**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D. C. 20459**

 

**FORM 10-Q**

 

**QUARTERLY REPORT UNDER SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THEQUARTER ENDED September 30, 2005**

 

**COMMISSIONFILE NUMBER 0-20970**

 

**VISION-SCIENCES, INC.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | **13-3430173**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       | (IRS  Employer  Identification Number) |
|                                                             |       |                                   |
| **9  Strathmore Road, Natick, MA**                               | ** ** | **01760**                              |
| (Address of  principal executive offices)                        |       | (Zip Code)                             |

 

**(508) 650-9971**

(Registrant’s telephone number,including area code)

 

**None**

(Former name, former address,and

former fiscal year if changedsince last report)

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirement for the past 90 days.

 

Yes  ý         No  o

 

Indicate by check mark whether the registrant isan accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o         No  ý

 

Indicate by check mark whether the registrant isa shell company (as defined by Rule 12b-2 of the Exchange Act).

 

Yes  o         No  ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of October 31, 2005.

 
| **Common  Stock, par value of $.01** | ** ** | **35,129,377**      |
|--------------------------------------|------------|---------------------|
| (Title of  Class)                    |       | (Number of  Shares) |

 

 

----

 

**VISION-SCIENCES,INC.**

**TABLE OFCONTENTS**

 
| 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 4.               | Submission of Matters to a Vote of  Stockholders                                            |   |
|          |                  |                                                                                        |   |
|          | Item 6.               | Exhibits                                                                                    |   |
|          |                  |                                                                                        |   |
|          | Signatures            |                                                                                        |
|          |                  |                                                                                        |   |
|          | Exhibits              |                                                                                        |

 

2

----

 

**PART I - FINANCIAL INFORMATION**

 

**Item 1: FINANCIAL STATEMENTS**

 

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

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
|                                                                                                                                                                                           |   | **September 30,  2005** |       | **March 31,  2005** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|--------------------------|--------|
| ASSETS                                                                                                                                                                                         |   |                         |       |                     |   |
| Current  Assets:                                                                                                                                                                               |   |                         |       |                     |   |
| Cash and  cash equivalents                                                                                                                                                                     |   | $                            | 7,724,411  |                     | $      | 9,868,586 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $136,209 and $70,097,  respectively                                                                                            |   | 1,336,125                    |       | 1,662,486                |   |
| Inventories                                                                                                                                                                                    |   | 2,573,651                    |       | 1,876,824                |   |
| Prepaid  expenses and deposits                                                                                                                                                                 |   | 51,607                       |       | 61,964                   |   |
| Total  current assets                                                                                                                                                                          |   | 11,685,794                   |       | 13,469,860               |   |
|                                                                                                                                                                                           |   |                         |       |                     |   |
| Property and  Equipment, at cost:                                                                                                                                                              |   |                         |       |                     |   |
| Machinery  and equipment                                                                                                                                                                       |   | 4,620,351                    |       | 4,427,047                |   |
| Furniture  and fixtures                                                                                                                                                                        |   | 242,735                      |       | 242,406                  |   |
| Leasehold  improvements                                                                                                                                                                        |   | 579,032                      |       | 573,780                  |   |
|                                                                                                                                                                                           |   | 5,442,118                    |       | 5,243,233                |   |
| Less-Accumulated  depreciation and amortization                                                                                                                                                |   | 4,242,993                    |       | 4,040,060                |   |
|                                                                                                                                                                                           |   | 1,199,125                    |       | 1,203,173                |   |
|                                                                                                                                                                                           |   |                         |       |                     |   |
| Other  assets, net of accumulated amortization of $56,955 and $53,815, respectively                                                                                                            |   | 71,676                       |       | 74,816                   |   |
| Total assets                                                                                                                                                                                   |   | $                            | 12,956,595 |                     | $      | 14,747,849 |   |
|                                                                                                                                                                                           |   |                         |       |                     |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                     |   |                         |       |                     |   |
| Current  Liabilities:                                                                                                                                                                          |   |                         |       |                     |   |
| Current  portion of note payable                                                                                                                                                               |   | $                            | 25,406     |                     | $      | 24,431 |   |
| Accounts  payable                                                                                                                                                                              |   | 695,706                      |       | 637,408                  |   |
| Accrued  expenses                                                                                                                                                                              |   | 1,010,211                    |       | 1,213,577                |   |
| Total  current liabilities                                                                                                                                                                     |   | 1,731,323                    |       | 1,875,416                |   |
|                                                                                                                                                                                           |   |                         |       |                     |   |
| Long-term  portion of note payable                                                                                                                                                             |   | 17,903                       |       | 31,089                   |   |
|                                                                                                                                                                                           |   |                         |       |                     |   |
| Stockholders’  Equity:                                                                                                                                                                    |   |                         |       |                     |   |
| Common  stock, $.01 par value—  Authorized—50,000,000 shares  Issued and outstanding—35,108,401 shares at September 30, 2005 and  34,998,877 shares at March 31, 2005 |   | 351,083                      |       | 349,988                  |   |
| Additional  paid-in capital                                                                                                                                                                    |   | 75,262,121                   |       | 74,987,548               |   |
| Accumulated  deficit                                                                                                                                                                           |   | (64,405,835                  | )          | (62,496,192              | )      |
| Total  stockholders’ equity                                                                                                                                                               |   | 11,207,369                   |       | 12,841,344               |   |
| Total  liabilities and stockholders’ equity                                                                                                                                               |   | $                            | 12,956,595 |                     | $      | 14,747,849 |   |

 

See accompanying notes toconsolidated financial statements.

 

3

----

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                            | ** ** | ** **                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                             |       | $                                          | 2,301,552  |                                     | $          | 2,031,438 |   | $ | 4,834,510 |   | $ | 4,808,219 |   |
| Cost of  sales                                                        |       | 1,807,204                                  |       | 1,780,599                                |       | 3,730,022 |   | 3,474,815 |   |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Gross profit                                                          |       | 494,348                                    |       | 250,839                                  |       | 1,104,488 |   | 1,333,404 |   |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Selling,  general and administrative expenses (1)                     |       | 1,119,817                                  |       | 844,622                                  |       | 2,065,186 |   | 1,841,057 |   |
| Research and  development expenses (1)                                |       | 442,375                                    |       | 308,548                                  |       | 939,439 |   | 648,743 |   |
| Stock-based  compensation                                             |       | 49,684                                     |       | 33,526                                   |       | 99,369 |   | 67,052 |   |
| Loss from  operations                                                 |       | (1,117,528                                 | )          | (935,857                                 | )          | (1,999,506 | ) | (1,223,448 | ) |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Interest  income                                                      |       | 41,093                                     |       | 7,389                                    |       | 86,880 |   | 16,074 |   |
| Interest  expense                                                     |       | (851                                       | )          | (1,298                                   | )          | (1,817 | ) | (2,701 | ) |
| Other  income, net                                                    |       | (1,260                                     | )          | —                                   |       | 4,800 |   | 3,659 |   |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Net loss                                                              |       | $                                          | (1,078,546 | )                                        | $          | (929,766 | ) | $ | (1,909,643 | ) | $ | (1,206,416 | ) |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Basic and  diluted net loss per common share                          |       | $                                          | (0.03      | )                                        | $          | (0.03 | ) | $ | (0.05 | ) | $ | (0.04 | ) |
|                                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Shares used  in computing basic and diluted net loss per common share |       | 35,092,438                                 |       | 30,925,047                               |       | 35,070,300 |   | 30,880,365 |   |

 

----

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

 
| Research and  development expenses            |   | $      | 109    |   | $      | 109    |   | $      | 219    |   | $ | 219    |   |
|-----------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|
| Selling,  general and administrative expenses |   | 49,575 |   | 33,417 |   | 99,150 |   | 66,833 |   |
| Total                                         |   | $      | 49,684 |   | $      | 33,526 |   | $      | 99,369 |   | $ | 67,052 |   |

 

See accompanying notes toconsolidated financial statements.

 

4

----

 

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

**CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

**andCOMPREHENSIVE LOSS**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Common Stock**      | ** ** | ** **          | ** ** | ** **                      | ** ** | **Total**                | ** ** | **Total**                      | ** **  |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|---------------------------------|------------|--------------------------|------------|--------------------------------|-------------|
| ** **                                                                  | ** ** | **Number  of Shares** | ** ** | **$.01  Par Value** | ** ** | **Additional  Paid-in-Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** **  | **Comprehensive  Loss** | ** ** |
|                                                                        |       |                  |       |                |       |                            |       |                     |       |                           |        |   |   |
| Balance, March 31,  2005                                               |       | 34,998,877            |       | $                   | 349,988    |                            | $          | 74,987,548               |       | $                              | (62,496,192 | ) | $ | 12,841,344 |   |   |   |
| Exercise of  stock options, net                                             |       | 109,524               |       | 1,095               |       | 119,335                         |       | —                   |       | 120,430                        |        |   |   |
| Receipt of  subscription receivable for shares sold February 2005, net |       |                  |       |                |       | 55,869                          |       |                     |       | 55,869                         |        |   |   |
| Compensation  expense related to non-employee non-qualified stock options   |       |                  |       |                |       | 92,775                          |       | —                   |       | 92,775                         |        |   |   |
| Compensation  expense related to employee non-qualified stock options       |       |                  |       |                |       | 6,594                           |       |                     |       | 6,594                          |        |   |   |
| Net loss                                                                    |       | —                |       | —              |       | —                          |       | (1,909,643               | )          | (1,909,643                     | )           | $ | (1,909,643 | ) |
|                                                                        |       |                  |       |                |       |                            |       |                     |       |                           |        |   |   |   |
| Total  comprehensive loss                                                   |       |                  |       |                |       |                            |       |                     |       |                           |        | $ | (1,909,643 | ) |
|                                                                        |       |                  |       |                |       |                            |       |                     |       |                           |        |   |   |   |
| Balance September 30,  2005                                            |       | 35,108,401            |       | $                   | 351,083    |                            | $          | 75,262,121               |       | $                              | (64,405,835 | ) | $ | 11,207,369 |   |   |   |

 

See accompanying notes toconsolidated financial statements.

 

5

----

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                          |   | **Six Months Ended  September 30, 2005** | ** ** | **Six Months Ended  September 30, 2004** |   |
|-------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|-----------------------------------------------|--------|
| Cash flows  from operating activities:                                        |   |                                          |       |                                          |   |
| Net loss                                                                      |   | $                                             | (1,909,643 | )                                             | $      | (1,206,416 | ) |
| Adjustments  to reconcile net loss to net cash used for operating activities: |   |                                          |       |                                          |   |
| Depreciation  and amortization                                                |   | 206,073                                       |       | 124,349                                       |   |
| Stock  compensation for non-qualified options                                 |   | 99,369                                        |       | 67,052                                        |   |
| Changes in  assets and liabilities:                                           |   |                                          |       |                                          |   |
| Accounts  receivable                                                          |   | 326,361                                       |       | 638,710                                       |   |
| Inventories                                                                   |   | (696,827                                      | )          | (403,219                                      | )      |
| Prepaid  expenses and deposits                                                |   | 10,357                                        |       | (550                                          | )      |
| Accounts  payable                                                             |   | 58,298                                        |       | 15,250                                        |   |
| Accrued  expenses                                                             |   | (203,366                                      | )          | (117,781                                      | )      |
|                                                                          |   |                                          |       |                                          |   |
| Net cash  used for operating activities                                       |   | (2,109,378                                    | )          | (882,605                                      | )      |
|                                                                          |   |                                          |       |                                          |   |
| Cash flows  used for investing activities                                     |   |                                          |       |                                          |   |
| Purchase of  property and equipment, net                                      |   | (198,885                                      | )          | (398,961                                      | )      |
| Increase in  other assets                                                     |   | —                                        |       | (14,437                                       | )      |
|                                                                          |   |                                          |       |                                          |   |
| Net cash  used for investing activities                                       |   | (198,885                                      | )          | (413,398                                      | )      |
|                                                                          |   |                                          |       |                                          |   |
| Cash flows  provided by (used for) financing activities:                      |   |                                          |       |                                          |   |
| Payments on  note payable for computer equipment                              |   | (12,211                                       | )          | (8,532                                        | )      |
| Proceeds  from acceptances payable to a bank                                  |   | —                                        |       | 4,378                                         |   |
| Proceeds  from the sale of common stock, net                                  |   | 55,869                                        |       | —                                        |   |
| Exercise of  stock options, net                                               |   | 120,430                                       |       | 302,262                                       |   |
| Net cash  provided by financing activities                                    |   | 164,088                                       |       | 298,108                                       |   |
|                                                                          |   |                                          |       |                                          |   |
| Net decrease  in cash and cash equivalents                                    |   | (2,144,175                                    | )          | (997,895                                      | )      |
| Cash and  cash equivalents, beginning of period                               |   | 9,868,586                                     |       | 2,714,941                                     |   |
| Cash and  cash equivalents, end of period                                     |   | $                                             | 7,724,411  |                                          | $      | 1,717,046 |   |
|                                                                          |   |                                          |       |                                          |   |
| Supplemental  Disclosure of Cash Flow Information:                            |   |                                          |       |                                          |   |
| Cash paid  during the period for interest                                     |   | $                                             | 1,817      |                                          | $      | 2,701 |   |
|                                                                          |   |                                          |       |                                          |   |
| Supplemental  Disclosure of Non-cash Items from Financing Activities:         |   |                                          |       |                                          |   |
|                                                                          |   |                                          |       |                                          |   |
| Fair market  value of non-qualified options granted in the period             |   | $                                             | —     |                                          | $      | 241,832 |   |

 

See accompanying notes toconsolidated financial statements.

 

6

----

 

**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. andsubsidiaries (the “Company”) in accordance with accounting principles generallyaccepted in the United States of America, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission and include, in theopinion of management, 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 statementsshould be read in conjunction with the audited consolidated financialstatements and notes thereto included in the Company’s latest annual report to stockholders.  The results for the interim periods presentedare not necessarily indicative of results to be expected for the full fiscalyear.

 

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

 

Theaccompanying consolidated financial statements reflect the application ofcertain accounting policies described below:

 

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

 

b**.****                                     ***Cash Equivalents*: Cash equivalents consist of a money marketaccount at a bank, and investments in commercial paper.  Cash equivalents are short-term highly liquidinvestments with original maturities of less than three months, and are carriedat amortized cost, which approximates market value*.*

 

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

 
|            |   | **September 30,  2005** |      | **March 31,  2005** |   |
|-----------------|--------|------------------------------|-----------|--------------------------|--------|
|            |   |                         |      | **(audited)**            |   |
| Raw  materials  |   | $                            | 1,636,300 |                     | $      | 1,166,946 |   |
| Work-in-process |   | 287,723                      |      | 253,449                  |   |
| Finished  goods |   | 649,628                      |      | 456,429                  |   |
|            |   | $                            | 2,573,651 |                     | $      | 1,876,824 |   |

 

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

 

7

----

 

d.                                      *Depreciation and Amortization*: The Company provides fordepreciation and amortization using the straight-line method in amounts thatallocate the cost of the assets to operations over their estimated useful livesas follows:

 
| **Asset Classification** | ** ** | **Estimated  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 Per Common 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.                                         *Revenue Recognition*: The following must occur before theCompany recognizes revenue: (1) persuasive evidence of an arrangementexists, (2) delivery has occurred or services have been rendered, (3) theprice is fixed or determinable, (4) collectibility is reasonably assuredand (5) the fair value of undelivered elements, if any, exists.  To date the Company has not entered into anymultiple element arrangements.  The Companyrecognizes revenue when title passes to the customer, generally upon shipmentof products F.O.B. shipping point.  SinceSeptember 2003, the Company’s medical segment has distributed all of itsproducts for the Ear-Nose-Throat (“ENT”) market in the U.S.A. and Canadathrough an agreement (the “Medtronic Agreement”) with Medtronic Xomed, Inc.(“Medtronic Xomed”).  The initial term ofthe Medtronic Agreement was three years, renewable thereafter annually, unlessterminated by either party.

 

During the fiscal year ended March 31, 2005 (“FY05”), the Company and Medtronic Xomed modified the Medtronic Agreement toprovide for a rebate to Medtronic Xomed for sales of ENT EndoSheaths to newcustomers who commit to large purchases. The rebate program was designed to run for one year to September 30,2005.  The Company accounts for thismodification under Emerging Issues Task Force (“EITF”) 01-9, *Accounting for Consideration Given by a Vendor to a Customer (Includinga Reseller of the Vendor’s Products)*.  As of September 30, 2005, the Companyhas provided for rebates of approximately $62,000.  The Company expects to terminate the rebateprogram in the three months ending December 31, 2005.

 

8

----

 

Since December 2004, the Company’s medicalsegment has distributed all of its products for the urology market in theU.S.A. and Canada through an agreement (the “MGU Agreement”) with Medtronic USA, Inc.(“MGU”).  The term of the MGU Agreementis through March 31, 2006, renewable for successive one-year periodsunless either party notifies the other party in writing at least 90 days priorto the end of any term that it does not want to renew.

 

Neither the Medtronic Agreement nor the MGU Agreementprovide for any contingencies, nor provide any terms related to productacceptance or warranty that are different from the normal terms provided by theCompany to its other customers.

 

g.                                      *Foreign Currency Transactions*: In accordance with Statementof Financial Accounting Standard (“SFAS”) No. 52, *ForeignCurrency Translation,* the Company charges foreign currency exchangegains or losses, in connection with its purchases of products from vendors inJapan, to operations, and charges foreign exchange translation gains and lossesto retained earnings.

 

h.                                      *Income Taxes*: The Company accounts for income taxes underthe liability method in accordance with SFAS No. 109, *Accountingfor Income Taxes*.  Under SFAS No. 109,deferred tax assets or liabilities are computed based upon the differencesbetween the financial statement and income tax bases of assets and liabilitiesas 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                                             *Accounting for Options Issued to Non-employees: *During the fiscal year ended March 31,2005, the Company granted options to purchase 150,000 shares of the Company’sCommon Stock to non-employees.  The fairvalue of these options measured at the option grant dates was approximately$371,000, determined using the Black-Scholes option-pricing model, and is beingrecorded as an expense over the vesting period. The assumptions used in the Black-Scholes option-pricing model by theCompany were as follows:

 
| Risk-free interest rate                 |   | .93% - 1.36% |
|-----------------------------------------|--------|--------------|
|                                    |   |         |
| Expected dividend yield                 |   | —       |
|                                    |   |         |
| Expected lives                          |   | 5 years      |
|                                    |   |         |
| Expected volatility                     |   | 79% - 83%    |
|                                    |   |         |
| Weighted average value grants per share |   | $3.81        |

 

9

----

 

Duringthe three months ended September 30, 2005 and 2004, the Company recognized$46,387 and $30,229, respectively, of expense related to such options.  During the six months ended September 30,2005 and 2004, the Company recognized $92,775 and $60,458, respectively, of expenserelated to such options.

 

j.                                          *Employee Stock-based Compensation Arrangements:*The Companyaccounts for its stock-based compensation arrangements for employees andindependent directors using the intrinsic value method under the provisions ofAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and Financial Interpretation No. (“FIN”)44.  The Company does not recognizestock-based compensation cost when the options granted have an exercise priceequal to, or greater than, the market value of the underlying common stock onthe date of the grant.  The Company doesrecognize stock-based employee compensation cost when the options granted havean exercise price less than the market value of the underlying common stock onthe date of the grant.

 

InJune 2003, the Company granted options to purchase 1,295,000 shares ofcommon stock to its employees at an exercise price of $1.04 per share.  The fair market value of the common stock onthe date of grant was $1.09 per share. As a result, the Company has recognized compensation expense for thedifference between the fair market value and the option price over the life ofthe options.  In each of the three monthsand six months ended September 30, 2005, and 2004, the Company recognized$3,297 and $6,594, respectively, of expense related to these options asstock-based compensation in the consolidated statements of operations.

 

Inthe three months ended September 30, 2005, the Company grantednon-qualified options to purchase 4,000 shares of the Company’s Common Stock toeach of three of its independent directors, as provided for in the Company’s2003 Director Option Plan.  The optionswere granted at exercise prices equal to the fair market value of theunderlying common stock on the dates of grant.

 

10

----

 

Inaccordance with the Financial Accounting Standards Board (“FASB”) Statement No. 148,*Accounting for Stock-Based Compensation –Transition and Disclosure*, beginning in the quarter ending March 31,2003, the Company adopted the disclosure requirements of FASB No. 148.  Had compensation expense for all stock optiongrants to employees and independent directors been determined under the fairvalue method at the grant dates, consistent with the method prescribed by SFAS No. 123,the Company’s net loss would have been increased to the pro forma amountsindicated as follows:

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss –  as reported                          |       | $                                          | (1,078,546 | )                                        | $          | (929,766 | ) | $ | (1,909,643 | ) | $ | (1,206,416 | ) |
| Stock-based  employee compensation – as reported |       | 3,297                                      |       | 3,297                                    |       | 6,594 |   | 6,594 |   |
| Pro forma  stock-based employee compensation          |       | (146,493                                   | )          | (103,500                                 | )          | (265,662 | ) | (198,000 | ) |
| Net loss -  pro forma                                 |       | $                                          | (1,221,742 | )                                        | $          | (1,029,969 | ) | $ | (2,168,711 | ) | $ | (1,397,822 | ) |
|                                                  |       |                                       |       |                                     |       |   |   |   |   |
| Net loss per  share – as reported                |       | $                                          | (.03       | )                                        | $          | (.03 | ) | $ | (0.05 | ) | $ | (0.04 | ) |
| Stock-based  employee compensation – as reported |       | —                                     |       | —                                   |       | — |   | — |   |
| Pro forma  stock-based employee compensation          |       | —                                     |       | —                                   |       | (0.01 | ) | (0.01 | ) |
| Net loss per  share - pro forma                       |       | $                                          | (.03       | )                                        | $          | (.03 | ) | $ | (0.06 | ) | $ | (0.05 | ) |

 

k.                                       *New Accounting Standards:* In November 2004,the FASB issued SFAS No. 151, *Inventory Costs*,an amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, *Inventory Pricing*, to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs and spoilage.  This statement requires that those items berecognized as current period charges regardless of whether they meet thecriterion of “so abnormal” which was the criterion specified in ARB No. 43.  In addition, this Statement requires thatallocation of fixed production overheads to the cost of production be based onnormal capacity of the production facilities. This pronouncement is effective for fiscal years beginning after June 15,2005.  The Company has not yet assessedthe impact of adopting this new standard.

 

11

----

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment*.  SFAS 123R is a revision of SFAS No. 123,*Accounting for Stock-Based Compensation*and supersedes APB No. 25, *Accounting for StockIssued to Employees*, and its related implementation guidance.  SFAS 123R requires all share-based paymentsto employees, including grants of employee stock options, to be recognized inthe financial statements based on their fair values.  The pro forma disclosures previously permittedunder SFAS 123 no longer will be an alternative to financial statementrecognition.  The Company is required toadopt SFAS 123R in the first quarter of the fiscal year ending March 31,2007, beginning April 1, 2006. Under SFAS 123R, the Company must determine the appropriate fair valuemodel to be used for valuing share-based payments, the amortization method forcompensation costs and the transition method to be used at date of adoption.The transition methods include prospective and retrospective adoption options.

 

Under the retroactive option, prior periodsmay be restated either as of the beginning of the year of adoption or for allperiods presented.  The prospectivemethod requires that compensation expense be recorded for all unvested stockoptions and restricted stock at the beginning of the first quarter of adoptionof SFAS 123R, while the retroactive method would record compensation expensefor all unvested stock options and restricted stock beginning with the firstperiod restated.  The Company isevaluating the requirements of SFAS 123R and expects that the adoption of SFAS123R may have a material impact on its consolidated results of operations andearnings per share.  The Company has notyet determined the method of adoption or the effect of adopting SFAS 123R, andit has not determined whether the adoption will result in amounts that aresimilar to the current pro forma disclosures under SFAS 123.

 

12

----

 

**3.****                                     ****3BY Ltd.**

 

In June 2003, the Company entered into aContract Manufacturing Agreement, a Loan Agreement and a Pledge Agreement(collectively, the “3BY Agreements”) with Three BY Ltd., an Israeli company (“3BY”).  The 3BY Agreements provided for, among otherthings, the manufacture of certain of the Company’s products by 3BY, and a loanof up to $267,500 by the Company to 3BY for the purchase and installation ofcertain manufacturing equipment by 3BY, at 3BY’s facility, to be used tomanufacture certain of the Company’s products. 3BY completed the purchase and installation of the manufacturingequipment, and the Company began receiving commercial production from 3BY inthe three months ending September 30, 2004.  On October 1, 2004, according to termsin the Loan Agreement, 3BY and the Company agreed that the Company would taketitle to the manufacturing equipment, in lieu of 3BY retaining title and payingback the advance.

 

In May 2005, the Company decided to bringthe manufacturing of these products back to its Natick, MA plant, due to theinability to exert sufficient control over the manufacturing processes to havethe confidence level necessary for its product quality.  In addition, the costs savings anticipatedhave not been attained.  On October 2,2005, the Company and 3BY entered into a Termination and Settlement Agreement(the “Termination Agreement”) pursuant to which the Company and 3BY terminatedthe 3BY Agreements.  Included in theTermination Agreement is a provision for the Company to purchase from 3BY180,000 units of the Company’s basic ENT Slide-On EndoSheath at a price thatrepresents an increase of approximately $62,000 in total, compared to the pricepaid prior to termination.  The Companyexpects this purchase order will be completed over six to nine months.  In addition, the Company will pay 3BY $16,700for costs related to equipment purchased by 3BY.  After completion of the purchase order, theequipment owned by the Company located at 3BY will be returned to the Company’sNatick, MA plant.  To date, the Companydoes not believe these assets are impaired based upon their intended use.  However, depending upon the demand for theCompany’s products that utilize this equipment, and the Company’s ability toreconfigure the equipment to manufacture other products, the Company may incura charge for impairment in the future related to this equipment which is valuedat approximately $330,000 at September 30, 2005.

 

13

----

 

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

 

The Company has three reportable segments –medical, industrial and corporate.  Themedical segment designs, manufactures and sells EndoSheaths and sellsendoscopes to users in the health care industry.  The industrial segment designs, manufacturesand sells borescopes to a variety of users, primarily in the aircraft enginemanufacturing and aircraft engine maintenance industries.  In addition, the industrial segmentmanufactures and repairs endoscopes for the medical segment.  The corporate segment consists of certainadministrative expenses applicable to the Company as a whole.

 

All segments follow the accounting policiesdescribed in the summary of significant accounting policies.  The Company evaluates segment performancebased upon operating income.  Identifiableassets are those used directly in the operations of each segment.  Corporate assets include cash, marketablesecurities and the assets of Vision-Sciences, Ltd.  Data regarding management’s view of theCompany’s segments are provided in the following tables.

 

14

----

 
| **Three months ended September 30,** | ** ** | **Medical** | ** ** | **Industrial** | ** ** | **Corporate** | ** ** | **Adjustments** | ** ** | **Total**  | ** ** |
|-------------------------------------------|------------|-------------|------------|----------------|------------|---------------|------------|-----------------|------------|------------|------------|
| **2005**                                  |       |        |       |           |       |          |       |            |       |       |       |
| Sales to  external customers              |       | $           | 1,706,980  |           | $          | 594,572       |       | $               | —     |       | $          | – |   | $ | 2,301,552 |   |
| Intersegment  sales                       |       | —      |       | 587,102        |       | —        |       | (587,102        | )          | —     |       |
| Operating  income (loss)                  |       | (735,852    | )          | (13,474        | )          | (368,202      | )          | —          |       | (1,117,528 | )          |
| Interest  income (expense), net           |       | —      |       | —         |       | 40,242        |       | —          |       | 40,242     |       |
| Depreciation  and amortization            |       | 92,960      |       | 8,862          |       | —        |       | —          |       | 101,822    |       |
| Other  significant non-cash items:        |       |        |       |           |       |          |       |            |       |       |       |
| Stock-based  compensation                 |       | 46,575      |       | 62             |       | 3,047         |       | —          |       | 49,684     |       |
| Expenditures  for fixed assets            |       | 80,789      |       | 8,044          |       | —        |       | —          |       | 88,833     |       |
|                                      |       |        |       |           |       |          |       |            |       |       |       |
| **2004**                                  |       |        |       |           |       |          |       |            |       |       |       |
| Sales to  external customers              |       | $           | 1,130,315  |           | $          | 901,123       |       | $               | —     |       | $          | – |   | $ | 2,031,438 |   |
| Intersegment  sales                       |       | —      |       | 330,253        |       | —        |       | (330,253        | )          | —     |       |
| Operating  income (loss)                  |       | (615,701    | )          | (51,737        | )          | (268,419      | )          | —          |       | (935,857   | )          |
| Interest  income (expense), net           |       | —      |       | —         |       | 6,091         |       | —          |       | 6,091      |       |
| Depreciation  and amortization            |       | 54,386      |       | 11,596         |       | 1,506         |       | —          |       | 67,488     |       |
| Other  significant non-cash items:        |       |        |       |           |       |          |       |            |       |       |       |
| Stock-based  compensation                 |       | 30,416      |       | 63             |       | 3,047         |       | —          |       | 33,526     |       |
| Expenditures  for fixed assets            |       | 227,078     |       | 17,491         |       | —        |       | —          |       | 244,569    |       |

 
| **Six months ended September 30,** | ** ** | **Medical** | ** ** | **Industrial** | ** ** | **Corporate** | ** ** | **Adjustments** | ** ** | **Total**  | ** ** |
|-----------------------------------------|------------|-------------|------------|----------------|------------|---------------|------------|-----------------|------------|------------|------------|
| **2005**                                |       |        |       |           |       |          |       |            |       |       |       |
| Sales to  external customers            |       | $           | 3,616,309  |           | $          | 1,218,201     |       | $               | —     |       | $          | – |   | $ | 4,834,510 |   |
| Intersegment  sales                     |       | —      |       | 1,415,893      |       | —        |       | (1,415,893      | )          | —     |       |
| Operating  income (loss)                |       | (1,348,375  | )          | (27,516        | )          | (623,615      | )          | —          |       | (1,999,506 | )          |
| Interest  income (expense), net         |       | —      |       | —         |       | 85,063        |       | —          |       | 85,063     |       |
| Depreciation  and amortization          |       | 182,403     |       | 23,670         |       | —        |       | —          |       | 206,073    |       |
| Other  significant non-cash items:      |       |        |       |           |       |          |       |            |       |       |       |
| Stock-based  compensation               |       | 93,150      |       | 125            |       | 6,094         |       | —          |       | 99,369     |       |
| Expenditures  for fixed assets          |       | 183,015     |       | 15,870         |       | —        |       | —          |       | 198,885    |       |
| Total assets                            |       | 3,741,647   |       | 1,842,183      |       | 7,810,366     |       | (437,601        | )          | 12,956,595 |       |
|                                    |       |        |       |           |       |          |       |            |       |       |       |
| **2004**                                |       |        |       |           |       |          |       |            |       |       |       |
| Sales to  external customers            |       | $           | 3,107,645  |           | $          | 1,700,574     |       | $               | —     |       | $          | – |   | $ | 4,808,219 |   |
| Intersegment  sales                     |       | —      |       | 977,214        |       | —        |       | (977,214        | )          | —     |       |
| Operating  income (loss)                |       | (605,442    | )          | (31,443        | )          | (586,563      | )          | —          |       | (1,223,448 | )          |
| Interest  income (expense), net         |       | —      |       | —         |       | 13,373        |       | —          |       | 13,373     |       |
| Depreciation  and amortization          |       | 98,769      |       | 22,568         |       | 3,012         |       | —          |       | 124,349    |       |
| Other  significant non-cash items:      |       |        |       |           |       |          |       |            |       |       |       |
| Stock-based  compensation               |       | 60,832      |       | 126            |       | 6,094         |       | —          |       | 67,052     |       |
| Expenditures  for fixed assets          |       | 376,811     |       | 22,150         |       | —        |       | —          |       | 398,961    |       |
| Total assets                            |       | 2,664,864   |       | 1,594,733      |       | 1,806,008     |       | (280,818        | )          | 5,784,787  |       |

 

15

----

 

## **Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

## **FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**ExecutiveSummary**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statements withinthe meaning of The Private Securities Litigation Reform Act of 1995.  Examples of forward-looking statementsinclude statements about expectations about future financial results, futureproducts and future sales of new and existing products, future expenditures,and capital resources to meet anticipated requirements.  Without limiting the foregoing, the words “believes”,“anticipates”, “plans”, “expects”, and similar expressions are intended toidentify forward-looking statements. These forward-looking statements involve risks and uncertainties, and ouractual results may differ significantly from those discussed in theforward-looking statements. Factors that might cause such a difference include,but are not limited to, the availability of capital resources, the availabilityof third-party reimbursement, government regulation, the availability ofsupplies, competition, technological difficulties, the continuation of ourcontracts with Medtronic Xomed and MGU, general economic conditions and otherrisks detailed in our most recent Annual Report on Form 10-K and anysubsequent periodic filings made with the Securities and ExchangeCommission.  We do not undertake anobligation to update our forward-looking statements to reflect future events orcircumstances.

 

We develop, manufacture and sell flexible endoscope products for themedical device and industrial device markets. We operate in three reporting segments, medical, industrial andcorporate.

 

#### *Medical Segment*

#### * *

The medical segment supplies flexible endoscopes and disposableSlide-OnTM EndoSheath® Systems (“EndoSheaths”) to the ENT, gastrointestinal (“GI”),urology and pulmonary markets. Health-care providers use EndoSheaths to cover the insertion tube offlexible endoscopes, such as ENT endoscopes, Trans-Nasal Esophagoscopes (“TNE”),sigmoidoscopes, cystoscopes and bronchoscopes. We have designed the EndoSheaths to allow the health-care providers toprocess patients economically by permitting the providers to minimizereprocessing the endoscopes between procedures. In addition, the EndoSheaths ensure a sterile insertion tube for eachpatient procedure.

 

Our strategy in the medical segment is comprised of three components:a) improve sales distribution, b) lower manufacturing costs and c) increase thenumber of new product offerings.

 

#### *SalesDistribution*

 

SinceSeptember 19, 2003, we have been distributing all of our products for theENT market in the U.S.A. and Canada through Medtronic Xomed as part of theMedtronic Agreement. The initial term of the Medtronic Agreement is threeyears.  Thereafter, the MedtronicAgreement is automatically renewed for successive one-year periods, unlessterminated by either party upon advance written notice.  Under the Medtronic Agreement, we havegranted Medtronic Xomed exclusive distribution rights in the U.S.A. and Canadato market and sell our ENT and TNE EndoSheaths and endoscopes to ENTpractitioners.  Medtronic Xomed fulfilledcertain minimum purchase requirements for the initial twelve-month period ofthe term.  The Medtronic Agreementresulted in an increase in sales of our ENT EndoSheaths and ENT endoscopes dueto the quantities of endoscopes and EndoSheaths purchased by Medtronic Xomed inthe initial twelve-month period.  In thesecond year (“Year 2”) of the Medtronic Agreement, Medtronic

 

16

----

 

purchasedfewer units of ENT endoscopes and ENT EndoSheaths than in the initial period,due to the build up of inventory that resulted from the purchases in theinitial period.  During Year 2, we andMedtronic Xomed began a rebate program, whereby we agreed to pay Medtronic acash rebate for ENT EndoSheaths they sold to new users who committed to a largeannual purchase. As of September 30, 2005, we recorded a reserve ofapproximately $62,000 for the rebate program. As of September 30, 2005, Medtronic Xomed had reduced their excessinventory, and had ordered ENT EndoSheaths at an annual rate of over 150,000units.  We expect we will terminate therebate program during the three months ending December 31, 2005.

 

Inaddition, in December 2004, we signed the MGU Agreement with MGU, thegastro-urology division of Medtronic, Inc., granting MGU exclusive rightsto distribute our new cystoscope with Slide-On EndoSheath System to urologistsin the U.S.A. and Canada.  The term ofthe MGU Agreement is through March 31, 2006, renewable for successiveone-year periods unless either party notifies the other party in writing atleast 90 days prior to the end of any term that it does not want to renew.  The total purchase commitment for cystoscopesand Slide-On EndoSheaths is $1,965,000, of which $353,500 was to be deliveredin the fiscal year ended March 31, 2005 (“FY 05”), and the remainder inthe fiscal year ending March 31, 2006 (“FY 06”).  There can be no assurance that MGU willpurchase the total commitment by March 31, 2006.

 

Webelieve the marketing and sales capabilities of Medtronic Xomed and MGU havefacilitated and will continue to facilitate the introduction of new products tothe ENT and urology markets by allowing quicker market acceptance of theseproducts than if we marketed them ourselves. As a result of these agreements, the success of our ENT and urologyproduct lines is substantially dependent upon the success of the marketing andsales activities of Medtronic Xomed and MGU, over which we have limited control.  We have retained our domestic network ofindependent sales representatives for the GI and pulmonary product lines.  Also, we have retained our own internationalnetwork of distributors for all our medical product lines.

 

#### *CostReduction*

 

DuringFY 06, we plan to implement reductions in the cost of materials and laboracross our endoscope and EndoSheath product lines by examining and updating ourmaterial costs and labor processes.  Inaddition, we are working on a development project for a new low-cost EndoSheaththat we expect will result in a new EndoSheath design and machinery that willautomate many of the processes performed in the manufacture ofEndoSheaths.  Our plan is to have thisdevelopment project result in new machinery that we expect will be in placeduring the second half of the fiscal year ending March 31, 2007 (“FY 07”).

 

17

----

 

#### *NewProducts*

#### * *

InMay 2005, we received clearance from the FDA to market our new ENT-3000portable endoscope with battery-powered LED light source.  During FY 06, our product development plansinclude a feasibility model of a new Trans-Esophageal Echo based cardioversionproduct to treat atrial fibrillation, and a thoracic surgery flexible endoscopewith three-dimensional imaging.  We alsoare continuing our design efforts for a new low-cost EndoSheath concept,described in *Cost Reduction* above.  In addition, we are designing a new family ofsmaller sized “D-shaped” proprietary endoscopes for use with our EndoSheathsthat incorporate channels, and a new family of videoscopes with a distal tipCCD based camera.  We also plan toinvestigate other potential products for the gastrointestinal and bariatricsurgery markets.

 

#### *Industrial Segment*

#### * *

The industrial segment designs, manufactures and sells flexibleendoscopes, termed borescopes, for industrial users, and manufactures andrepairs flexible endoscopes for the medical segment.  The industrial segment users consistprimarily of companies in the aircraft engine manufacturing and maintenancemarkets and the defense market.

 

#### *Corporate Segment*

#### * *

The corporate segment consists of certain administrative and businessdevelopment activities applicable to the Company as a whole.

 

18

----

 

Critical Accounting Policies and Estimates

 

Thisdiscussion and analysis of our financial condition and results of operations isbased upon our Consolidated Financial Statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  See the Notes to theConsolidated Financial Statements included elsewhere herein.  Certain of our accounting policies requirethe application of judgment in selecting the appropriate assumptions forcalculating financial estimates.  Bytheir nature these judgments are subject to an inherent degree ofuncertainty.  We periodically evaluatethe judgments and estimates used for our critical accounting policies to ensurethat such judgments and estimates are reasonable for our interim and year-endreporting requirements.  These judgmentsand estimates are based upon our historical experience, current trends andinformation available from other sources, as appropriate.  If different conditions result from thoseassumptions used in our judgment, the results could be materially differentfrom our estimates.  Our criticalaccounting policies include the following:

 

### *Revenue Recognition*

### * *

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104,*Revenue Recognition in Financial Statements*andEITF 00-21, *Revenue Arrangements with Multiple Deliverables.*These pronouncements require that five basic criteria must be met beforerevenue can be recognized: (1) persuasive evidence that an arrangementexists; (2) delivery has occurred or services rendered; (3) the feeis fixed and determinable; (4) collectibility is reasonably assured and (5) thefair value of undelivered elements, if any, exists.  Determination of criterion (4) is basedon management’s judgment regarding the collectibility of invoices for productsand services delivered to customers. Should changes in conditions cause management to determine thesecriteria are not met for certain future transactions, revenue recognized forany reporting period could be adversely affected.

 

We account for the rebate we granted to Medtronic Xomed in accordancewith EITF 01-9, *Accounting for Consideration Given by aVendor to a Customer (Including a Reseller of the Vendor’s Products)*.  This pronouncement requires that a vendor recognizerebates as a reduction of revenue based on a systematic and rational allocationof the cost of honoring rebates earned and claimed to each of the underlyingrevenue transactions that result in progress by the customer toward earning therebate.  Accordingly, as of September 30,2004, we recognized an allowance of $39,000 for the estimated rebate that wouldaccrue to Medtronic Xomed for sales of ENT EndoSheaths that were in MedtronicXomed’s inventory at that date that would be sold to new customers under therebate program.  Subsequent to September 30,2004, we recognize revenue on sales of ENT EndoSheaths to Medtronic Xomed, netof an estimated sales allowance related to that rebate program.  Measurement of the total rebate is based onthe estimated numberof customers that will ultimately earn rebates under the offer.  Determination of the number of customers thatwill earn rebates and the amount of those rebates is based on management’sjudgment.  We review our estimates of thenumber of customers that will earn benefits under the rebate program eachfiscal quarter.  If different conditionsresult from those assumptions used in our judgment, the results could bematerially different from our estimates.

 

19

----

 

*Options Issued to Non-employees*

 

We account for non-qualified options issued to non-employees as equityinstruments, in accordance with the provisions of EITF 96-18.  Fair values for these non-qualified optionsare derived from pricing models that consider current market and contractualprices for the underlying financial instruments, as well as time value, yieldcurve and volatility factors underlying the positions.  Pricing models and their underlying assumptionsimpact the amount and timing of the value of these non-qualified options, andthe use of different pricing models or assumptions could produce differentfinancial results.  We use theBlack-Scholes option-pricing model for determining the value of non-qualifiedoptions issued to non-employees, and we expense that value over the vestingperiod of the non-qualified options.

 

We account for certain non-qualified options granted to employees andindependent members of our Board of Directors to purchase our common stock inaccordance with APB Opinion No. 25, *Accounting for**Stock Issued to Employees.* If the fair market value of the underlying stock at the date of grant isgreater than the option price, we recognize compensation expense for thedifference between the market price and the option price over the vestingperiod of the options.

 

*Income Taxes*

 

Under our income tax policy, we record the estimated future tax effectsof temporary differences between the tax bases of assets and liabilities andamounts recorded in the accompanying consolidated balance sheets, as well asoperating loss and tax credit carryforwards. The evaluation of the recoverability of any tax assets recorded on thebalance sheet is subject to significant judgment.  We have provided valuation allowances for allour deferred tax assets to date.

 

**Results of Operations**

 

Net Sales

 

*Q2 06 Compared to Q2 05*

 

Netsales for the three months ended September 30, 2005 (“Q2 06”) were$2,301,552, an increase of $270,114, or 13%, compared to the three-month periodended September 30, 2004 (“Q2 05”). During Q2 06, net sales of the medical segment increased by $576,665, or51%, to $1,706,980, and net sales of the industrial segment decreased by$306,551, or 34%, to $594,572, compared to Q2 05.  In the medical segment, the net sales andchanges in net sales by market were as follows ($000’s):

 
| **Market** | ** ** | **Q2 06** | ** ** | **Q2 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| ENT        |       | $         | 1,253      |      | $          | 906                      |       | $           | 347        |   | 38 | % |
| Urology    |       | 155       |       | 72        |       | 83                       |       | 115         | %          |
| Other      |       | 299       |       | 152       |       | 147                      |       | 97          | %          |
| Total      |       | $         | 1,707      |      | $          | 1,130                    |       | $           | 577        |   | 51 | % |

 

20

----

 

*Medical Sales – ENT Market*

 

Net sales to the ENT market include products for domestic andinternational customers as follows:

 
| **ENT Market** | ** ** | **Q2 06** | ** ** | **Q2 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Domestic       |       | $         |  638  |      | $          | 557                      |       | $           |  81   |   | 15 | % |
| International  |       | 615       |       | 349       |       | 266                      |       | 76          | %          |
| Total ENT      |       | $         | 1,253      |      | $          | 906                      |       | $           | 347        |   | 38 | % |

 

We further delineate products sold to the domestic ENT market asfollows:

 
| **ENT Products**     | ** ** | **Q2 06** | ** ** | **Q2 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Slide-On EndoSheaths |       | $         | 258        |      | $          | 266                      |       | $           | (8         | ) | (3 | )% |
| Endoscopes           |       | 380       |       | 291       |       | 89                       |       | 31          | %          |
| Total Domestic ENT   |       | $         | 638        |      | $          | 557                      |       | $           | 81         |   | 15 | % |

 

Theprimary reason for the increase in sales of products to the domestic ENT marketwas the initial shipment of our new ENT-3000 endoscope with the re-chargeablebattery-powered LED light source to Medtronic Xomed, our exclusive distributorof ENT products in the U.S. and Canada. Total sales to Medtronic Xomed in Q2 06 were $0.765 million, an increaseof approximately $0.139 million, or 22%, compared to $0.626 million in Q2 05,due primarily to the sales of ENT-3000 referred to above.  Also during Q2 06, Medtronic Xomed purchased34,830 ENT Slide-On EndoSheaths (“ENT SOS”). During Q2 06, Medtronic Xomed began re-ordering ENT SOS at an annualrate of approximately 180,000 units. From this activity and discussions with Medtronic Xomed, we believetheir excess inventory of ENT SOS has been sold, and we expect to do a finalaccounting for any rebate owed Medtronic Xomed in our fiscal quarter ending December 31,2005 (“Q3 06”).  In Q2 06, we recordedsales discounts of approximately $11,000 as part of the rebate program,resulting in cumulative reserves of approximately $62,000.

 

AlthoughMedtronic Xomed has not purchase the required number of ENT EndoSheaths tomaintain their exclusivity under the Medtronic Agreement, we have not exercisedour right to terminate their exclusivity, as we believe their sales of ourproducts will continue to improve, and we currently believe they represent thebest alternative for us to distribute our current line of ENT products anddrive product acceptance of new ENT products in the domestic market.

 

21

----

 

InFY 06, we and Medtronic Xomed plan to introduce a more attractive pricingprogram, allowing the price for all new purchases to decline in steps.  The first 150,000 units of ENT EndoSheathspurchased by Medtronic Xomed will be at the contract price; the next 100,000will be at the contract price less $1.50 per unit; units over 250,000 will beat the contract price less $2.00 per unit. The purpose of this price schedule is to allow Medtronic Xomed topenetrate the market for large institutions and sell ENT EndoSheaths to them atprices those institutions find reasonable. In addition, we and Medtronic Xomed are having discussions to establishadditional new programs that will increase the sales of our ENT and TNEproducts.

 

Asa result of the Medtronic Agreement, the success of our ENT product lines aresubstantially dependent upon the success of the marketing and sales activitiesof Medtronic Xomed over which we have limited control.

 

Unitsales of ENT EndoSheaths in Q2 06 to the domestic market were 34,830, anincrease of 1,350, or 4% compared to the 33,480 units sold in Q2 05.  The increase in unit sales was directlyrelated to the reduction of inventory that had built-up at Medtronic Xomedduring the first year of the Medtronic Agreement.  Unit sales of ENT endoscopes, which includeour ENT-2000, ENT-1000 and ENT-3000 models, in Q2 06 were 108, an increase of69, or 177%, compared to the unit sales of 39 in Q2 05.  The increase was due primarily to initialshipments of 40 units of the ENT-3000, and higher demand for the ENT-2000.

 

We further delineate products sold to the international ENT market asfollows:

 
| **ENT Products**     | ** ** | **Q2 06** | ** ** | **Q2 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Slide-On EndoSheaths |       | $         | 509        |      | $          | 237                      |       | $           | 272        |   | 115 | % |
| Endoscopes           |       | 106       |       | 112       |       | (6                       | )          | (5          | )%         |
| Total International  |       | $         | 615        |      | $          | 349                      |       | $           | 266        |   | 76 | % |

 

The increase in net sales to international distributors is primarilydue to higher unit volume of ENT SOS. Unit sales of ENT SOS to the international distributors were 79,460 inQ2 06, an increase of 43,246 units, compared to sales in Q2 05.  The increase in sales was due to higherdemand, especially in Europe, and to sales of ENT SOS to new distributors inthe Middle East.  We expect unit demandfrom international distributors to continue at this rate for the remainder ofFY 06.

 

22

----

 

Unit sales of ENT endoscopes in Q2 06 to international distributorswere 25, compared to 27 in Q2 05.  Inaddition, we sold 2 TNE Therapeutic (“TNE Bx”) endoscopes to our internationaldistributors in Europe.  We are in theearly stages of selling TNE endoscopes to our distributors, and we plan toincrease our sales of this product by increasing the number of distributors incountries where we do not have representation. However, there can be no assurance we will be able to consummate theseagreements on terms that are beneficial to us. Also, we expect sales of the TNEendoscopes will improve after we release the new smaller D-shaped fiberscopeand new videoscope in FY 07.

 

Sales of endoscopes are dependent upon a variety of factors, includingthe timing requirements of end users, foreign exchange rates, sales promotionsof international competitors and other factors.

 

*Medical Sales – Urology*

 

The increase in sales of urology products reflects primarily increasedshipments of our new Flexible Cystoscope (“CST-2000”) with Slide-On EndoSheathSystem to MGU, offset partially by lower shipments to internationaldistributors.  We sold approximately$140,000 of CST-2000 and Slide-On EndoSheaths to MGU in Q2 06, andapproximately $15,000 to international distributors.  We expect sales of the CST-2000 to MGU willbe approximately the same in the fiscal quarter ending December 31, 2005compared to sales in Q2 06, but to increase in the fiscal quarter ending March 31,2006.  This is due to the time requiredto train MGU sales personnel and to the time needed by the MGU salesrepresentatives to penetrate the urology market.  However, there can be no assurance that thesesales goals will be met.

 

We believe the CST-2000 and EndoSheath System can significantly enhancethe practice efficiency of urologists by allowing them to avoid the tedious andtime-consuming reprocessing of conventional cystoscopes, and presents thesignificant benefit of a sterile insertion tube for each patient.  In addition, the use of our CST-2000 withSlide-On EndoSheath System avoids the need to reprocess endoscopes with harshchemicals, one of which has been contraindicated for use on patients withbladder cancer.

 

*Industrial Segment*

 

The decrease in net sales of the industrial segment was due to higherdemand in the market for video borescopes, compared to our line of fiberborescopes, and lower demand for repairs of fiber borescopes.

 

*6 Months 06 Compared to 6 Months 05*

 

Net sales for the six months ended September 30, 2005 (“6M 06”)were $4,834,510, an increase of $26,291, or 0.5%, compared to net sales of$4,808,219 for the 6 months ended September 30, 2004 (“6M 05”).  In 6M 06, sales of the medical segment were$3,616,309, an increase of $508,664, or 16%, compared to net sales of$3,107,645 in 6M 05.  Also in 6 M 06,sales of the industrial segment were $1,218,201, a decrease of $482,373, or28%, compared to net sales of $1,700,574 in 6M 05.  In the medical segment, net sales and changesin net sales by market were as follows ($000’s):

 

23

----

 
| **Market** | ** ** | **6M 06** | ** ** | **6M 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| ENT        |       | $         | 2,443      |      | $          | 2,544                    |       | $           | (101       | ) | (4 | )% |
| Urology    |       | 503       |       | 95        |       | 408                      |       | 429         | %          |
| Other      |       | 670       |       | 469       |       | 201                      |       | 43          | %          |
| Total      |       | $         | 3,616      |      | $          | 3,108                    |       | $           | 508        |   | 16 | % |

 

*Medical Sales – ENT Market*

 

Sales to the ENT market include products for the domestic andinternational customers as follows:

 
| **ENT Market** | ** ** | **6M 06** | ** ** | **6M 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Domestic       |       | $         | 1,194      |      | $          | 1,577                    |       | $           | (383       | ) | (24 | )% |
| International  |       | 1,249     |       | 967       |       | 282                      |       | 29          | %          |
| Total ENT      |       | $         | 2,443      |      | $          | 2,544                    |       | $           | (101       | ) | (4 | )% |

 

We furtherdelineate products sold to the domestic ENT market as follows:

 
| **ENT Products**     | ** ** | **6M 06** | ** ** | **6M 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Slide-On EndoSheaths |       | $         | 429        |      | $          | 950                      |       | $           | (521       | ) | (55 | )% |
| Endoscopes           |       | 765       |       | 627       |       | 138                      |       | 22          | %          |
| Total Domestic ENT   |       | $         | 1,194      |      | $          | 1,577                    |       | $           | (383       | ) | (24 | )% |

 

The primary reason for the lower sales of ENT EndoSheaths to thedomestic market in 6M 06 compared to 6M 05 was the build-up of inventory atMedtronic Xomed during FY 05.  Asdiscussed above, we believe this build-up has been sold through to end users,and that comparisons of sales of ENT EndoSheaths to Medtronic Xomed will bepositive going forward.  The primaryreason for the increase in sales of ENT endoscopes was the sales to MedtronicXomed of our new ENT-3000 in Q2 06.

 

We further delineate products sold to the international ENT market asfollows:

 
| **ENT Products**     | ** ** | **6M 06** | ** ** | **6M 05** | ** ** | **Increase  (Decrease)** | ** ** | **Percent** | ** ** |
|----------------------|------------|-----------|------------|-----------|------------|--------------------------|------------|-------------|------------|
| Slide-On EndoSheaths |       | $         | 942        |      | $          | 758                      |       | $           | 184        |   | 24 | % |
| Endoscopes           |       | 307       |       | 209       |       | 98                       |       | 47          | %          |
| Total International  |       | $         | 1,249      |      | $          | 967                      |       | $           | 282        |   | 29 | % |

 

The primary reason for the increase in sales of ENT SOS tointernational distributors was higher demand, especially in Europe.  In addition, we established new distributorsin the Middle East for our ENT SOS.  Theincrease in sales of endoscopes was caused primarily by higher sales in thethree months ended June 30, 2005 (“Q1 06”) of our ENT-1000, the smalldiameter ENT endoscope.

 

24

----

 

*Medical Sales –Urology Market*

 

The increase in sales of products to the urology market was primarilydue to shipments of our new CST-2000 with Slide-On EndoSheath System to MGU,and secondarily to international distributors. We sold approximately $460,000 of CST-2000 and Slide-On EndoSheaths toMGU and $43,000 to international distributors.

 

*Industrial Segment*

 

The decrease in sales of the industrial segment was due primarily tohigher demand in the market for video borescopes, compared to our line of fiberborescopes.

 

Gross Profit

 

*Q2 06 Compared to Q2 05*

 

Gross profit was $494,348 in Q2 06, an increase of $243,509, comparedto gross profit in Q2 05.  Gross profitincreased by approximately $127,000 in the medical segment, and byapproximately $117,000 in the industrial segment.  Gross profit in the medical segment increaseddue to higher volume of sales of ENT SOS sold to internationaldistributors.  This increase waspartially offset by a write down of approximately $138,000 of inventory,primarily to reflect the excess of the cost over the market value of ourSlide-On cystoscope EndoSheath.  We areworking to redesign this EndoSheath to result in lower manufacturingcosts.  Based upon current estimates, webelieve there is sufficient inventory of the current EndoSheath at MGU and ourNatick facility to last for approximately one year.

 

We are in the process of developing a new EndoSheath concept andautomated equipment to manufacture our EndoSheaths at significantly lowermanufacturing costs than our current costs. We now expect this automation equipment to be in place at the last halfof FY 07.

 

In the industrial segment, the increase in gross profit was dueprimarily to lower fixed costs for personnel.

 

*6M 06 Compared to 6M 05*

* *

Gross profit was $1,104,488 in 6M 06, a decrease of $228,916, comparedto gross profit in 6M 05. Gross profit decreased by approximately $304,000 inthe medical segment and increased by approximately $75,000 in the industrialsegment. The decrease in the medical segment was due primarily to the lowerunit volume of ENT EndoSheaths sold to the domestic market in Q1 06. As statedabove, we expect sales of ENT EndoSheaths to the domestic market to increase inthe subsequent fiscal quarters of FY 06.

 

The increase in gross profit in the industrial segment was primarilydue to the lower fixed costs for personnel in Q2 06.

 

Operating Expenses

 

*Selling, General and Administrative Expenses*

 

*Q2 06 Compared to Q2 05*

 

The increase in selling, general and administrative (“SG&A”)expenses was due primarily to an increase in the charges by our outside publicaccounting firm of $50,000, higher costs related to severance of approximately$61,000 and higher spending for recruiting fees for new personnel of$30,000.  In addition, we incurred ahigher charge for the provision for doubtful accounts in the industrial segmentof approximately $72,000.

 

*6M 06 Compared to 6M 05*

 

Theincrease in SG&A expenses was due primarily to the items listed above,offset partially by lower spending for product promotion in Q1 06.  Expenses for the promotion of our ENT andurology products are incurred primarily by our exclusive distributors,Medtronic Xomed and MGU.

 

25

----

 

*Research and Development Expenses*

 

*Q2 06 Compared to Q2 05*

 

Theincrease in research and development (“R&D”) expenses was due primarily toadditional spending for materials and personnel hired to work on developing newproducts and manufacturing methods for the medical segment.  We expect R&D expenses will continue tobe higher in FY 06, compared to FY 05, as we increase our efforts to developnew products for medical markets, both those that will utilize the technologyinherent in our EndoSheaths, and other products for the medical market.

 

*6M 06 Compared to 6M 05*

 

Theincrease in R&D expenditures was due to the same reasons as noted above.

 

*Stock-based Compensation Expenses*

 

Weincurred stock-based compensation costs during FY 06 and FY 05, due primarilyto grants in April 2004 and July 2004 of non-qualified options topurchase 100,000 shares and 50,000 shares, respectively, of our Common Stock toan outside consultant.  These grants werein accordance with an agreement entered into with that consultant in January 2003.  The value of the non-qualified options weredetermined to be approximately $371,000, using the Black-Scholes option-pricingmodel, and are being recorded in our statements of operations over the vestingperiod of the options.  We recorded$46,387 and $92,775 of expense in Q2 06 and 6M 06, respectively, related tothese non-qualified options.  Inaddition, during the three months ended June 30, 2003, the compensationcommittee of our board of directors authorized the issuance of non-qualifiedoptions to purchase 1,295,000 shares of common stock to certain of ouremployees.  These options were pricedbelow the fair market price of our common stock on the date of grant.  Accordingly, we are recognizing compensationexpense totaling approximately $65,000 from June 2003 through December 2007,the vesting period of these options.  InQ2 06 and 6M 06, we incurred $3,297 and $6,594, respectively, of expenserelated to these options in our statements of operations.

 

Operating Income (Loss)

 

Operatingincome (loss) by segment was as follows ($000’s):

 
| **Segment** | ** ** | **Q2 06** | ** ** | **Q2 05** | ** ** | **Change** | ** ** | **6M 06** | ** ** | **6M 05** | ** ** | **Change** | ** ** |
|-------------|------------|-----------|------------|-----------|------------|------------|------------|-----------|------------|-----------|------------|------------|------------|
| Medical     |       | $         | (736       | )         | $          | (616       | )          | $         | (120       | )         | $          | (1,348     | )          | $ | (605 | ) | $ | (743 | ) |
| Industrial  |       | (14       | )          | (52       | )          | 38         |       | (27       | )          | (31       | )          | 4          |       |
| Corporate   |       | (368      | )          | (268      | )          | (100       | )          | (624      | )          | (587      | )          | (37        | )          |
| Total       |       | $         | (1,118     | )         | $          | (936       | )          | $         | (182       | )         | $          | (1,999     | )          | $ | (1,223 | ) | $ | (776 | ) |

 

In the medical segment, the higher gross profit was more than offset byhigher spending for SG&A and R&D, resulting in a higher loss in Q2 06,compared to Q2 05.  For 6M 06, comparedto 6M 05, the lower gross profit in Q1 06 combined with higher spending forR&D resulted in a higher loss.

 

26

----

 

In the industrial segment, the higher gross profit was partially offsetby the increased provision for bad debts, resulting in a lower loss in Q2 06,compared to Q2 05.  For 6M 06, comparedto 6M 05, the higher gross profit was approximately equal to the higher chargefor bad debts, resulting in a lower loss.

 

In the corporate segment, the higher spending for professional fees andseverance costs resulted in higher losses in Q2 06, compared to Q2 05, and inthe 6M 06, compared to 6M 05.

 

Liquidity and Capital Resources

 

At September 30, 2005, our principal sourceof liquidity was working capital of approximately $10 million, including$7.7 million in cash and cash equivalents.   We have pledged $125,000 to supportacceptances payable to banks, as we incur them when we purchase inventory usingletters of credit.

 

We also have an agreement with a bank, whichincludes a revolving line of credit under which we may borrow up to $1,000,000,net of up to $250,000 of any outstanding letters of credit and banker’sacceptances.  Borrowings under this loanarrangement must be fully cash collateralized. The agreement also stipulates that when we achieve positive cash flow,as defined in the agreement, we will be eligible to negotiate changes to thisloan arrangement that may include changing the borrowing base for revolvingloans, and the release of the pledged cash collateral.

 

Ourcash and cash equivalents decreased by approximately $2,144,000 in the sixmonths ended September 30, 2005, due primarily to cash used for operationsof approximately $2,109,000 and cash used for investing activities ofapproximately $199,000.  These uses wereoffset by the exercise of stock options by employees and non-employees totalingapproximately $120,000, and the receipt of a subscription receivable from oneof the investors in our sale of common shares in February 2005 ofapproximately $56,000, net.  We expectthat our current balance of cash and cash equivalents will be sufficient tofund our operations for the next twelve months.

 

We have incurred losses since our inception, and losses are expected tocontinue at least during FY 06.  We havefunded the losses principally with the proceeds from public and private equityfinancings.  The private equityfinancings have included sales of new common stock to two employees who arealso directors, to a hedge fund, to other independent directors and toindependent private individuals.

 

We expect total spending for property and equipment to be approximately$850,000 for FY 06.  This amount could behigher depending upon the terms we negotiate for the purchase of the equipmentwe are designing to manufacture our new low-cost EndoSheath.  We expect to obtain long-term financing forthis purchase, but there can be no assurance such financing will be availableto us, or available on terms acceptable to us.

 

We conduct our operations in certain leasedfacilities.  These leases expire on variousdates through August 31, 2010.  Inaddition, we have operating leases for certain office equipment.  These leases expire on various dates through June 2007.  The following chart summarizes ourcontractual obligations as of September 30, 2005.

 
| **Contractual Obligation** | ** ** | **Total** | ** ** | **Due within 1 year** | ** ** | **Due in 1-3 years** | ** ** |
|----------------------------|------------|-----------|------------|-----------------------|------------|----------------------|------------|
| Operating leases           |       | $         | 1,240,390  |                  | $          | 375,726              |       | $ | 864,664 |   |
| Capital lease              |       | 43,309    |       | 25,406                |       | 17,903               |       |
|                            |            |           |            |                       |            |                      |            |  |  |  |

 

27

----

 

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

 

28

----

 

## **Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

## ** **

In the normal course of business, we are subject to the risksassociated with fluctuations in interest rates and changes in foreign currencyexchange rates.

 

#### *Interest and 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.

 

Investments in both fixed-rate and floating-rate interest earninginstruments carry a degree of interest rate risk.  Fixed-rate securities may have their fairmarket value adversely impacted due to a rise in interest rates, whilefloating-rate securities may produce less income than expected if interestrates decline.  Due in part to thesefactors, our future investment income may fall short of expectations due tochanges in interest rates, or we may suffer losses in principal if forced tosell securities which have seen a decline in market value due to changes ininterest rates.

 

#### *Foreign CurrencyExchange*

#### * *

We face exposure, due to purchases of raw materials from Japanesesuppliers, to adverse movements in the value of the Japanese Yen.  This exposure may change over time, and couldhave a materially adverse effect on our financial results.  We may attempt to limit this exposure bypurchasing forward contracts, as required. Most of our Japanese Yen liabilities are settled within 90 days of receiptof materials.  At September 30,2005, our liabilities relating to Japanese Yen were approximately $9,000.

 

29

----

 

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

## ** **

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

 

Based on an evaluation of our disclosure controls and procedures (asdefined in Rules 13a-14(c) and 15d-14(c) under the SecuritiesExchange Act of 1934), the chief executive officer and chief financial officerhave concluded that our disclosure controls and procedures as of the end of thethree months ended September 30, 2005, are effective.

 

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

 

Therewere no changes in our internal controls over financial reporting that occurredduring the fiscal quarter ended September 30, 2005 that have materiallyaffected, or are reasonable likely to materially affect, our internal controlsover financial reporting.

 

30

----

 

**PART II - OTHER INFORMATION**

 

## **Item 4. Submission of Matters to a Vote of Stockholders**

## ** **

We held the 2005 Annual General Meeting of Shareholders(the “Annual Meeting”) on July 25, 2005. At the Annual Meeting, the following actions were taken:

 

1.               The stockholders elected Katsumi Oneda andRon Hadani as Class II directors to serve for a three-year term.  Holders of 22,127,476 shares of Common Stockvoted for and holders of 125,473 shares of Common Stock withheld votes for Mr. Oneda.  Holders of 22,118,111 shares of Common Stockvoted for and holders of 134,838 shares of Common Stock withheld votes for Mr. Hadani.  In addition to Messrs. Oneda and Hadani,Messers Lewis C. Pell, Kenneth W. Anstey and John J. Wallace continue to serveon the Board of Directors.  On August 12,2005 Mr. William F. Doyle resigned as a member of the Board of Directorsof the Company.

 

2.               The stockholders ratified an amendment to theCompany’s 2000 Stock Incentive Plan (the “Plan”) to increase the number ofshare of Common Stock that may be issued pursuant to awards granted under thePlan from 4,000,000 to 4,500,000. Holders of 22,044,635 shares of Common Stock voted for, holders of206,254 shares of Common Stock voted against and holders of 2,060 shares ofCommon Stock abstained from voting to increase the number of shares that may beissued pursuant to awards granted under the Plan.

 

**Item6.  Exhibits**

 
| Exhibits |
|----------|
|     |   |   |
| 31.1     |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a)/15d-14(a), promulgated under the Securities  Exchange Act of 1934, as amended. |
|     |   |   |
| 31.2     |   | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a)/15d-14(a), promulgated under the Securities  Exchange Act of 1934, as amended. |
|     |   |   |
| 32       |   | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

31

----

 

##### **SIGNATURES**

##### ** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

VISION-SCIENCES, INC.

 

 
| Date: November 14,  2005 | /s/ Ron Hadani                                                                                                                        |   |
|-------------------------------|---------------------------------------------------------------------------------------------------------------------------------------|--------|
|                          | Ron Hadani                                                                                                                            |
|                          | President, CEO (Duly Authorized Officer)                                                                                              |
|                          |                                                                                                                                  |
|                          |                                                                                                                                  |
| Date: November 14, 2005  | /s/ James A. Tracy                                                                                                                    |   |
|                          | James A. Tracy                                                                                                                        |
|                          | Vice President Finance, Chief Financial  Officer and  Controller (Principal Financial Officer and Principal  Accounting Officer) |
|                               |                                                                                                                                       |        |  |

 

32

----