


4



2



2



100
%Net loss

$
(2,576
)

$
(3,234
)

$
(658
)


-20
%
 
 Loss Before Provision for Income Taxes
 
 Loss before provision for income taxes decreased $0.7 million, or 20%, in the third quarter of fiscal 2011 to $2.6 million, primarily attributable to a higher gross profit ($0.5 million).
 
 Income Tax Provision
 
 We recorded a provision for state income taxes of $4 thousand and $2 thousand in the third quarter of fiscal 2011 and 2010, respectively.
 
 Net Loss
 
 Net loss decreased $0.7 million, or 20%, in the third quarter of fiscal 2011 to $2.6 million, primarily attributable to a higher gross profit ($0.5 million).
  21
 
 Nine months ended December 31, 2010 compared to the nine months ended December 31, 2009 (in thousands, except percentages)
 
 Net Sales
 
 Net sales decreased $1.1 million, or 13%, in the first nine months of fiscal 2011 to $7.7 million compared to $8.8 million in the first nine months of fiscal 2010. During the first nine months of fiscal 2011, our medical segment’s net sales of $5.9 million decreased by $0.8 million, or 12%, primarily attributable to lower sales of our ENT fiberscopes due to the end of our distribution agreement with Medtronic ($0.8 million). Our industrial segment’s net sales of $1.8 million decreased by $0.4 million, or 17%, primarily attributable to lower sales of our borescopes ($0.4 million).
 
 In the medical segment, we track sales of endoscopes and EndoSheath disposables by market. We also track sales of peripherals and accessories which can be sold to more than one market. Sales by segment, market, and by category for the nine months ended December 31, 2010 and 2009 were as follows:
 
 Nine Months EndedDecember 31,Market/Category

2010


2009


Difference


PercentageENT and TNE

$
1,775


$
2,744


$
(969
)


-35
%Urology


2,471



1,702



769



45
%Bronchoscopy


541



426



115



27
%SpineView


74



225



(151
)


-67
%Repairs, peripherals, and accessories


1,048



1,598



(550
)


-34
%Total medical sales


5,909



6,695



(786
)


-12
%Borescopes


1,223



1,581



(358
)


-23
%Repairs


539



531



8



2
%Total industrial sales


1,762



2,112



(350
)


-17
%Net sales

$
7,671


$
8,807


$
(1,136
)


-13
%
 
 Medical Segment
  Medical Segment – ENT and TNE Markets
 Sales to the ENT and TNE markets include both our ENT and TNE endoscopes and EndoSheath disposables and were as follows:
  Nine Months Ended

December 31,ENT/TNE Market

2010


2009


Difference


PercentageEndoscopes

$
1,733


$
2,673


$
(940
)


-35
%Slide-On EndoSheaths


42



71



(29
)


-41
%Total ENT/TNE market

$
1,775


$
2,744


$
(969
)


-35
%
  Net sales to the ENT and TNE markets decreased $1.0 million, or 35%, in the first nine months of fiscal 2011 to $1.8 million compared to $2.7 million in the first nine months of fiscal 2010. The decrease in net sales was primarily attributable to lower sales of our ENT fiberscopes due to the end of our distribution agreement with Medtronic ($0.8 million).
  22
 
 Medical Segment – Urology Market
 
 Sales to the urology market include urology endoscopes and EndoSheath disposables and were as follows:
 
 Nine Months Ended

December 31,Urology Market

2010


2009


Difference


PercentageEndoscopes

$
1,135


$
711


$
424



60
%Slide-On EndoSheaths


1,336



991



345



35
%Total urology market

$
2,471


$
1,702


$
769



45
%
  Net sales to the urology market increased $0.8 million, or 45%, in the first nine months of fiscal 2011 to $2.5 million compared to $1.7 million in the first nine months of fiscal 2010. The increase in net sales was primarily attributable to higher sales of our fiberscopes ($0.2 million) and EndoSheath disposables ($0.3 million).
 
 Medical Segment – Bronchoscopy Market
 
 Sales to the bronchoscopy market include bronchoscopy endoscopes and EndoSheath disposables and were as follows:
 
 Nine Months Ended

December 31,Bronchoscopy Market

2010


2009


Difference


PercentageEndoscopes

$
475


$
387


$
88



23
%Slide-On EndoSheaths


66



39



27



69
%Total bronchoscopy market

$
541


$
426


$
115



27
%
 
 Net sales to the bronchoscopy market increased $0.1 million, or 27%, in the first nine months of fiscal 2011 to $0.5 million compared to $0.4 million in the first nine months of fiscal 2010. The increase in net sales was primarily attributable to higher sales of our fiberscopes ($0.1 million).
 
 Medical Segment – Repairs, Peripherals, and Accessories
 
 Net sales of repairs, peripherals, and accessories decreased $0.6 million, or 34%, in the first nine months of fiscal 2011 to $1.0 million compared to $1.6 million in the first nine months of fiscal 2010. The decrease was primarily attributable to lower sales volume of peripherals and accessories for our ENT endoscopes due to the end of our distribution agreement with Medtronic ($0.5 million).
 
 Industrial Segment
 
 Net sales of industrial products of $1.8 million decreased $0.4 million, or 17%, in the first nine months of fiscal 2011 compared to $2.1 million in the first nine months of fiscal 2010. The decrease was primarily attributable to lower sales of our borescopes ($0.4 million). This segment’s products are mature, and therefore, we expect future sales to remain relatively flat.
  Gross Profit (Net Sales Less Cost of Sales)
  Gross profit from our two reportable segments was as follows:
  Nine Months Ended

December 31,Gross Profit

2010


2009


Difference


PercentageMedical

$
1,589


$
552


$
1,037



188
%As percentage of net sales


27
%


8
%


19
%Industrial


550



1,051



(501
)


-48
%As percentage of net sales


31
%


50
%


-19
%Gross profit

$
2,139


$
1,603


$
536



33
%Gross margin percentage


28
%


18
%


10
%


23
  Gross profit increased $0.5 million, or 33%, in the first nine months of fiscal 2011 to $2.1 million from $1.6 million in the first nine months of fiscal 2010, primarily attributable to favorable manufacturing variances ($1.0 million), partially offset by loss in gross profit from lower sales volume (decrease in net sales of $1.1 million). Gross margin percentage increased 10% in the first nine months of fiscal 2011 to 28% of net sales from 18% of net sales in the first nine months of fiscal 2010. The higher gross margin percentage was primarily attributable to favorable manufacturing variances in the first nine months of fiscal 2011 compared to the same period last year ($1.0 million, or 13% gross margin percentage impact).
 
 Gross Profit – Medical Segment
 
 Gross profit in our medical segment increased $1.0 million, or 188%, in the first nine months of fiscal 2011 to $1.6 million from $0.6 million in the first nine months of fiscal 2010, primarily attributable to favorable manufacturing variances ($1.1 million). Gross margin percentage increased 19% in the first nine months of fiscal 2011 to 27% of net sales from 8% of net sales in the first nine months of fiscal 2010. The higher gross margin percentage was primarily attributable to favorable manufacturing variances in the first nine months of fiscal 2011 compared to the same period last year ($1.1 million, or 18% gross margin percentage impact on our medical segment gross profit).
 
 Gross Profit – Industrial Segment
 
 Gross profit in our industrial segment decreased $0.5 million, or 48%, in the first nine months of fiscal 2011 to $0.6 million from $1.1 million in the first nine months of fiscal 2010, primarily attributable to increased cost of sales for repairs and a higher inventory reserve ($0.3 million). Gross margin percentage decreased 19% in the first nine months of fiscal 2011 to 31% of net sales from 50% of net sales in the first nine months of fiscal 2010. The lower gross margin percentage was primarily attributable to increased cost of sales for repairs and a higher inventory reserve ($0.3 million, or 16% gross margin percentage impact on our industrial segment gross profit).
 
 Operating Expenses
 
 Total operating expenses decreased $0.6 million, or 6%, in the first nine months of fiscal 2011 to $9.9 million from $10.5 million in the first nine months of fiscal 2010. SG&A expenses decreased $0.2 million, or 3%, and R&D expenses decreased $0.4 million, or 15%, compared to the same period last year.
 
 Operating expenses, by segment, were as follows:
  Nine Months Ended

December 31,Operating Expenses

2010


2009


Difference


PercentageSG&A expensesMedical

$
7,147


$
7,404


$
(257
)


-3
%Industrial


725



704



21



3
%Total SG&A expenses


7,872



8,108



(236
)


-3
%R&D expensesMedical


1,984



2,342



(358
)


-15
%Industrial


-



-



-



-Total R&D expenses


1,984



2,342



(358
)


-15
%Total operating expenses

$
9,856


$
10,450


$
(594
)


-6
%
  SG&A Expenses – Medical Segment
 
 SG&A expenses in our medical segment decreased $0.3 million, or 3%, in the first nine months of fiscal 2011 to $7.1 million, primarily attributable to one-time termination costs for the former CEO recorded in the first nine months of fiscal 2010, which was not repeated in the current fiscal year ($0.5 million). Partially offsetting this decrease was higher stock-based compensation expense in the first nine months of fiscal 2011 compared to the same period last year ($0.3 million).
 
 SG&A Expenses – Industrial Segment
 
 SG&A expenses in our industrial segment increased $21 thousand, or 3%, in the first nine months of fiscal 2011 to $0.7 million, primarily attributable to higher repair costs for demonstration equipment ($48 thousand), partially offset by lower sales commissions for our independent sales reps ($33 thousand).
  24
 
 R&D Expenses – Medical Segment
 
 R&D expenses in our medical segment decreased $0.4 million, or 15%, in the first nine months of fiscal 2011 to $2.0 million, primarily attributable to lower manufacturing overhead allocations ($0.4 million).
 
 R&D Expenses – Industrial Segment
 
 There were no material R&D expenses incurred by our industrial segment during the first nine months of fiscal 2011 or 2010.
 
 Other (Expense) Income
 
 Other (expense) income was as follows:
  Nine Months EndedDecember 31,Other (Expense) Income

2010


2009


Difference


PercentageInterest income

$
4


$
85


$
(81
)


-95
%Interest expense


(235
)


(52
)


(183
)


-352
%Debt cost expense


(101
)


(12
)


(89
)


-742
%Other, net


(1
)


(28
)


27



96
%Other expense

$
(333
)

$
(7
)

$
(326
)


-4657
%
  Interest Income
 
 Interest income decreased $81 thousand, or 95%, in the first nine months of fiscal 2011 primarily attributable to lower cash and short-term investments balances.
 
 Interest Expense
 
 Interest expense increased $183 thousand, or 352%, in the first nine months of fiscal 2011 primarily attributable to the interest associated with Advances of $5.0 million on the Loan.
 
 Debt Cost Expense
 
 Debt cost expense increased $89 thousand, or 742%, in the first nine months of fiscal 2011 primarily associated with the issuance of Additional Warrant Shares.
 
 Other, Net
 
 Other net, decreased $27 thousand, or 96%, in the first nine months of fiscal 2011 primarily attributable to a loss on the sale of investments recorded in the first nine months of fiscal 2010, which was not repeated in the current fiscal year ($28 thousand).
  Net Loss
 
 Net loss was as follows:
  Nine Months EndedDecember 31,Net Loss

2010


2009


Difference


PercentageLoss before provision for income taxes

$
(8,050
)

$
(8,854
)

$
(804
)


-9
%Income tax provision


10



18



(8
)


-44
%Net loss

$
(8,060
)

$
(8,872
)

$
(812
)


-9
%
 Loss Before Provision for Income Taxes
 
 Loss before provision for income taxes decreased $0.8 million, or 9%, in the first nine months of fiscal 2011 to $8.1 million, primarily attributable to a higher gross profit ($0.5 million).
  25
 
 Income Tax Provision
 
 We recorded a provision for state income taxes of $10 thousand and $18 thousand in the first nine months of fiscal 2011 and 2010, respectively. We incurred a net operating loss (“NOL”) for the first nine months of fiscal 2011 and expect to have a NOL for the entire fiscal year. As a result, no income tax provision was recorded for federal income tax purposes.
 
 Net Loss
 
 Net loss decreased $0.8 million, or 9%, in the first nine months of fiscal 2011 to $8.1 million, primarily attributable to a higher gross profit ($0.5 million).
 
 Liquidity and Capital Resources
 
 At December 31, 2010, our principal source of liquidity was working capital of approximately $1.9 million, including $1.2 million in cash and cash equivalents. Our cash and cash equivalents decreased $1.3 million during the first nine months of fiscal 2011 as compared to a decrease of $1.6 million in the first nine months of fiscal 2010. The decrease was primarily attributable to advances received from two customers during the first nine months of fiscal 2011 ($3.9 million).
 
 In the first nine months of fiscal 2011, we used $4.1 million of net cash in our operating activities compared to $6.7 million in the first nine months of fiscal 2010. The lower cash used in operations was primarily attributable to the receipt of a proceeds from customers for advances during the first nine months of fiscal 2011 ($3.9 million), partially offset by the building of inventories in anticipation of future shipments under such customer agreements ($2.4 million).
 
 In the first nine months of fiscal 2011, we provided $0.1 million of net cash in our investing activities compared to $5.1 million in the first nine months of fiscal 2010. The decrease was primarily attributable to reduced proceeds yielded from sales and maturities of our short-term investments ($7.7 million), partially offset by reduced purchases of short-term investments ($2.4 million).
 
 In the first nine months of fiscal 2011, we provided $2.7 million of net cash from our financing activities compared to $12 thousand in the first nine months of fiscal 2010. The increase was primarily attributable to the proceeds from Advances on the Loan during the first nine months of fiscal 2011 ($2.5 million).
 
 We have incurred losses since our inception, and losses are expected to continue through at least fiscal years 2011 and 2012. We have funded the losses principally with cash flow from operations, advances under the Loan with our Chairman, Lewis C. Pell, proceeds from public and private equity financings, payments from Medtronic related to the sale of certain assets related to our ENT EndoSheath technology business, and the sale of other assets. We have also received an aggregate of $3.9 million of deposits from two customers (the “Prepayments”) in September 2010 to support anticipated orders, which are expected to ship by June 30, 2011 (the end of the first quarter of our fiscal year 2012). We believe that our cash, including the Prepayments, and the $10.5 million in proceeds we received from the private placement in January 2011 will be sufficient to fund our working capital, capital expenditures, and future operating losses until March 31, 2012. However, if our performance expectations fall short (including regaining sales or profits historically generated from Medtronic and generating expected sales from Stryker and SpineView) or our expenses exceed expectations, we will need to either secure additional financing or reduce expenses or a combination thereof. Our failure to do so would have a material adverse impact on our prospects and financial condition. There can be no assurance that any contemplated external financing will be available on terms acceptable to us, if at all, or that we will be able to reduce our expenses.
 
 Off-Balance Sheet Arrangements
 
 We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
  26
 
 Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
 We are a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act, and are not required to provide the information required by this item.
 
 Item 4.  Controls and Procedures
 
 Disclosure Controls and Procedures
 
 We have evaluated, under the supervision and with the participation of our senior management, including our Interim Chief Executive Officer (“Interim CEO”) and Chief Financial Officer (“CFO”), the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2010. Based upon the foregoing, our Interim CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2010.
 
 Changes in Internal Controls Over Financial Reporting
 
 There have been no changes in our internal controls over financial reporting during the three months ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
 
 27
 
 
 PART II—OTHER INORMATION
 Item 1.  Legal Proceedings
  None
  Item 1A.  Risk Factors
  There have been no material changes from the information discussed in Part I, Item 1A. Risk Factors, on page 19 of our Annual Report on Form 10-K for the year ended March 31, 2010, except for the information discussed below. You should carefully consider the risks and uncertainties we discussed in our Form 10-K and the risks described below in this quarterly report before deciding to invest in, or retain, shares of our common stock. These are not the only risks and uncertainties that we face. Additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, may also harm our business operations or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, operating results, or liquidity could be materially harmed.
 
 We have a history of operating losses and we may not achieve or maintain profitability in the future
 
 We have incurred substantial operating losses since our inception and there can be no assurance that we will achieve a profitable level of operations in the future. We anticipate a negative cash flow during fiscal years 2011 and 2012, because of spending for research and development, increasing our global network of independent sales representatives and distributors, investing in a direct sales force for the North American market, general business operations, and capital expenditures. As of December 31, 2010, we had cash and cash equivalents totaling approximately $1.2 million. We expect that our current balance of cash (including the remaining balance of the Prepayments) and the $10.5 million in proceeds we received from the private placement transaction we entered into in January 2011 will be sufficient to fund our operations until March 31, 2012. However, if our performance expectations fall short (including regaining sales or profits historically generated from Medtronic and generating expected sales from Stryker and SpineView) or our expenses increase, we will need to either secure additional financing or reduce expenses or a combination thereof, and in such instance, the failure to do so would have a material adverse impact on our financial condition. There can be no assurance that any contemplated external financing will be available on terms acceptable to us, if at all.
 
 Our risk related to the supply agreement with Stryker
 
 Pursuant to our agreement with Stryker, we will supply to Stryker our flexible video and fiber cystoscopes and related EndoSheath products for a term of three years. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during calendar 2011. Stryker will initially have the exclusive rights to distribute these products in North and Latin America, South America, China and Japan, and 12 months post-launch, throughout the rest of the world. There can be no assurance that Stryker will purchase any products from us or will succeed in marketing and selling these products. If they do not purchase such products or are unsuccessful in marketing or selling these products, will not be able to distribute those products to others and could generate little or no revenue from the Stryker agreement. Stryker also agreed to prepay $5 million in anticipation of ordering scopes and EndoSheath products from us, of which $2.5 million was prepaid as of December 31, 2010 and $2.5 million is due on or before March 31, 2011. There is no required minimum purchase amount which Stryker is required to buy from us. Although we expect that they will order sufficient quantities of products to fully utilize these prepayments, if they do not do so by the end of the term, we would be required to return any unused amount which they prepaid to us. This would include amounts that we used to purchase parts and components, of which we will not receive compensation or reimbursement.  If we are required to refund any amounts paid to us, it will have a material adverse effect on our liquidity, ability to fund working capital and our financial condition. There can be no assurance that we will have available funds to do so.
 
 Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
  The private placement of 7 million shares of our common stock for aggregate proceeds of $10.5 million has been disclosed on Form 8-K filed on January 19, 2011.
  Item 3.  Defaults Upon Senior Securities
  N/A
  28
  Item 4.  (Removed and Reserved)
  Item 5.  Other Information
 
 N/A
 
 Item 6.  Exhibits
 
 Exhibits

Description3.1

Certificate of Amendment to the Certificate of Incorporation dated December 15, 2010 (incorporated by reference to the Form 8-K of the Company filed on December 15, 2010).10.1

Form of Common Stock Purchase Agreement dated January 18, 2011 (incorporated by reference to the Form 8-K of the Company filed on January 19, 2011).31.1

Certifications of Interim Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32

Certification of Interim Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
 
 29
 
 SIGNATURES
  Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
   VISION-SCIENCES, INC.Date: February 9, 2011
By:
/s/ Warren BielkeWarren Bielke

Interim Chief Executive Officer (Duly Authorized Officer)
  Date: February 9, 2011
By:
/s/ Katherine L. WolfKatherine L. Wolf

Chief Financial Officer and EVP, Corporate Development

(Principal Financial Officer andPrincipal Accounting Officer)