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 October 31, 2011January 30, 2012

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

The results for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year. Please read these condensed consolidated financial statements in conjunction with the consolidated financial statements and the related notes 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 $10.0 million revolving loan agreement (the “Agreement”) 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 in fiscal 2007, and the sale of other assets. We also received an aggregate of $6.4 million of deposits (the “Prepayments”) from two customers, (the “Prepayments”Stryker and SpineView Inc. (“SpineView”), during fiscal 2011 to support anticipated sales orders, some of which have shipped through the secondthird quarter of fiscal 2012 and the remainder are expected to ship over the course of 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 at December 31, 2011, our cash on-hand and the $4.0remaining $2 million of capital available, subject to certain conditions, under the revolving loan agreement at September 30, 2011Agreement will be sufficient to fund our working capital needs, capital expenditures, and future operating losses through September 30,December 31, 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.level to continue to operate as a going concern.

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:

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 beare co-branded Stryker and Vision-Sciences. We will also supply Stryker with flexible ureteroscopes upon launch of this product line, expected to occur during the first half of fiscal 2012.2013. Stryker will initially have the exclusive rights to distribute our cystoscopes, urology EndoSheath technology, and ureteroscopes, 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 theirits end customers, based upon reports received from Stryker monthly. While growing each month, suchSuch 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 sixnine months ended September 30,December 31, 2011, we recognized $0.9$1.1 million and $2.5$3.5 million in revenue, respectively, for delivery of cystocopes and EndoSheath technology. At September 30,December 31, 2011, the advance from customer balance pertaining to Stryker was $2.0$0.9 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 surgical endoscope systems. We recorded this prepayment as an advance from customer in our condensed consolidated balance sheet. During the sixthree and nine months ended September 30,December 31, 2011, we recognized $0.4$0.2 million and $0.6 million in revenue, respectively, for delivery of SpineView surgical endoscope systems. At September 30,December 31, 2011, the advance from customer balance pertaining to SpineView was $0.8$0.6 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 Loanthe 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 borrowed $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 DateNovember 9, 2014 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 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).

Subject to the terms of the Agreement, we will be required to prepay all amounts outstanding under the Agreement upon a change in control or event of default. In addition, we will be required to repay all of the New Loan and a portion of the Original Loan Amount, if we secure other financing or consummate a sale or license of assets.

Any amounts drawn against the New Loan (an “Advance”) accrue interest at an annual rate of 7.5%. The Lender will receive an availability fee equal to an 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 Agreement and the maximum amount of aggregate Advances of $10.0 million.

In connection with the Loan Agreement, the Lender received a warrant to purchase an aggregate of 1,229,105 shares of our common stock at an exercise price of $2.034 per share (the “New Warrant”).  The New Warrant vested immediately upon issuance and expires on the later of the fifth anniversary of the Effective Date or one year after the termination of the Loan Agreement (the "Expiration Date"“Expiration Date”) and repayment of all amounts due and payable under the Loan Agreement. As part of the Original Agreement, the Lender received warrants to purchase up to 272,727 shares of our common stock at an exercise price of $1.375 per share and up to 378,788 shares of our common stock at an exercise price of $1.65 per share.

We have accounted for the fair value of the New Warrant and incremental fair value arising from the extension of the maturity date of the old warrants as an increase to the deferred debt cost. Such deferred debt costs are amortized to expense over the term of the Loan Agreement to its Expiration Date.

We estimated the fair value of all of the stock 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 and warrant issuances:

Debt cost expense and interest expense related to the stock warrants and availability fee and accrued interest on outstanding borrowings, respectively, for the three and sixnine months ended September 30,December 31, 2011 and 2010 was recorded in our condensed consolidated statement of operations as follows:

At September 30,December 31, 2011, we had $0.1 million in accrued interest related to the Agreement, which is included in accounts payableaccrued expenses on our condensed consolidated balance sheet.

The stock option plans provide that options may be granted at an exercise price of 100% of fair market value of our common stock on the date of grant, may be exercised in full or in installments, at the discretion of our Board or its Compensation Committee, and must be exercised within ten years from date of grant. We recognize stock-based compensation expense on a straight-line basis over the requisite service period based on fair values, generally four years. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and included these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date.

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

The following table summarizes stock options activity for the sixnine months ended September 30,December 31, 2011:

The weighted average fair value of options granted during the three months ended September 30,December 31, 2011 and 2010 was $1.60$1.65 and $0.87$0.98 per share, respectively. The weighted average fair value of options granted during the sixnine months ended September 30,December 31, 2011 and 2010 was $1.70$1.68 and $0.79$0.82 per share, respectively.

The total intrinsic value (the excess of the market price over the exercise price) was approximately $3.2$2.9 million for stock options outstanding, $2.7$2.6 million for stock options exercisable, and $3.0$2.8 million for stock options vested and expected to vest as of September 30,December 31, 2011. The total intrinsic value for stock options exercised during the three months ended September 30,December 31, 2011 and 2010 was approximately $77$101 thousand and $21$1 thousand, respectively. The total intrinsic value for stock options exercised during the sixnine months ended September 30,December 31, 2011 and 2010 was approximately $281$382 thousand and $21$22 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 1,880,620 stock warrants related to our line of credit – related party outstanding with a weighted average exercise price of $1.86 at September 30,December 31, 2011. At September 30,December 31, 2011, unrecognized debt cost expense related to the stock warrants was approximately $1.8$1.7 million, which is expected to be recognized over a weighted average period of approximately 3.12.9 years.

During the sixnine months ended September 30,December 31, 2011, we granted 366,089 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 period. The restrictions on 59,122 shares of restricted stock issued to Ms. Ansari lapse in quarterly installments starting on each of June 30, 2012, September 30, 2012, December 31, 2012, and March 31,30, 2013. The restrictions on the remainder will lapse consistent with the shares of restricted stock granted to the other management employees. Those restrictions for the restricted stock awards granted to management lapse after certain Company (net sales and operating loss) and individual milestones are met followed by a three-yearfour-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 sixnine months ended September 30,December 31, 2011:

During the sixnine months ended September 30,December 31, 2011, we recognized approximately $134 thousand$0.2 million of stock-based compensation expense related to performance based restricted stock awards. At September 30,December 31, 2011, unrecognized stock-based compensation expense related to nonvested awards was approximately $850 thousand,$0.6 million, which is expected to be recognized over a weighted average period of approximately 2.92.7 years.

We repurchased 3,2684,902 shares of our common stock at its fair value for a cost of $7$11 thousand during the sixnine months ended September 30,December 31, 2011. The shares were purchased from a management employee to cover income tax withholdings upon the lapse 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:

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 9,833,2269,913,951 shares and 8,072,9898,078,221 shares as of September 30,December 31, 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'sStryker’s ability to successfully market and sell the products we manufacture for them;them and to do so at prices that are favorable to us; 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 (and the expected margin of such sales); competition; technological difficulties; product recalls; 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.

 

Within our medical segment we target five main areas for our fiber and video endoscopes and our EndoSheath technology:

We sell our ENT and TNE endoscopes and bronchoscopes through our direct sales force in the U.S. For the rest of the world, we sell our ENT and TNE endoscopes, bronchoscopes, and cystoscopes through international distributors.

 

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 morea higher patient appointments in a single day.throughput. 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 moreup to 24 hours 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.