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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of JulyOctober 31, 2011

Vision-Sciences, Inc. and its Subsidiariessubsidiaries (the “Company” – which may be referred to as “our”, “us” or “we”) have prepared the condensed consolidated financial statements included herein according to generally accepted accounting principles in the United States of America (“U.S. GAAP”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and include, in the opinion of management, all adjustments that we consider necessary for a fair presentation of such information.  We have condensed or omitted certain information and footnote disclosures normally included in financial statements pursuant to those rules and regulations. We believe, however, that our disclosures are adequate to make the information presented not misleading. The presentation of certain prior year information has been reclassified to conform with the current year presentation.

The results for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year. Please read these condensed consolidated financial statements in conjunction with the consolidated financial statements and the related notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

We design, develop, manufacture, and market products for endoscopy – the science of using an instrument, known as an endoscope, to provide minimally invasive access to areas not readily visible to the human eye. Our products are sold throughout the world through direct sales representatives in the United States (“U.S.”) and independent distributors for the rest of the world. With respect to our urology products, we are the exclusive supplier to the Endoscopy Division of Stryker Corporation (“Stryker”). Our largest geographic markets are the U.S. and Europe.

We were incorporated in Delaware, and are the successor to operations originally begun in 1987. Machida Incorporated (“Machida”), our wholly-owned subsidiary, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries.

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

We have incurred losses since our inception, and losses are expected to continue through at least fiscal years 2012 and 2013. We have funded the losses principally with cash flow from operations, advances under a three-year $5.0$10.0 million revolving loan agreement (the “Loan”) with our Chairman, Lewis C. Pell (the “Lender”), proceeds from equity financings (most recently the $10.5 million of proceeds we received from a private placement in January 2011), payments from Medtronic related to the sale of certain assets related to our ENT EndoSheath technology business, and the sale of other assets. We have also received an aggregate of $6.4 million of deposits from two customers (the “Prepayments”) during fiscal 2011 to support anticipated sales orders, some of which have shipped duringthrough the second quarter of fiscal 20112012 and the remainder are expected to ship over the course of fiscal 2012.the next few quarters. We have invested some of our working capital in inventory to fulfill these orders and forecasts provided from Stryker. We believe that our cash and the $4.0 million of capital available, subject to certain conditions, under the revolving loan agreement at JuneSeptember 30, 2011 will be sufficient to fund our working capital needs, capital expenditures, and future operating losses through JuneSeptember 30, 2012. However, if our performance expectations fall short (including generating expected sales from Stryker and SpineView) or our expenses exceed expectations, we will need to either secure additional financing or reduce expenses or a combination thereof. Our failure to do so would have a material adverse impact on our prospects and financial condition. There can be no assurance that any contemplated external financing will be available on terms acceptable to us, if at all. If required, we believe we would be able to reduce our expenses to a sufficient level.

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

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

The carrying amounts reflected in our condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, accrued compensation, and capital lease obligations approximate fair value due to their short-term nature. The fair value of the line of credit is based on its demand value, which is equal to its carrying value.

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

Raw materials include components purchased from independent suppliers. Most purchased components are available from multiple sources, with the exception of certain key components which are supplied to us by key suppliers, with whom we have long-term supply arrangements, but no long-term supply agreements.

On September 22, 2010, we signed a three-year agreement (the “Stryker Agreement”) under which we became the exclusive supplier to Stryker of Stryker-branded flexible video and fiber cystoscopes. These cystoscopes will employ our patented slide-on EndoSheath technology, which will be co-branded Stryker and Vision-Sciences. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during calendar 2011.fiscal 2012. Stryker will initially have the exclusive rights to distribute products, includingour cystoscopes, urology EndoSheath technology, and ureteroscopes, manufactured by us, in North and Latin America, South America, China and Japan and 12 months post-launch, throughout the rest of the world. Stryker launched these product lines during April 2011 and introduced them at the American Urological Association annual meeting in May 2011.

The purchase price for the products is based on our cost to manufacture plus a margin specified in the Stryker Agreement. We will recognize revenue for products sold to Stryker in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers, based upon reports received from Stryker monthly. While growing each month, such amounts have not been significant to date. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us.

During fiscal 2011, we received a prepayment from Stryker of $5 million, of which we received $2.5 million at signing and the balance in March 2011. The prepayment was recorded as an advance from customer in our condensed consolidated balance sheet. During the three and six months ended JuneSeptember 30, 2011, we recognized $1.6$0.9 million and $2.5 million in revenue, respectively, for delivery of cystocopes and EndoSheath technology. At JuneSeptember 30, 2011, the advance from customer balance pertaining to Stryker was $2.8$2.0 million. We will continue to apply the amounts due from Stryker for purchases of scopes and EndoSheath technology to the prior advance by Stryker and recognize the associated revenue in accordance with our revenue recognition policy. Stryker will thereafter continue to pay us for products supplied.

On June 19, 2008, we entered into a Development and Supply Agreement with SpineView, Inc. (the “SpineView Agreement”), pursuant to which we were to develop and supply a CCD-based video surgical endoscope to SpineView for use with SpineView’s products. In September 2010, we received a prepayment of $1.4 million from SpineView for the initial, firm stocking order of 50 SpineView spinoscope sytems.surgical endoscope systems. We recorded this prepayment as an advance from customer in our condensed consolidated balance sheet. During the threesix months ended JuneSeptember 30, 2011, we recognized $0.1$0.4 million in revenue for delivery of SpineView spinoscopesurgical endoscope systems. At JuneSeptember 30, 2011, the advance from customer balance pertaining to SpineView was $1.2$0.8 million. We will continue to apply the amounts due from SpineView to the prior advance by SpineView for purchases of scopes and recognize the associated revenue until the balance is exhausted. SpineView will thereafter continue to pay us for products supplied.

On September 30, 2011 (the “Effective Date”), we entered into an Amended and Restated Revolving Loan Agreement (the “Agreement”) with the Lender providing for an additional $5.0 million in available loans (the “New Loan”) to us, in addition to $5.0 million previously borrowed under the Original Agreement (as defined below), for an aggregate loan of up to $10.0 million.

This Agreement amends and restates the original Revolving Loan Agreement between the Lender and us dated November 9, 2009 (the “Original Agreement”) pursuant to which we entered into aborrowed $5 million (the “Original Loan Amount”). Under the Agreement, we may draw up to the New Loan Amount until the third anniversary of the Effective Date or such earlier time as the agreement is terminated in accordance with its terms. The Agreement extends the Original Loan Amount repayment date to be consistent with the Lender. New Loan Amount and extends the expiration date of the stock warrants issued under the Original Loan Agreement to be consistent with the terms of the New Warrant (as defined below).

Any amounts drawn against the New Loan (an “Advance”) accrue interest at an annual rate of 7.5%. The Lender receiveswill receive an availability fee equal to a per annuman annual rate of 0.5% on the unused portion of the New Loan calculated based on the difference between the average annual principal amount of the outstanding Advances under the LoanAgreement and the maximum advanceamount of $5.0aggregate Advances of $10.0 million.

In connection with the Loan Agreement, the Lender received a five-year warrant (the “Initial Warrant Shares”) to purchase up to 272,727an aggregate of 1,229,105 shares of our common stock at an exercise price of $1.375$2.034 per share which(the “New Warrant”).  The New Warrant vested immediately vested upon issuance. In addition, we issued a second five-year warrantissuance and expires on the later of the fifth anniversary of the Effective Date or one year after the termination of the Loan Agreement (the “Additional"Expiration Date") and repayment of all amounts due and payable under the Loan Agreement.

We estimated the fair value of all of the Initial and Additional Warrant Sharesstock warrants issued on the date of vesting using a Black-Scholes valuation model that used the weighted average assumptions for the risk-free interest rate, expected life (in years), and expected volatility. The following table summarizes Advances taken on the Loan and warrant issuances:

The weighted average fair value of options granted during the three months ended JuneSeptember 30, 2011 and 2010 was $1.94$1.60 and $0.72$0.87 per share, respectively. The weighted average fair value of options granted during the six months ended September 30, 2011 and 2010 was $1.70 and $0.79 per share, respectively.

The total intrinsic value (the excess of the market price over the exercise price) was approximately $6.5$3.2 million for stock options outstanding, $5.4$2.7 million for stock options exercisable, and $6.2$3.0 million for stock options vested and expected to vest as of JuneSeptember 30, 2011. The total intrinsic value for stock options exercised during the three months ended JuneSeptember 30, 2011 and 2010 was approximately $0.2 million. There were no$77 thousand and $21 thousand, respectively. The total intrinsic value for stock options exercised during the threesix months ended JuneSeptember 30, 2010.2011 and 2010 was approximately $281 thousand and $21 thousand, respectively.

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

We had 651,5151,880,620 stock warrants outstanding with a weighted average exercise price of $1.53$1.86 at JuneSeptember 30, 2011. At JuneSeptember 30, 2011, unrecognized debt cost expense related to the Initial and Additional Warrant Sharesstock warrants was approximately $0.2$1.8 million, which is expected to be recognized over a weighted average period of approximately 1.43.1 years.

WeDuring the six months ended September 30, 2011, we granted 247,845366,089 shares and 40,000 shares of restricted stock to management and outside directors of our Board, respectively, under our 2007 Plan. At the time of her appointment, Ms. Ansari was granted 118,244 shares of restricted stock, which is included in the number granted to management during the three months endedperiod.  The restrictions on 59,122 shares of restricted stock lapse in quarterly installments starting on each of June 30, 2011.2012, September 30, 2012, December 31, 2012, and March 31, 2013.  The restrictions on the remainder will lapse consistent with the shares of restricted stock granted to the other management employees. Those restrictions for thesethe restricted stock awards granted to management lapse after certain Company (net sales and operating loss) and individual milestones are met followed by a three-year graded vesting schedule. Irrespective of achieving the Company milestones, management will receive 25% of their restricted stock award if their individual milestones are met. The restrictions for the restricted stock awards granted to outside directors lapse quarterly over a one-year period.

The following table summarizes restricted stock activity for the threesix months ended JuneSeptember 30, 2011:

We determined stock-based compensation expense for performance based restricted stock based upon the fair value of our common stock at the date of grant and recognized expense based upon the most probable outcome as to whether the performance targets will be achieved and the stock-based compensation being earned.

During the threesix months ended JuneSeptember 30, 2011, we recognized approximately $16$134 thousand of stock-based compensation expense related to the performance based restricted stock awards. At JuneSeptember 30, 2011, unrecognized stock-based compensation expense related to nonvested awards was approximately $417$850 thousand, which is expected to be recognized over a weighted average period of approximately 3.42.9 years.

We repurchased 1,6343,268 shares of our common stock at its fair value for a cost of $4$7 thousand during the threesix months ended JuneSeptember 30, 2011. The shares were purchased from a management employee to cover income tax withholdings as result ofupon the lapsinglapse of restrictions on a restricted stock award. Although not required to under our equity incentive plans, we anticipate repurchasing shares in a similar arrangement during the remainder of fiscal 2012.

We have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics.

Management evaluates the revenue and profitability performance of each of our product lines to make operating and strategic decisions. We have no intersegment revenue.

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

The following table presents the reconciliation to loss before provision for income taxes for the three and six months ended JuneSeptember 30, 2011 and 2010:

Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding. For all periods presented, the diluted net loss per common share is the same as basic net loss per common share, as the inclusion of other shares of stock issuable pursuant to stock options and warrants would be anti-dilutive. Stock options, warrants, and restricted stock of 7,706,1659,833,226 shares and 7,996,9448,072,989 shares as of JuneSeptember 30, 2011 and 2010, respectively, were excluded from the calculation of fully diluted loss per share as their inclusion would have been anti-dilutive due to our net loss per share.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. Such factors include, but are not limited to, further weakening of economic conditions that could adversely affect the level of demand for our products; our ability to satisfactorily distribute our ENT endoscopes without an arrangement with Medtronic; our ability to sell products to Stryker in at least the amounts necessary to retain the remainder of the prepayments received from Stryker; Stryker's ability to successfully market and sell the products we manufacture for them; pricing pressures, including cost-containment measures which could adversely affect the price of, or demand for, our products; availability of parts on acceptable terms; our ability to design new products and the success of such new products; changes in foreign exchange markets; changes in financial markets and changes in the competitive environment. Examples of forward-looking statements include statements about expectations about future financial results, future products and future sales of new and existing products, future expenditures, and capital resources to meet anticipated requirements. Generally, words such as “expect” “believe”, “anticipate”, “may”, “will”, “plan”, “intend”, “estimate”, “could”, and other similar expressions are intended to identify forward-looking statements. The forward-looking statements are based on our future plans, strategies, projections and predictions and involve risks and uncertainties, and our actual results may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference could include the availability of capital resources; the availability of third-party reimbursement; government regulation; the availability of raw material components; our ability to satisfactorily distribute our ENT endoscopes without an arrangement with Medtronic; our dependence on certain distributors and customers; our ability to effect expected sales to Stryker;Stryker (and the expected margin of such sales); competition; technological difficulties; general economic conditions and other risks detailed in this Quarterly Report on Form 10-Q and any subsequent periodic filings we make with the Securities and Exchange Commission (“SEC”). While we believe the assumptions underlying such forward-looking statements are reasonable, there can be no assurance that future events or developments will not cause such statements to be inaccurate. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement. We do not undertake an obligation to update our forward-looking statements to reflect future events or circumstances.

 

 

We believe our technology delivers significant value to our customers – doctors, clinics and hospitals – through reduced capital, staff and service costs, and increased patient throughput, practice revenue, and profitability. Our EndoSheath technology allows our customers to buy fewer endoscopes to service their patients and enables them to schedule more patient appointments in a single day. Our single-use EndoSheath technology provides a sterile barrier between patients and our reusable endoscopes, eliminating the need for time-consuming reprocessing routines necessary with conventional endoscopes. Our endoscopes are therefore typically ready for the next procedure in ten minutes, unlike conventional endoscopes which may take from 45 minutes to a day or more to reprocess. We believe our EndoSheath technology is the solution to the challenges and problems with conventional flexible endoscopes.  By offering a technology that provides simpler and quicker endoscope reprocessing and sterility derived from use of a single-use disposable sheath, we have removed the limitations of conventional flexible endoscopy.

Our current strategic focus is to continue to transform ourselves from a research and development-focused company to a sales and marketing-driven Company,company, with the primary goal of increasing top-line revenue and margins.  We are doing this by:

 

We continue to enhance our current family of videoscopes and improve and refine their manufacturing.the manufacturing process. With respect to our fiberscope line of products, during fiscal 2011, we launched our 4000 Series bronchoscope which is inserted down the mouth or nose into the lungs, providing visualization of the lungs and the ability to perform a variety of diagnostic and therapeutic procedures. Additionally, during fiscal 2011, we launched our 2.8mm channel EndoSheath disposable for bronchoscopy to international pulmonology markets and we expect to launch this same product in the U.S. towardduring the endfirst half of fiscal 2012.2013.

While we currently anticipate the development and release of the products as noted above, there can be no assurances that the timelines and related budgeted costs will be attained.

On September 22, 2010, we signed a three-year agreement under which we became the exclusive supplier to Stryker of Stryker-branded flexible video and fiber cystoscopes. These cystoscopes will employ our patented slide-on EndoSheath technology, which will be co-branded Stryker and Vision-Sciences. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during calendar 2011.fiscal 2012. Stryker will initially have the exclusive rights to distribute products, including cystoscopes, urology EndoSheath technology, and ureteroscopes manufactured by us, in North and Latin America, South America, China and Japan and 12 months post-launch, throughout the rest of the world. Stryker launched these product lines during April 2011 and introduced them at the American Urological Association annual meeting in May 2011.

The purchase price for the products is based on our cost to manufacture plus a margin specified in the Stryker Agreement. We will recognize revenue for products sold to Stryker in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker’s gross profit after Stryker sells the products to their end customers, based upon reports received from Stryker monthly. While growing each month, such amounts have not been significant to date. There is no cost of sales associated with revenue under this second step. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us.

During fiscal 2011, we received a prepayment from Stryker of $5 million, of which we received $2.5 million at signing and the balance in March 2011. The prepayment was recorded as an Advanceadvance from customer in our condensed consolidated balance sheet. During the threesix months ended JuneSeptember 30, 2011, we recognized $1.6$2.5 million in revenue for delivery of cystocopes and EndoSheath technology. At JuneSeptember 30, 2011, the advance from customer balance pertaining to Stryker was $2.8$2.0 million. We will continue to apply the amounts due from Stryker for purchases of scopes and EndoSheath technology to the prior advance by Stryker and recognize the associated revenue in accordance with our revenue recognition policy. Stryker will thereafter continue to pay us for products supplied.

On June 19, 2008, we entered into a Development and Supply Agreement with SpineView Inc. (the “SpineView Agreement”), pursuant to which we were to develop and supply a CCD-based video surgical endoscope to SpineView for use with SpineView’s products. In September 2010, we received a prepayment of $1.4 million from SpineView for the initial, firm stocking order of 50 SpineView spinoscope sytems.surgical endoscope systems. We recorded this prepayment as an Advanceadvance from customer in our condensed consolidated balance sheet. During the threesix months ended JuneSeptember 30, 2011, we recognized $0.1$0.4 million in revenue for delivery of SpineView spinoscopesurgical endoscope systems. At JuneSeptember 30, 2011, the advance from customer balance pertaining to SpineView was $1.2$0.8 million. We will continue to apply the amounts due from SpineView to the prior advance by SpineView for purchases of scopes and recognize the associated revenue until the balance is exhausted. SpineView will thereafter continue to pay us for products supplied.

In the medical segment, we track sales of endoscopes and EndoSheath disposables by market. We also track sales of peripherals and accessories which can be sold to more than one market. SalesNet sales by operating segment market, and by market/category for the three and six months ended JuneSeptember 30, 2011 and 2010 were as follows: