VISION SCIENCES INC /DE/ - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the Fiscal Year Ended March 31, 1997

Commission File No. 0-20970
Vision-Sciences, Inc.
(Exact name of Registrant as specified in its charter)

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DELAWARE 13-3430173
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

6 Strathmore Road 01760
Natick, Massachusetts (Zip Code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (508) 650-9971

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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01

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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
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Aggregate market value of Common Stock held by non-affiliates
of the Registrant as of May 31, 1997 based upon the last sale
price of the Common Stock in the Nasdaq National Market as
reported by Nasdaq: $16,534,023
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Number of shares outstanding of the Registrant's Common Stock
as of May 31, 1997 14,696,909
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Documents incorporated by reference: Portions of the Proxy Statement for the
1997 Annual Meeting of Stockholders are incorporated by reference into Part III
of this Form 10-K.

PART I

Item 1. Business
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This Annual Report on Form 10-K contains forward-looking statements,
including statements about new product introductions, expectations as to future
sales of the Company's products, the availability of supplies and the
sufficiency of the Company's capital resources to meet anticipated capital
requirements. These forward-looking statements involve risks and uncertainties,
and the Company's actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause such a
difference include, but are not limited to the availability of capital
resources, the availability of third-party reimbursement, government regulation,
commercialization and technological difficulties, general economic conditions
and other risks detailed below and in the Company's filings with the Securities
and Exchange Commission.

Vision-Sciences, Inc., develops, manufactures and markets products for
endoscopy which have infection control advantages over conventional flexible
endoscopes. The Company has developed, and is marketing, proprietary flexible
endoscope systems designed to eliminate the risk of cross-contamination to
patients and health-care professionals which results from the reuse of
conventional flexible endoscopes. The Company's systems consist of two main
components - a proprietary sterile disposable sheath, known as an EndoSheath(R)
System (EndoSheath) and a reusable flexible endoscope incorporating the
Company's proprietary design. The EndoSheath is designed to cover all surfaces
of the endoscope that come in contact with the patient and contains the air,
water, suction and accessory channels that are a part of conventional flexible
endoscopes, thus providing a contamination-free instrument and substantially
reducing the burdensome cleaning required of conventional flexible endoscopes.
The Company has developed a family of disposable EndoSheath/reusable flexible
endoscope systems for gastrointestinal endoscopy and began commercial shipments
of its first such system, a fiberoptic sigmoidoscope, in April 1993.

The Company also manufactures and sells disposable EndoSheaths for use with
certain conventional flexible endoscopes currently sold by the Company and other
manufacturers. In December 1992 the Company began commercial shipments of its
first such EndoSheath, for use with one of its nasopharyngo-laryngoscopes ("ENT
endoscopes"). In January 1993 the Company received clearance from the U.S. Food
and Drug Administration (the "FDA") to market four additional disposable
EndoSheaths for use with certain other ENT endoscopes. In February 1994 the
Company received clearance from the FDA to market its black and white CCD video
sigmoidoscope and EndoSheath system. In February 1995 the Company received
clearance from the FDA to market its 130 cm length fiberoptic colonoscope and
EndoSheath system and its fiberoptic gastroscope and EndoSheath system. In
December 1995 the Company received clearance from the FDA to market its
fiberoptic ENT scope. In December 1996 the Company received clearance from the
FDA to market its fiberoptic bronchoscope and EndoSheath system. In January
1997 the Company received clearance from the FDA to market its color video
sigmoidoscope.

Endoscopy

Background

Endoscopy is a minimally invasive technique that is being used with
increased frequency in a growing number of medical applications. Endoscopes are
used for a variety of screening and diagnostic procedures and are also used
therapeutically as an alternative to more traditional surgical procedures.
Endoscopic therapeutic procedures, unlike more traditional "open" surgical
procedures, can be performed without a major incision, in most cases without
general anesthesia, and are, therefore, safer and less expensive than
traditional surgical procedures. In addition, endoscopic procedures are
typically performed on an outpatient basis and generally involve less recovery
time and patient discomfort than traditional surgery. The patient benefits and
cost savings associated with endoscopy have caused many governmental
reimbursement programs and private health insurance plans to encourage the use
of endoscopic procedures in a number of medical applications.

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Flexible endoscopes are tubular instruments that enter the body through a
natural orifice and enable physicians to view the interior of a body organ or
cavity remotely and perform various screening, diagnostic, and therapeutic
procedures. Flexible endoscopes generally utilize fiberoptic bundles or video
camera technology for image production. The physician can steer the distal
portion of a flexible endoscope with control knobs on the endoscope's operator
body. By maneuvering the tip of the endoscope, the physician can access body
regions through lengthy and twisted passageways (such as the colon) and perform
a variety of procedures. Most flexible endoscopes contain a series of channels
running the length of the endoscope for delivery of air, water, suction and
accessory devices, such as biopsy forceps and cutting instruments.

Rigid endoscopes generally utilize a stainless steel tube encasing a series
of high resolution lenses to transmit the optical image. Most rigid endoscopes
do not contain the channels that are characteristic of flexible endoscopes.
Rigid endoscopes are currently utilized for diagnostic and surgical procedures
such as arthroscopy, laparoscopy, and urological and gynecological procedures.
While rigid endoscopes for other medical applications, such as bronchoscopes,
sigmoidoscopes, and nasopharyngo-laryngoscopes are still marketed, they have
largely been supplanted by flexible endoscopes, which offer improved patient
comfort and better handling capabilities. The Company does not currently plan to
participate in the rigid endoscope market.

Applications

Flexible endoscopes are widely used in hospitals, clinics, and physicians'
offices primarily on an outpatient basis. The Company's flexible endoscopes are
designed primarily for screening, diagnostic, and therapeutic procedures in
fields such as gastroenterology, surgery, primary care, otolaryngology (ear-
nose-throat medicine, or "ENT"), and pulmonary medicine. The Company estimates,
based on various industry sources, that approximately 20 million flexible
endoscopic procedures in these fields were performed in the United States in
1995.

Gastrointestinal Endoscopy. The Company estimates, based on industry
sources, that over 12 million flexible endoscopic procedures involving the
screening, diagnosis or treatment of the colon, esophagus, stomach and duodenum
were performed in the United States in 1995. Continued growth in such procedures
is expected to result from an increase in sigmoidoscopies performed for the
purpose of detecting cancer of the descending colon, as well as the increased
medical needs associated with an aging population. The American Cancer Society
has recommended that every adult over the age of 50 (currently approximately 60
million Americans) receive a screening sigmoidoscopy every three to five years.

The most common flexible endoscopes used in gastrointestinal endoscopy
are as follows:

. Sigmoidoscopes are used for viewing the sigmoid colon and descending
colon for screening and diagnostic purposes, such as screening for colon
cancer. An estimated 4.7 million procedures were performed in the United
States in 1995 by gastroenterologists, family practitioners, and general
and colon-rectal surgeons in hospitals, clinics, and physicians' offices
primarily on an outpatient basis.

. Colonoscopes are used for viewing the complete colon for screening,
diagnostic and therapeutic purposes, such as removing polyps. Colonoscopy
is often performed following sigmoidoscopy. An estimated 3.6 million
procedures were performed in the United States in 1995, primarily by
gastroenterologists and colon-rectal surgeons in hospitals and clinics.

. Gastroscopes are used for viewing the esophagus and the stomach for
diagnostic and therapeutic purposes, such as detecting and cauterizing
ulcers. An estimated 4.2 million procedures were performed in the United
States in 1995 by gastroenterologists in hospitals and clinics.

. Duodenoscopes are used for viewing and intubating the biliary and
pancreatic ducts from the duodenum for diagnostic and therapeutic
purposes, such as detecting gallstones. An estimated 400,000 procedures
were performed in the United States in 1995 by gastroenterologists in a
hospital setting.

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. ENT Endoscopes. These endoscopes are used for viewing the ears, nose,
throat and larynx for diagnostic purposes, such as testing for throat
cancer. The Company estimates, based on industry sources, that
approximately 4 million such procedures were performed in the United
States in 1995, generally by otolaryngologists and allergists in
hospitals, clinics, and physicians' offices.

. Pulmonary Endoscopes. A bronchoscope and an intubation endoscope are
flexible endoscopes used for viewing the trachea, bronchi and lungs for
diagnostic and therapeutic purposes, generally by pulmonary specialists
and anesthesiologists in a clinic or hospital setting. The Company
estimates, based on industry sources, that approximately 1 million
procedures using flexible bronchoscopes were performed in the United
States in 1995. Because pneumonia is common in persons infected with the
HIV virus, and because bronchoscopy is often used to make this diagnosis,
there has been increased usage of bronchoscopes for this purpose, as well
as greater recognition of the need to perform bronchoscopies in a
contamination-free manner to protect both the HIV positive patients (who
have weakened immune systems) and subsequent patients on whom the
bronchoscope is used.

Problems with Conventional Flexible Endoscopes

While endoscopy represents a significant advance in the field of clinical
medicine, conventional flexible endoscopes present a number of health risks and
problems to both patients and medical personnel. Conventional flexible
endoscopes are intended for repeated use in hundreds of procedures and, with
each use, come in contact with some combination of the patient's blood, tissue,
mucus, saliva and stool. Therefore, a conventional flexible endoscope must be
meticulously manually cleaned and disinfected after each procedure. However,
the design of conventional flexible endoscopes makes it difficult to attain
high-level disinfection after cleaning. As a result, the repeated use of
conventional flexible endoscopes and the difficulty in thoroughly cleaning and
disinfecting them after each use create the following problems:

. Patients, and to a lesser degree the physician using the flexible
endoscope and the nurse assistant cleaning it, are exposed to the risk of
infection from contaminated endoscopes that results from their repeated
use.

. The nurses or other medical personnel who clean the endoscope face health
risks from exposure to toxic disinfecting agents used in the cleaning
process.

. The proper cleaning of a flexible endoscope is relatively expensive,
time-consuming and arduous.

. The repeated cleaning of a flexible endoscope subjects it to wear and
tear, reduces its useful life, and impairs the quality of its optics; in
addition, improper cleaning can cause blocked channels, which require
expensive endoscope repairs.

. The time needed to clean a flexible endoscope after each use results in a
period of "down time" during which the endoscope cannot be used and may
require users to buy and maintain multiple endoscopes.

Difficulty of Proper Cleaning. The problems associated with cleaning
conventional flexible endoscopes can be better understood by examining the
cleaning procedures they require. The cleaning of endoscopes is generally the
responsibility of the nurse or endoscopic assistant. The Society of
Gastroenterology Nurses and Associates, Inc., in 1990 published Recommended
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Guidelines for Infection Control in Gastrointestinal Endoscopy Settings (the
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"SGNA Guidelines"). Although cleaning procedures for endoscopes vary widely,
the following is a summary of the principal steps in the cleaning procedures
that are called for by the SGNA Guidelines.

. Inspection - Endoscopes should be tested for leaks and inspected for
damage. Even small leaks can lead to costly fiberoptic or video component
damage or contamination of the endoscope.

. Cleaning - After gross cleaning to remove patient material, endoscopes
should be thoroughly rinsed, the detachable parts should be removed and
cleaned and exteriors should be sponge-cleaned. All

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internal channels that are accessible should be scrubbed with brushes,
while unreachable air and water channels should be rinsed clear of
residual patient organic matter, as the presence of such matter
diminishes the effectiveness of the disinfecting agents used. The
endoscope should then be washed in a detergent and enzyme solution, with
such cleaning agents drawn through internal channels. The endoscope
should then be rinsed, with excess water removed, since residual water
can dilute disinfectants.

. Disinfection - Endoscopes should be disinfected using recommended
chemical agents or an automated cleaner. Disinfectants must also be drawn
through internal channels during this process. Although certain
sterilization methods are available for flexible endoscopes, conventional
heat sterilization will destroy flexible endoscopes.

. Rinsing - To ensure that patients are not exposed to toxic disinfectants,
endoscopes should be thoroughly rinsed using either tap water or sterile
water, followed by a final rinse in an alcohol solution.

. Drying - Endoscopes and channels should be dried using forced air, then
flushed with an alcohol solution, prior to storage.

. Storage - Endoscopes should be hung vertically in well-ventilated
cabinets to prevent recontamination or damage between uses.

Proper cleaning of conventional flexible endoscopes, even when done in
compliance with the SGNA Guidelines, is difficult to achieve for a number of
reasons. Firstly, the design of conventional flexible endoscopes, which
includes channels, joints and crevices, makes it difficult to reach and clean
all parts of the endoscope. As the SGNA Guidelines state, an endoscope's
"complex and fragile structure presents problems in cleaning/disinfecting/
sterilizing". Secondly, because the Company believes the most important step in
the cleaning process is the manual removal of organic material, the opportunity
for human error is always present, even if optimal cleaning procedures are
followed. Finally, there are questions concerning the efficiency of some
disinfecting agents used in the endoscope cleaning process. For example, in 1991
the FDA recommended that the medical profession cease the use of Sporicidin, a
widely-used endoscope disinfectant, based upon the FDA's conclusion that this
disinfectant does not work. The FDA has also required that the manufacturers of
chemical glutaraldehyde-based disinfectants change the recommended soak time on
their instructions for use from 20 minutes to 45 minutes, and increased the
temperature from 20 degrees Celsius to 25 degrees Celsius. This longer soak time
means slower turnaround on conventional scopes, and the increased temperature of
the glutaraldehyde is hazardous due to increased caustic vapors released during
heating.

Health Risks. Because flexible endoscopes are difficult to clean properly,
sterilization (the complete elimination of microbial life) is virtually
impossible to achieve. Therefore, "high-level disinfection" (the elimination of
all microbial life other than the most highly resistant spores) is the standard
for flexible endoscope cleaning currently recommended by the Centers for Disease
Control. However, studies indicate that high-level disinfection is often not
attained and that cross-contamination remains a risk to patients and medical
personnel.

An FDA-sponsored study published in The American Journal of Medicine in
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March 1992, reported that 23.9% of the gastrointestinal endoscopes tested
produced 100,000 or more bacterial colonies after all cleaning and disinfection
procedures had been completed, and the endoscopes were deemed ready for use on
the next patient. This study concluded that "actual disinfection/sterilization
procedures for endoscopes are not always optimal, and high-level disinfection of
gastrointestinal endoscopes is not always achieved." Numerous infectious agents,
including tuberculosis and salmonella, have been reported in the medical
literature as having been transmitted through the use of contaminated
endoscopes. Concern about the risk of endoscopic cross-contamination has also
been heightened by the increasing prevalence of the HIV and hepatitis viruses.
Moreover, a nationwide survey of gastrointestinal nurses and assistants
published in 1991 (that involved the mailing of 4,952 survey forms, of which
2,030 were returned in a complete and evaluable form) reports that many
respondents believe that endoscopic cross-contamination is widely under
reported. The growing body of evidence on endoscopic cross-contamination has

5

prompted the FDA to fund a study to examine the efficiency of endoscope cleaning
by viewing the channels of endoscopes using miniature endoscopes. The FDA also
recently formed a committee of physicians, nurses, industry representatives, and
government officials to ensure that effective standards for cleaning and product
design are established for flexible endoscopes.

The cleaning procedures required for endoscopes also subject medical
personnel to health risks (such as severe eye, nose and throat irritation,
nausea, headaches, asthma and skin rashes) from exposure to toxic disinfecting
agents. The Occupational Safety and Health Administration has classified
glutaraldehyde, a key ingredient in many endoscope disinfecting agents, as a
highly toxic material and requires hospitals, clinics, and physicians' offices
to reduce the level of emissions to .2 parts per million wherever glutaraldehyde
is used. In addition, toxic disinfectants must be disposed of in compliance with
applicable environmental laws.

Other Problems. In addition to the health problems posed by the use and
cleaning of conventional flexible endoscopes, the required cleaning of these
products is relatively expensive, time-consuming and arduous. The Company
estimates, based upon its own experience, that the cleaning and disinfection
procedure required following each use of a flexible endoscope, if done in
compliance with the FDA recommendations, would take 60 minutes. The repeated
cleaning in harsh chemical disinfectants also subjects a flexible endoscope to
wear and tear, reducing its useful life and impairing the quality of its optics.
Moreover, the failure to clean all organic materials from a flexible endoscope's
channels is a common cause of blocked channels, which require expensive
endoscope repairs as well as a back-up inventory of endoscopes. In addition, the
need to properly clean a flexible endoscope after each use requires that each
doctor performing endoscopies must either have access to a number of endoscopes
or be forced to wait an estimated 60 minutes between each endoscopic procedure
(assuming the endoscope is cleaned in compliance with FDA Guidelines).

Company Strategy

The Company's business strategy is to develop, manufacture and market
products for endoscopy which have infection-control advantages over conventional
flexible endoscopes. To implement this strategy, the Company has developed, and
is marketing and selling, a proprietary flexible endoscope system which consists
of two main components - a proprietary sterile disposable sheath, known as an
EndoSheath, and a reusable flexible endoscope incorporating the Company's
proprietary design. In particular, the Company has developed, and is marketing
and selling, a family of disposable EndoSheath/reusable flexible endoscope
systems for gastrointestinal endoscopy and pulmonary endoscopy. The Company has
also developed EndoSheaths for use with certain conventional flexible endoscopes
(such as ENT endoscopes) currently sold by the Company and other manufacturers.

The Company believes that its EndoSheath technology offers the following
advantages over conventional reusable flexible endoscopes:

. It represents the only known effective technology designed to eliminate
the risk of cross-contamination from prior use of a flexible endoscope.

. It is designed to substantially reduce the health risks to nurses and
other medical personnel resulting from exposure to toxic disinfecting
agents used in the cleaning process.

. It significantly reduces the time and effort involved in the cleaning and
disinfection of conventional flexible endoscopes by hospital staff.

. It will reduce endoscope wear and tear resulting from repeated cleaning
and reduces endoscope repair costs, as the air, water, suction, and
accessory channels that are the source of a majority of repairs have been
made part of the disposable EndoSheath.

. It reduces endoscope "down time" and thereby allows hospitals and clinics
to stock a smaller number of flexible endoscopes, since there is little
delay before an endoscope is ready for use in the next procedure.

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. It increases the number of patients physicians can examine because of the
reduced delay in endoscope processing between procedures.

Products and Product Development Programs

The Company's primary products include proprietary flexible endoscopes,
EndoSheaths, and related products for a variety of medical applications. In
addition, the Company currently manufactures and sells ENT endoscopes,
borescopes (endoscope-like devices for industrial applications), and related
products.

EndoSheath/Endoscope Systems

The Company has developed a family of proprietary flexible endoscope
systems consisting of two main components - proprietary sterile disposable
sheaths, known as EndoSheaths and reusable flexible endoscopes incorporating the
Company's propriety design. The EndoSheaths and endoscopes included in this
system are functional only when used together.

Conventional flexible endoscopes generally include fiberoptic bundles or
video cameras for image production, a series of channels for delivery of air,
water, suction, and accessory devices and an operator body containing user
control knobs. The Company's proprietary design separates these features between
the disposable EndoSheath and the reusable endoscope. The Company's proprietary
flexible endoscopes include the lighting, imaging and operator control features
necessary to perform the intended medical procedures. The endoscopes also
include microswitches instead of valves, and control knobs that may be removed
for sterilization. The EndoSheaths, which are designed to cover all surfaces of
the endoscope that come in contact with the patient, contain the air, water,
suction, and accessory channels that are a part of conventional flexible
endoscopes, thus eliminating the need to clean these channels. The Company
believes, based upon its own quality assurance testing of this product and
physicians who have purchased and are using the system, that this product
functions clinically in essentially the same manner as conventional flexible
endoscopes, requiring no retraining of personnel or changes in procedural
techniques.

Installation of the EndoSheath onto the reusable endoscope can be performed
in a matter of minutes and is accomplished by inflating the sterile EndoSheath
with air, allowing the endoscope to be easily inserted into the EndoSheath.
After an endoscopic procedure, the disposable EndoSheath is then re-inflated,
and the flexible endoscope is removed from the EndoSheath. The EndoSheath and
packaging are then discarded, and the reusable endoscope is ready for use with a
new EndoSheath in the next procedure. This process takes 4 to 5 minutes, as
compared to the 60 minutes estimated for the proper cleaning of a conventional
flexible endoscope.

Due to the fact that the Company believes that sigmoidoscopy is one of the
most frequently performed endoscopic procedures, a fiberoptic sigmoidoscope was
the Company's first disposable EndoSheath/reusable flexible endoscope system.
The Company received FDA clearance of its 510(k) Pre-market Notification for
this product in October 1992 and began commercial shipments of this product in
April 1993. The Company also received FDA clearance of its 510(k) Pre-market
Notification for its black and white CCD video sigmoidoscope and EndoSheath
system in February 1994, its 130 cm length fiberoptic colonoscope and EndoSheath
system in February 1995, its fiberoptic gastroscope and EndoSheath system in
February 1995, and its fiberoptic ENT scope in December 1995. In December 1996
the Company received clearance from the FDA to market its fiberoptic
bronchoscope and EndoSheath system. In January 1997 the Company received
clearance from the FDA to market its color video sigmoidoscope.

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Other EndoSheaths

The Company has developed EndoSheaths for use with ENT endoscopes. ENT
endoscopes do not contain air, water, suction, or accessory channels and,
therefore, do not require the Company's proprietary flexible endoscope design in
order to be used with an EndoSheath. In addition, because ENT endoscopes do not
contain channels, the EndoSheath covers the distal end of the endoscope thus
making these EndoSheaths a simpler and less expensive product. The Company
received FDA clearance of its 510(k) Pre-market Notification for its first ENT
EndoSheath in October 1992 and began commercial shipments of this product in
December 1992. In January 1993, the Company received FDA clearance of its
510(k) Pre-market Notification covering four additional disposable EndoSheaths
for use with the Company's other ENT endoscope, two ENT endoscopes sold by
Pentax Precision Instrument Corporation ("Pentax"), and an ENT endoscope sold by
Olympus Optical Co., Ltd. ("Olympus"). The Company began shipping its
EndoSheath for use with an endoscope sold by Olympus in March 1993 and began
shipments of the three other EndoSheaths during fiscal 1994. In December 1995
the Company received clearance from the FDA to market its own fiberoptic ENT
scope, and in December 1996 the Company received clearance from the FDA to
market its fiberoptic bronchoscope and EndoSheath barrier.

Other Products

Under the Machida name, the Company designs, manufactures and markets
flexible borescopes, which are similar in design to endoscopes and are used for
inspection and quality-control functions in industrial applications, such as the
inspection of aircraft engines and nuclear power plants. Through Machida, the
Company was the first to offer a flexible borescope with a grinding attachment
that allows users to "blend", or smooth small cracks, in small turbine blades of
jet engines without disassembling the engine, which would involve significant
expense and delay. The Company also offers a variety of ancillary products for
use with flexible endoscopes and borescopes, such as light sources, cameras,
adapters, accessories and imaging systems. Sales of these non-medical and
ancillary products were approximately $3.5 million, or 42%, of the Company's net
sales in fiscal 1997. The Company expects that net sales of these products over
the next several years will remain relatively constant and will constitute a
continually decreasing percentage of the Company's total business.

Sales and Marketing

The Company expects that the customers for its disposable EndoSheaths,
flexible endoscopes and related products will be Gastroenterologists, Colon and
Rectal Surgeons, Otolaryngologists, Pulmonologists, Primary Care Physicians, and
high-volume users in hospitals, medical clinics, and physicians' offices. As of
May 31, 1997, the Company had seven marketing employees, and utilized
independent sales representatives, distributors and/or dealers in both North
America and Europe, and intends to expand this indirect sales force over the
next year.

Although the Company has no specific plans or commitments in this regard,
the Company may also license to one or more third parties rights to manufacture
and sell reusable flexible endoscopes incorporating the Company's proprietary
design features, while retaining the rights to manufacture and sell the
EndoSheaths used with these endoscopes.

The Company sells its ENT endoscopes, disposable ENT EndoSheaths, and
related ancillary ENT products through an exclusive five-year distribution
agreement, which commenced in March 1994, with Smith & Nephew Richards Inc. The
Company's borescopes are sold both directly by its Machida subsidiary and
through independent sales representatives.

In the fiscal year ended March 31, 1997, sales to foreign customers
accounted for approximately 9% of the Company's annual net sales. The Company
currently sells certain models of its borescopes and ENT endoscopes outside of
the United States. Although the Company expects to continue to sell such
products outside of the United States, the Company expects that the substantial
majority of the sales of its new EndoSheaths and proprietary flexible endoscopes
will be made to customers within the United States.

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Sales to unaffiliated customers outside of the United States were
approximately $1,088,000, $675,000 and $718,000 for the fiscal years ended March
31, 1995, 1996 and 1997, respectively.

In the fiscal year ended March 31, 1995, Pratt & Whitney accounted for 11%
of net sales and Smith & Nephew Richards accounted for 33% of net sales. For the
fiscal year ended March 31, 1996, Smith & Nephew Richards accounted for 15% of
net sales and Kelly Air Force Base accounted for 10% of net sales. For the
fiscal year ended March 31, 1997, Smith & Nephew Richards accounted for 36% of
net sales.

Manufacturing

The Company produces its EndoSheaths at its Natick, Massachusetts facility
using molded and extruded components purchased from independent vendors, some of
which are manufactured to the Company's specifications. Most purchased
components are available from multiple sources. With the exception of its supply
agreement with Asahi Optical Co., Ltd. ("Asahi") and Applied Fiberoptics, Inc.
discussed below, the Company has no agreements with any of its vendors or
suppliers and purchases its required components and supplies on a purchase-order
basis. The Company contracts with third parties for the sterilization of the
EndoSheaths.

The Company assembles its flexible endoscopes designed for use with its
EndoSheaths at its Orangeburg, New York facility using purchased components and
subassemblies, as well as certain proprietary components produced by the
Company. Most purchased components and subassemblies are available from more
than one supplier. However, certain critical components, such as image bundles
and operator control bodies are currently being purchased solely from Asahi,
which is the parent company of a competitor of the Company. These components
are being purchased pursuant to a supply agreement, which expires in March 1999,
subject to earlier termination by mutual consent or upon breach or bankruptcy
and which may be extended with the consent of both parties. The Company
believes that while substitute components, which are currently produced by
sources other than Asahi, would be available, such substitute components may be
more expensive and of a lower quality and may require a redesign of the
Company's endoscope and additional regulatory clearances. Moreover, such
substitute components may not be immediately available in quantities needed by
the Company. The Company's inability to obtain a sufficient quantity of such
critical components on favorable terms could materially adversely affect the
Company's business. To date, the Company has encountered no significant
difficulties or delays in obtaining a sufficient quantity of such critical
components or subassemblies for the Company's proprietary flexible endoscopes
designed for use with its EndoSheaths. However, there can be no assurance that
no difficulties or delays will be experienced in the future as the Company
increases its manufacturing operations.

In February 1995, the Company terminated its ENT Scope supply relationship
with Machida Endoscope Company Ltd., an unaffiliated Japanese company. The
Company has entered into a manufacturing agreement, which expires February 2001,
with Applied Fiberoptics of Sturbridge, Massachusetts, to supply a fiberoptic
ENT scope.

The Company's borescopes are assembled using components and sub-assemblies
purchased from independent vendors. While most components and sub-assemblies
are currently available from more than one supplier, certain critical components
are currently purchased only from Machida Endoscope Company, Ltd. The failure
of the Company to obtain a sufficient quantity of such components on favorable
terms could materially adversely affect the Company's business.

The Company's light sources, camera, adapters, accessories and imaging
systems for non-medical applications are generally purchased by the Company from
a variety of vendors.

The Company has negotiated a license from a third party for a polymer
technology for manufacturing optically clear windows to be included in its
EndoSheaths for use with ENT endoscopes, intubation endoscopes and
bronchoscopes.

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Competition

The Company believes that the primary competitive factors in the flexible
endoscope market are the safety and effectiveness (including optical quality) of
the products offered, ease of product use, product reliability, price, physician
familiarity with the manufacturer and its products and third-party reimbursement
policies. In its non-medical markets, the Company believes that product
effectiveness, ease of product use, product reliability and price are the
principal competitive factors. The Company's ability to compete in its markets
is affected by its product development and innovation capabilities, its ability
to obtain required regulatory clearances, its ability to protect the proprietary
technology included in its products, its manufacturing and marketing skills and
its ability to attract and retain skilled employees.

The flexible endoscopes and related products currently sold and under
development by the Company face competition primarily from medical products
companies such as Olympus and Pentax, a subsidiary of Asahi. In addition, any
company that is able to significantly redesign conventional flexible endoscopes
to simplify the cleaning process, or significantly improve the current methods
of cleaning flexible endoscopes, would provide competition for the Company's
products. The principal competitors for the Company's non-medical products are
Olympus and Welch Allyn, Inc.

Many of the Company's competitors and potential competitors have greater
financial resources, research and development personnel, and manufacturing and
marketing capabilities than the Company. In addition, it is possible that other
large health care companies may enter the flexible endoscope market in the
future.

Patents and Proprietary Rights

The Company's success depends in part on its ability to maintain patent
protection for its products, to preserve its trade secrets and to operate
without infringing the proprietary rights of third parties. The Company's
strategy regarding the protection of its proprietary rights and innovations is
to seek patents on those portions of its technology that it believes are
patentable, and to protect as trade secrets other confidential and proprietary
information.

The Company and its subsidiaries currently hold 19 U.S. and 11 foreign
patents and have 7 U.S. patent applications and 13 foreign patent applications
pending, all of which relate to its disposable EndoSheaths and reusable flexible
endoscopes. These issued patents will expire on various dates in the years 2004
through 2013. There can be no assurance that the Company's pending patent
applications will result in patents being issued or that competitors of the
Company will not circumvent, or challenge the validity of, any patents issued to
the Company. In addition, in the event that another party infringes the
Company's patent rights, the enforcement of such rights is at the option of the
Company and can be a lengthy and costly process, with no guarantee of success.

Some of the technology used in, and that may be important to, the Company's
products is not covered by any patent or patent application of the Company. The
Company seeks to maintain the confidentiality of its proprietary technology by
requiring all employees who work with proprietary information to sign
confidentiality agreements and by limiting access by parties outside the Company
to such confidential information. However, there can be no assurance that these
measures will prevent the unauthorized disclosure or use of this information, or
that others will not be able to independently develop such information.
Moreover, as is the case with the Company's patent rights, the enforcement by
the Company of its trade secret rights can be lengthy and costly, with
no guarantee of success.

To date, no claims have been brought against the Company alleging that its
technology or products infringe intellectual property rights of others.
However, there can be no assurance that such claims will not be brought against
the Company in the future or that any such claims will not be successful.

10

Government Regulation

The medical products currently marketed and under development by the
Company are regulated as medical devices by the FDA under the federal Food, Drug
and Cosmetic Act (the "FDC Act") and require regulatory clearance prior to
commercialization in the United States. Under the FDC Act, the FDA regulates
clinical testing, manufacturing, labeling, distribution and promotion of medical
devices in the United States. Various states and other countries in which the
Company's products may be sold in the future may impose additional regulatory
requirements.

Following the enactment of the Medical Device Amendments to the FDC Act in
May 1976, the FDA classified medical devices in commercial distribution into one
of three classes, Class I, II, or III. This classification is based on the
controls necessary to reasonably ensure the safety and effectiveness of the
medical device. Class I devices are those devices whose safety and effectiveness
can reasonably be ensured through general controls, such as adequate labeling,
pre-market notification, and adherence to the FDA's GMP (Good Manufacturing
Practices) regulations. Some Class I devices are further exempted from some of
the general controls. Class II devices are those devices whose safety and
effectiveness can reasonably be ensured through the use of special controls,
such as performance standards, post-market surveillance, patient registries and
FDA guidelines. Class III devices are devices which must receive pre-market
approval by the FDA to ensure their safety and effectiveness. Generally, Class
III devices are limited to life-sustaining, life-supporting or implantable
devices.

If a manufacturer or distributor of medical devices can establish that a
new device is "substantially equivalent" to a legally marketed Class I or Class
II medical device or to a Class III medical device for which the FDA has not
required pre-market approval, the manufacturer or distributor may seek FDA
marketing clearance for the device by filing a 510(k) Pre-market Notification.
The 510(k) Pre-market Notification and the claim of substantial equivalence may
have to be supported by various types of information indicating that the device
is as safe and effective for its intended use as a legally marketed predicate
device.

Following submission of the 510(k) Pre-market Notification, the
manufacturer or distributor may not place the device into commercial
distribution until an order is issued by the FDA. By regulation, the FDA has no
specific time limit by which it must respond to a 510(k) Pre-market
Notification. At this time, the FDA typically responds to the submission of a
510(k) Pre-market Notification within approximately 90 days. The FDA may declare
that the device is "substantially equivalent" to another legally marketed device
and allow the proposed device to be marketed in the United States. The FDA may,
however, determine that the proposed device is not substantially equivalent, or
may require further information, such as additional test data, before the FDA is
able to make a determination regarding substantial equivalence. Such
determination or request for additional information could delay the Company's
market introduction of its products and could have a material adverse effect on
the Company.

If a manufacturer or distributor cannot establish to the FDA's satisfaction
that a new device is substantially equivalent, the manufacturer or distributor
will have to seek pre-market approval ("PMA") or reclassification of the new
device. A PMA application would have to be submitted and be supported by
extensive data, including pre-clinical and clinical trial data, to demonstrate
the safety and efficacy of the device. Upon receipt, the FDA will conduct a
preliminary review of the PMA application to determine whether the submission is
sufficiently complete to permit a substantive review. If sufficiently complete,
the submission is declared fileable by the FDA. By regulation, the FDA has 180
days to review a PMA application once it is determined to be fileable. While the
FDA has responded to PMA applications within the allotted time period, PMA
reviews more often occur over a significantly protracted time period and
generally take approximately two years or more from the date of filing to
complete. A number of devices for which FDA marketing clearance has been sought
have never been cleared for marketing.

If human clinical trials of a proposed device are required and the device
presents "significant risk", the manufacturer or distributor of the device will
have to file an investigational device exemption ("IDE") application with the
FDA prior to commencing human clinical trials. The IDE application must be
supported by data, typically including the results of animal and mechanical
testing. If the IDE application is approved, human clinical trials may begin at
the specific number of investigational sites and could include the number of
patients approved by the FDA.

11

Flexible endoscopes, EndoSheaths, and accessory products have been
classified by the FDA as Class II devices, and a Section 510(k) Pre-market
Notification must be submitted to and cleared by the FDA before such devices can
be sold. The Company has received FDA clearance of its 510(k) Pre-market
Notifications for the following products as of the dates noted. The Company
expects that it will be required to obtain 510(k) clearance for each additional
disposable EndoSheath/reusable flexible endoscope system that it develops in the
future.

Date of Clearance Product
- ----------------- ----------------------------------------------------------------------

October 1992 EndoSheath/reusable fiberoptic sigmoidoscope system
October 1992 EndoSheath for use with the Company's flexible ENT endoscope
January 1993 Four models of EndoSheaths for use with certain other ENT endoscopes
February 1994 EndoSheath/reusable black and white CCD video sigmoidoscope system
February 1995 EndoSheath/reusable fiberoptic 130 cm length colonoscope system
February 1995 EndoSheath/reusable fiberoptic gastroscope system
December 1995 Fiberoptic ENT scope
July 1996 EndoSheath for use with the Company's reusable fiberoptic ENT endoscope
August 1996 Vacuum ENT EndoSheath barrier
November 1996 EndoSheath barrier for use with the Company's fiberoptic sigmoidoscope
December 1996 EndoSheath barrier for use with the Company's fiber/video sigmoidoscopes
December 1996 EndoSheath barrier/reusable fiberoptic bronchoscope system
January 1997 EndoSheath barrier/reusable color video sigmoidoscope system

The Natick, Massachusetts and Orangeburg, New York facilities are
registered with the FDA as medical device manufacturers. As a result, these
facilities are subject to the FDA's "Good Manufacturing Practices" ("GMP")
regulations, which regulate their manufacturing, testing, quality control and
documentation procedures. The Company is also required to comply with the FDA's
labeling requirements, as well as its information reporting regulations. The
export of medical devices is also subject to regulation in certain instances.
The Company's compliance with these various regulatory requirements will be
monitored through periodic inspections by the FDA.

The process of obtaining required regulatory clearances can be lengthy and
expensive, and compliance with the FDA's GMP regulations and regulatory
requirements can be burdensome. Moreover, there can be no assurance that the
required regulatory clearances will be obtained, and those obtained may include
significant limitations on the uses of the product in question. In addition,
changes in existing regulations or the adoption of new regulations could make
regulatory compliance by the Company more difficult in the future. The failure
to obtain the required regulatory clearances or to comply with applicable
regulations may result in fines, delays or suspensions of clearances, seizures,
or recalls of products, operating restrictions and criminal prosecutions, and
could have a material adverse effect on the Company.

Third-Party Reimbursement

Hospitals, medical clinics and physicians' offices that purchase medical
devices such as the Company's EndoSheaths and flexible endoscopes generally rely
on third-party payors, such as Medicare, Medicaid, and private health insurance
plans to pay for some or all of the costs of the screening, diagnostic and
therapeutic procedures performed with these devices. Whether a particular
procedure qualifies for third-party reimbursement depends upon such factors as
the safety and effectiveness of the procedure, and reimbursement may be denied
if the medical device used is experimental or was used for non-approved
indication. The Company believes, based upon its knowledge of third-party
reimbursement practices, advice from consultants in this area and three years of
selling experience, that third-party reimbursement will be available for most
procedures using its disposable EndoSheath/reusable flexible endoscope systems.
However, the Company's Sigmoidoscope EndoSheath when used in a physician's
office on a Medicare patient has, to date, not received a reimbursement value
from the Health Care Financing Administration.

Third-party payors use a variety of mechanisms to determine reimbursement
amounts for procedures such as endoscopies. In some cases, reimbursement
amounts are based upon the provider's costs associated with the

12

procedure, including materials costs. In such a situation, the cost of the
EndoSheath used in the procedure would likely be covered by the reimbursement
payment. In other cases, payment is a fixed amount per procedure, per hospital
day, or per hospital stay; such a payment would not cover the cost of materials,
such as the EndoSheath, used in the procedure. However, in some cases where
reimbursement is a fixed amount per procedure, an additional materials
reimbursement may be available to cover the cost of certain supplies used. As
endoscopies performed with conventional flexible endoscopes do not require any
significant supplies, materials reimbursements for the Company's EndoSheaths may
become available at some point in the future.

There can be no assurance that third-party reimbursement will be available
for procedures performed with the Company's products or that the cost of the
Company's EndoSheaths would be covered by such reimbursement in the future. In
addition, reimbursement standards and rates may change. The Company believes
that the failure of users of the Company's products to obtain adequate
reimbursement from third-party payors could have a materially adverse effect on
the Company.

Product Liability and Insurance

The nature of the Company's products exposes the Company to significant
product liability risks. The Company maintains product liability insurance with
coverage limits of $2,000,000 per year. The Company believes that this level of
coverage is adequate, given its past sales levels and its anticipated sales
levels for the fiscal year ending March 31, 1998. The Company will reevaluate
the adequacy of this coverage when and if its sales levels substantially
increase. No product liability claims have been brought against the Company to
date. However, there can be no assurance that product liability insurance will
continue to be available to the Company on acceptable terms, or that product
liability claims in excess of the Company's insurance coverage, if any, will not
be successfully asserted against the Company in the future.

Research and Development

The Company believes that its future success depends in large part upon its
ability to develop new products and enhance its existing products. Accordingly,
the Company devotes significant funds and efforts to research and development.

The Company's research and development efforts in fiscal 1995 focused on
the 130 cm length fiberoptic colonoscope and EndoSheath system, the fiberoptic
gastroscope and EndoSheath system, the fiberoptic bronchoscope and EndoSheath
system, the fiberoptic ENT Scope and the vacuum ENT sheath. During fiscal 1996,
the research and development efforts focused on the 130 cm length fiberoptic
colonoscope and EndoSheath system, the fiberoptic gastroscope and EndoSheath
system, the fiberoptic bronchoscope and EndoSheath system, the vacuum ENT
EndoSheath, the fiberoptic ENT EndoSheath and the color CCD video sigmoidoscope
and EndoSheath system. During fiscal 1997, the research and development efforts
focused on the fiberoptic bronchoscope and EndoSheath system, the vacuum ENT
EndoSheath, the color CCD video sigmoidoscope and EndoSheath system as well as
refinement and cost reduction of existing products. The Company's research and
development expenses in fiscal years 1995, 1996, and 1997 were $2,223,000,
$2,399,000 and $2,289,000, respectively. The Company's research and development
efforts in fiscal 1998 are expected to be concentrated primarily on continuing
enhancements of, and additions to, the fiberoptic bronchoscope and EndoSheath
system, additional applications of small diameter endoscopes and EndoSheath
systems in the high growth field of minimally invasive surgery (such as
neurological, sinus and laparoscopic surgery), image guided surgical
applications using third-party surgical navigation technology combined with
EndoSheath technology and refinement and cost reduction of existing products.

13

Employees

As of April 30, 1997, the Company had 84 employees. No Company employees
are represented by a labor union. The Company believes that its employee
relations are good. The Company's success will depend in large part upon its
ability to attract and retain highly qualified scientific, management, sales and
marketing personnel.

Item 2. Properties
- ---------------------

The Company's principal executive offices and medical research and
development facilities currently occupy approximately 20,000 square feet of
space in Natick, Massachusetts under a lease which expires in November 2000. The
Company's EndoSheath products are manufactured in a 20,000 square foot facility
in the same industrial park in Natick under a lease which expires in November
2003. The operations of the Company's Machida subsidiary are located in
Orangeburg, New York under a lease for approximately 25,000 square feet which
expires in August 2000.

The Company's currently occupied Natick facilities and the Orangeburg
facility are registered with the FDA as medical device manufacturing facilities
and are, therefore, subject to the FDA's GMP regulations regarding
manufacturing, testing, quality control and documentation procedures. The
Company believes that the physical characteristics and layouts of these
facilities are adequate to manufacture its products in compliance with
applicable FDA regulations.

Item 3. Legal Proceedings
- ----------------------------

As of March 31, 1997, there were no material legal proceedings to which the
Company or any of its subsidiaries is a party, or of which any of their
properties is subject.

Item 4. Submission of Matters to a Vote of Security Holders
- --------------------------------------------------------------

No matters were submitted to a vote of the Company's security holders
during the last quarter of the fiscal year ended March 31, 1997.

Executive Officers of the Company

Katsumi Oneda, age 59, a co-founder of the Company, has been President,
Chief Executive Officer and Chairman of the Board of Directors of the Company
since October 1993. He served as Vice-Chairman of the Board of Directors of the
Company from May 1992 to October 1993, as Honorary Chairman of the Board of
Directors from October 1991 to October 1993, and as Chairman of the Board of
Directors from September 1990 to October 1991. From 1979 to December 1990, he
was President and Chief Executive Officer of Pentax Precision Instrument
Corporation. Mr. Oneda is a director of several private companies. He has been
a director of the Company since 1987.

Lewis C. Pell, age 53, a co-founder of the Company, has been Vice-Chairman
of the Board of Directors of the Company since May 1992. Mr. Pell has served as
a director of Heart Technology, Inc., a publicly-held medical device company.
Mr. Pell is a founder or co-founder of a number of other privately-held medical
device companies, including Biosense, Inc., Influence, Inc., Flexiclave, Inc.,
iSight, Inc., Vitality Biotechnologies, Inc. Mr. Pell was a co-founder and a
director of Versaflex Delivery Systems, Inc. and InStent, Inc. which were sold
in 1988 and 1996, respectively, to Medtronic, Inc. In 1983, Mr. Pell co-founded
American Endoscopy, Inc. and served as a director until it was sold in 1986 to
C.R. Bard, Inc. In September 1979, he co-founded Pentax Precision Instrument
Corporation and served as Executive Vice President and director until December
1990, when it was sold to Asahi Optical Company.

Gerald B. Lichtenberger, Ph.D., joined the Company in January 1997 as
Executive Vice President, Chief Operating Officer, Acting Chief Financial
Officer and Secretary. Prior to joining the Company, Dr. Lichtenberger served
since 1990 as President and a Director of iSight, Inc., a developer and
manufacturer of digital video cameras and components. Dr. Lichtenberger was Vice
President of Strategic Planning and Vice President of Operations of Pentax
Precision Instrument Corporation from 1986 until 1990, and was President, Chief
Executive Officer and Chairman of the Board of Directors of Systems of the
Future, Inc. from 1979 until 1986.

14

Robert A. LaRoche joined the Company in July 1994 as Vice President of
Marketing, became Vice President of Sales and Marketing in January 1995 and was
elected Treasurer in November 1995. Prior to joining the Company, Mr. LaRoche
held various positions in the sales and marketing departments of three divisions
of C. R. Bard, Inc., a medical products company, from May 1985 until June 1994.
Mr. LaRoche resigned from the Company effective April 30, 1997.

E. Paul Harhen joined the Company in September 1993 as Manager of
Manufacturing Engineering and was elected Vice President of Operations in
November 1995. Prior to joining the Company, Mr. Harhen worked from March 1993
until September 1993 as a manufacturing consultant helping companies to find
ways to automate production of high volume products. Mr. Harhen held various
engineering and operations positions at Johnson & Johnson, a medical products
company, from April 1981 until March 1993.

Officers are elected on an annual basis and serve at the discretion of the
Board of Directors.

15

PART II

Item 5. Market for the Registrant's Common Stock and Related Stockholder
- ---------------------------------------------------------------------------
Matters
- -------

Since December 15, 1992, the Company's Common Stock has been quoted on the
Nasdaq National Market under the symbol VSCI. The following table sets forth
the high and low sale prices for the Common Stock on the Nasdaq National Market
as reported by Nasdaq during the periods indicated.

Fiscal Year Ended
March 31, 1997 High Low
-------------- ---- ---

1st Quarter 4 1/8 1 3/4
2nd Quarter 3 1/4 1 3/4
3rd Quarter 2 1/4 1 3/16
4th Quarter 2 1/2 1 1/8

Fiscal Year Ended
March 31, 1996 High Low
-------------- ---- ---

1st Quarter 5 2 7/8
2nd Quarter 4 1/2 3 1/4
3rd Quarter 5 1/4 1 1/2
4th Quarter 5 5/8 2 3/4

Such over-the-counter market quotations reflect inter-dealer prices without
retail mark-up, mark-down, or commission and may not necessarily represent
actual transactions.

As of May 31, 1997, there were 14,696,909 outstanding shares of Common
Stock held by 291 stockholders of record, in addition to which there were
approximately 2,250 beneficial stockholders.

The Company has never paid cash dividends on its Common Stock, and the
Company does not expect to pay any cash dividends on its Common Stock in the
foreseeable future.

Item 6. Selected Financial Data
- ----------------------------------

The following table summarizes certain selected financial data and should
be read in conjunction with the financial statements and related notes on
Appendix A to this report.
- ----------

Year Ended March 31
------------------------------------------------
(in thousands, except per share data)
Statement of Operations Data:
1993 1994 1995 1996 1997
---- ---- ---- ---- ----

Net sales $ 5,623 $ 6,828 $ 7,702 $ 6,222 $ 8,330
Gross profit (loss) 1,828 (116) 193 (978) 736
Net loss from operations (5,507) (8,670) (8,727) (9,736) (6,453)
Net loss per share (.56) (.79) (.83) (.84) (.46)

Balance Sheet Data:

Cash, cash equivalents and
marketable securities 24,815 14,650 6,421 5,866 2,681
Total assets 28,937 21,549 12,837 11,076 6,850
Total liabilities 2,077 2,400 2,020 2,579 2,461
Stockholders' equity 26,860 19,149 10,817 8,497 4,389

16

Item 7. Management's Discussion and Analysis of Financial Condition and
- --------------------------------------------------------------------------
Results of Operations
- ---------------------

Background
- ----------

Vision-Sciences, Inc. develops, manufactures and markets unique flexible
endoscope products utilizing disposable sheaths which provide the users quick,
efficient product turnover while ensuring the patient a contaminant-free
product.

Results of Operations
- ---------------------

Fiscal Years Ended March 31, 1997 and 1996

Net sales for the fiscal year ended March 31, 1997 increased $2,108,000, or
34%, compared to the prior fiscal year. The increase in net sales was primarily
attributable to medical sales increasing $2,210,000, or 85%, partially offset by
a decrease in industrial sales of $102,000, or 3%, compared to the prior fiscal
year ended March 31, 1996.

The increase in medical sales primarily resulted from the Company being
allowed to market the ENT EndoSheath(R) product, which received FDA 510(k)
clearance to market during December 1995, throughout the entire fiscal year,
together with growing shipments of the sigmoidoscope EndoSheath system during
the year. The decrease in industrial sales for the fiscal year ended March 31,
1997, compared to the prior fiscal year, resulted primarily from the fact that
non-recurring revenue of $634,000 was recognized during the third quarter of the
prior fiscal year upon completion of a government contract.

Gross profit for the fiscal year ended March 31, 1997 increased $1,714,000
to $736,000. The increase in gross profit was primarily a result of increased
sales volume, which allowed better utilization of manufacturing capacity and
higher absorption of manufacturing overhead, as compared to the prior fiscal
year.

Selling, general, and administrative expenses for the fiscal year ended
March 31, 1997 decreased $1,458,000, or 23%, compared to the prior fiscal year
and represented 59% of net sales versus 102% in the prior fiscal year. The
decrease resulted primarily from general and administrative expenses decreasing
$890,000, or 30%, versus the prior fiscal year, primarily due to reduced
headcount, and selling and marketing expenses decreasing $568,000, or 17%,
versus the prior fiscal year, primarily due to the restructuring of the
Company's sales and marketing organization, wherein sales activities are to be
performed by independent sales representatives rather than a direct sales force.

Research and development expenses for the fiscal year ended March 31, 1997
decreased $110,000, or 5%, versus the prior fiscal year and represented 27% of
net sales in the current year versus 39% of net sales in the prior fiscal year.
These expenses were primarily due to the Company focusing its research and
development efforts on bringing its bronchoscope EndoSheath System to market, as
well as ongoing improvements in its other products. The bronchoscope EndoSheath
System received FDA 510(k) clearance to market in January 1997, and initial
orders for the system were received during the fiscal year ended March 31, 1997.

Interest income, net, for the fiscal year ended March 31, 1997 decreased
$135,000, or 44%, over the prior fiscal year due to lower levels of cash
equivalents and marketable securities.

Other income (expense) for the fiscal year ended March 31, 1997 increased
$72,000, or 389% over the prior fiscal year, primarily due to increased royalty
income.

Fiscal Years Ended March 31, 1996 and 1995

Net sales for the fiscal year ended March 31, 1996 decreased $1,480,000, or
19%, compared to the prior fiscal year. The decrease in net sales is primarily
attributable to sales of the ENT product line decreasing $1,593,000, or 51%,
compared to the prior fiscal year.

17

The decrease in net sales of the ENT product line was primarily
attributable to the Company not being allowed to sell its fiberoptic ENT scope
until the last week of December 1995 when the Company received clearance from
the FDA allowing the Company to market the scope as described in the Company's
510(k) pre-market notification.

Gross profit for the fiscal year ended March 31, 1996 decreased $1,171,000
to $(978,000). The decrease in gross profit resulted primarily from adjustments
to record excess/obsolete inventory as well as under-absorbed overhead due to
the lower sales volume.

Selling, general, and administrative expenses for the fiscal year ended
March 31, 1996 decreased $63,000, or 1%, compared to the prior fiscal year and
represented 102% of net sales versus 83% in the prior fiscal year. The decrease
resulted primarily from general and administrative expenses decreasing $368,000,
or 11%, compared to the prior fiscal year primarily due to the implementation of
new financial and administrative systems. Selling and marketing expenses
increased $305,000, or 10%, compared to the prior fiscal year primarily due to
the introduction of the Company's new marketing program designed to highlight
product awareness coupled with the addition of four new direct sales
representatives.

Research and development expenses for the fiscal year ended March 31, 1996
increased $176,000, or 8%, compared to the prior fiscal year and represented 39%
of net sales in the current year versus 29% of net sales in the prior fiscal
year. The increase in these expenses is primarily the result of the Company
implementing a development plan aimed at improving its existing products and
bringing additional products to market.

Interest income, net, for the fiscal year ended March 31, 1996 decreased
$131,000, or 30%, compared to the prior fiscal year due to lower levels of cash
equivalents and marketable securities.

Other income (expense) for the fiscal year ended March 31, 1996 increased
$146,000 compared to the prior fiscal year primarily due to increased royalty
income.

Liquidity and Capital Resources
- -------------------------------

In the fiscal years ended March 31, 1995, 1996 and 1997 the amount of cash
used in the Company's operation was $7,016,000, $6,953,000 and $4,964,000,
respectively. Cash used in operations during fiscal years 1995, 1996 and 1997
was primarily devoted to manufacturing, marketing and research and development.

The Company's inventories decreased from $1,804,000 at March 31, 1996 to
$706,000 at March 31, 1997. The decrease was primarily due to reductions of raw
materials and finished goods inventories due to increased sales volume, together
with adjustments to record excess/obsolete inventory.

The Company currently plans to spend no more than $250,000 on capital
purchases in fiscal year 1998. These capital expenditures are expected to relate
primarily to manufacturing equipment, tooling, molds and, to a lesser extent,
computer equipment and software, leasehold improvements, demonstration
equipment, laboratory equipment, and furniture and fixtures. The Company has no
material commitments for capital expenditures. The Company anticipates a
negative cash flow during at least the first two quarters of fiscal 1998.

On December 24, 1996, the Company completed a $2.0 million private equity
placement of the Company's common stock with Mr. Katsumi Oneda, Chairman, CEO
and President, and Mr. Lewis C. Pell, Vice Chairman. Mr. Oneda and Mr. Pell
each purchased 842,105 shares of common stock at a price of $1.1875 per share,
the closing price on December 17, 1996. After this transaction, Mr. Oneda and
Mr. Pell beneficially own approximately 23.5% and 22.0%, respectively, of the
outstanding shares of common stock of the Company.

At March 31, 1997 the Company's principal sources of liquidity included an
aggregation of $2.7 million in cash and cash equivalents. In addition, the
company has a demand bank line of credit under which the Company may borrow up
to $250,000 in cash net of any outstanding letters of credit. At March 31,
1997, the Company had

18

acceptances payable totaling $46,000 maturing in April and May 1997. The Company
has pledged $250,000 to secure the bank line of credit. The line is subject to
renewal in February 2002.

The Company has incurred losses since its inception, and losses are
expected to continue at least through the first two quarters of the fiscal year
ending March 31, 1998. The Company has funded the losses principally with the
proceeds from public and private equity financings. Management will be required
to obtain additional financing or an alternative means of support during fiscal
year 1998 and, accordingly, is pursuing various sources of financial support.
However, there can be no assurances that such funding or financial support will
be available or adequate to allow the Company to continue as a going concern. In
the event that these or other plans are not successful, there is substantial
doubt concerning the Company's ability to continue as a going concern. The
Company is also subject to other risks, including, but not limited to, the
successful marketing of its product, FDA clearance and regulation, and
dependence on key personnel.

Item 8. Financial Statements and Supplementary Data
- ------------------------------------------------------

The information required by this Item is attached as Appendix A.
----------

Item 9. Changes in and Disagreements with Accountants on Accounting and
- --------------------------------------------------------------------------
Financial Disclosure
- --------------------

Not applicable.

19

Part III

Item 10. Directors and Executive Officers of the Registrant
- -------------------------------------------------------------

The information required by this Item is contained in (1) the table
appearing under the heading "Election of Directors" in the Company's Proxy
Statement for its 1997 Annual Meeting of Stockholders (the "1997 Proxy
Statement"), which table is incorporated herein by reference, and (2) Part I
hereof under the caption "Executive Officers of the Company."

Item 11. Executive Compensation
- ---------------------------------

The information required by this Item appears under the headings "Election
of Directors - Director Compensation; - Executive Compensation; - Agreements
with Senior Executives"; and "- Compensation Committee Interlocks and Insider
Participation" in the 1997 Proxy Statement, which sections are incorporated
herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management
- -------------------------------------------------------------------------

The information required by this Item appears under the heading "Stock
Ownership of Certain Beneficial Owners and Managers" in the 1997 Proxy
Statement, which section is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions
- ---------------------------------------------------------

The information required by this Item appears under the heading "Certain
Relationships and Related Transactions" in the 1997 Proxy Statement, which
section is incorporated herein by reference.

20

Part IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- ---------------------------------------------------------------------------

(a) Index to Consolidated Financial Statements.

1. Financial Statements. The following financial statements and schedule
of Vision-Sciences, Inc. are included as Appendix A of this Report:
----------
Consolidated Balance Sheets - March 31, 1996 and 1997.

Consolidated Statements of Operations - For the years ended March 31,
1995, 1996 and 1997.

Consolidated Statements of Stockholders' Equity - For the years ended
March 31, 1995, 1996, 1997.

Consolidated Statements of Cash Flows - For the years ended March 31,
1995, 1996, and 1997.

Notes to Consolidated Financial Statements.

2. Financial Statement Schedules. The following consolidated financial
-----------------------------
statement schedule is included on page S-1.

Schedule II - Valuation and Qualifying Accounts

All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are not applicable and,
therefore, have been omitted.

3. Exhibits. The exhibits which are filed with this report or which are
--------
incorporated herein by reference, are set forth in the Exhibit Index on
page E-1.

(b) Reports on Form 8-K.
Not applicable.

21

SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

VISION-SCIENCES, INC.

By: /s/ Katsumi Oneda
---------------------------
Katsumi Oneda
President, Chief Executive
Officer and Chairman of
the Board of Directors

Date: June 16, 1997

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.

Signature Title Date
--------- ----- ----

/s/ Katsumi Oneda President, Chief ) June 16, 1997
- -------------------------- Executive Officer )
Katsumi Oneda and Chairman of the )
Board of Directors )
(Principal Executive )
Officer) )

/s/ Gerald B. Lichtenberger Executive Vice President, ) June 16, 1997
- -------------------------- Chief Operating Officer, )
Gerald B. Lichtenberger Acting Chief Financial )
Officer and Secretary )
(Principal Financial )
and Accounting Officer) )

/s/ Kenneth Anstey Director ) June 17, 1997
- --------------------------
Kenneth Anstey

/s/ William J. Nydam Director ) June 18, 1997
- --------------------------
William J. Nydam

/s/ Lewis C. Pell Director ) June 16, 1997
- --------------------------
Lewis C. Pell

/s/ Edward W. Benecke Director ) June 18, 1997
- --------------------------
Edward W. Benecke

/s/ Fred E. Silverstein Director ) June 17, 1997
- --------------------------
Fred E. Silverstein

Director ) June _, 1997
- --------------------------
Janice B. Wyatt

APPENDIX A

VISION-SCIENCES, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-1

CONSOLIDATED BALANCE SHEETS F-2

CONSOLIDATED STATEMENTS OF OPERATIONS F-3

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-4

CONSOLIDATED STATEMENTS OF CASH FLOWS F-5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-6

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS S-1

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Vision-Sciences, Inc.:

We have audited the accompanying consolidated balance sheets of Vision-Sciences,
Inc. (a Delaware corporation) and subsidiaries as of March 31, 1996 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended March 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Vision-Sciences, Inc. and
subsidiaries as of March 31, 1996 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended
March 31, 1997, in conformity with generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has incurred
substantial losses for the years ended March 31, 1995, 1996 and 1997. The
Company will be required to obtain additional funding or alternative means of
financial support in order to continue to operate as a going concern. Given
these factors, there is substantial doubt concerning the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
discussed in Note 1. The accompanying consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not a part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states, in all material respects, the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.

Boston, Massachusetts
May 9, 1997

F-1

VISION-SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS--MARCH 31, 1996 AND 1997

ASSETS 1996 1997

CURRENT ASSETS:
Cash and cash equivalents $ 1,688,651 $ 2,681,271
Marketable securities 4,177,322 -
Accounts receivable, net of allowance for doubtful
accounts of $52,000 and $127,000 in 1996 and
1997, respectively 1,124,379 1,849,407
Inventories 1,803,720 706,342
Prepaid expenses and deposits 285,904 150,021
---------------- ----------------

Total current assets 9,079,976 5,387,041
---------------- ----------------

PROPERTY AND EQUIPMENT, AT COST:
Machinery and equipment 2,680,261 2,684,286
Furniture and fixtures 214,626 214,626
Leasehold improvements 302,764 304,563
---------------- ----------------
3,197,651 3,203,475

Less--Accumulated depreciation and amortization 1,433,572 1,949,596
---------------- ----------------
1,764,079 1,253,879
---------------- ----------------

OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION
OF $56,000 AND $63,000 IN 1996 AND 1997, RESPECTIVELY 231,839 208,913
---------------- ----------------

Total assets $ 11,075,894 $ 6,849,833
================ ================

LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1997

CURRENT LIABILITIES:
Acceptances payable to a bank $ 127,602 $ 46,251
Accounts payable 418,054 499,142
Accrued expenses 1,923,282 1,878,638

---------------- ----------------
Total current liabilities 2,468,938 2,424,031
---------------- ----------------
DEFERRED CREDIT (Note 3) 109,665 36,558
---------------- ----------------
COMMITMENTS (Note 6)

STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--5,000,000 shares
Issued and outstanding--none - -
Common stock, $.01 par value-
Authorized--25,000,000 shares
Issued and outstanding--12,972,699 shares and
14,696,909 shares at 1996 and 1997, respectively 129,726 146,968
Additional paid-in capital 44,035,454 46,098,212
Accumulated deficit (35,667,889) (41,855,936)
---------------- ----------------

Total stockholders' equity 8,497,291 4,389,244
---------------- ----------------

Total liabilities and stockholders' equity $ 11,075,894 $ 6,849,833
================ ================

The accompanying notes are an integral part of these consolidated
financial statements.

F-2

VISION-SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1995, 1996 AND 1997

1995 1996 1997

NET SALES $ 7,702,008 $ 6,222,053 $ 8,329,971

COST OF SALES 7,509,253 7,199,994 7,593,485
------------ ------------ ------------

Gross profit (loss) 192,755 (977,941) 736,486

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 6,421,540 6,358,795 4,900,380

RESEARCH AND DEVELOPMENT EXPENSES 2,223,179 2,399,024 2,289,275

RESTRUCTURING CHARGE 274,908 -- --
------------ ------------ ------------

Loss from operations (8,726,872) (9,735,760) (6,453,169)

INTEREST INCOME, NET 439,706 309,204 174,602

OTHER INCOME (EXPENSE), NET (127,647) 18,521 90,520
------------ ------------ ------------

Net loss $ (8,414,813) $ (9,408,035) $ (6,188,047)
============ ============ ============

NET LOSS PER COMMON SHARE $ (.83) $ (.84) $ (.46)
========== ========== ==========

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 10,135,511 11,236,094 13,456,323
========== ========== ==========

The accompanying notes are an integral part of these consolidated financial
statements.

F-3

VISION-SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1995, 1996 AND 1997

Common Stock Additional Total
Number $.01 Paid-in Accumulated Stockholders'
of Shares Par Value Capital Deficit Equity

BALANCE, MARCH 31, 1994 10,134,511 $ 101,345 $ 36,892,712 $ (17,845,041) $ 19,149,016
Compensation expense from
stock option grants -- -- 72,740 -- 72,740
Exercise of stock options
and warrants 10,380 103 9,976 -- 10,079
Net loss -- -- -- (8,414,813) (8,414,813)
---------- --------- ------------ ------------- ------------

BALANCE, MARCH 31, 1995 10,144,891 101,448 36,975,428 (26,259,854) 10,817,022
Sale of common stock 2,615,308 26,153 6,473,847 -- 6,500,000
Compensation expense
from stock option grants -- -- 98,304 -- 98,304
Exercise of stock
options and warrants 212,500 2,125 487,875 -- 490,000
Net loss -- -- -- (9,408,035) (9,408,035)
---------- --------- ------------ ------------- ------------

BALANCE, MARCH 31, 1996 12,972,699 129,726 44,035,454 (35,667,889) 8,497,291
Sale of common stock 1,684,210 16,842 1,983,158 2,000,000
Exercise of stock
options and warrants 40,000 400 79,600 -- 80,000
Net loss -- -- -- (6,188,047) (6,188,047)
---------- --------- ------------ ------------- ------------

BALANCE, MARCH 31, 1997 14,696,909 $ 146,968 $ 46,098,212 $ (41,855,936) $ 4,389,244
========== ========= ============ ============= ============

The accompanying notes are an integral part of these consolidated financial
statements.

F-4

VISION-SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1995, 1996 AND 1997

1995 1996 1997

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (8,414,813) $ (9,408,035) $ (6,188,047)
Adjustments to reconcile net loss
to net cash used in operating activities-
Depreciation and amortization 370,544 573,894 538,801
Loss on disposal of property and equipment 127,682 -- 213,575
Compensation expense from stock option grants 72,740 98,304 --
Amortization of deferred credit (73,107) (73,109) (73,107)
Changes in current assets and liabilities-
Accounts receivable 186,420 (157,044) (725,028)
Inventories 567,400 1,470,993 1,097,378
Prepaid expenses and deposits 188,365 (95,396) 135,883
Accounts payable (538,612) 206,132 81,088
Accrued expenses 356,168 572,731 (44,644)
Accrued restructuring costs 141,423 (141,423) --
------------- ------------- -------------
Net cash used in operating activities (7,015,790) (6,952,953) (4,964,101)
------------- ------------- -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in marketable securities 6,450,477 (1,235,562) 4,177,322
Purchase of property and equipment (981,088) (512,869) (235,835)
Decrease (increase) in other assets 23,412 (73,792) 16,585
------------- ------------- -------------
Net cash provided by (used in) investing
activities 5,492,801 (1,822,223) 3,958,072
------------- ------------- -------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of acceptances payable to a bank (225,190) (5,208) (81,351)
Payments on long-term debt (40,956) -- --
Proceeds from the sale of common stock -- 6,500,000 2,000,000
Proceeds from exercise of stock options and
warrants 10,079 490,000 80,000
------------- ------------- -------------
Net cash provided by (used in) financing
activities (256,067) 6,984,792 1,998,649
------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (1,779,056) (1,790,384) 992,620

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 5,258,091 3,479,035 1,688,651
------------- ------------- -------------

CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,479,035 $ 1,688,651 $ 2,681,271
============= ============= =============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 1,959 $ -- $ --
============= ============= =============

The accompanying notes are an integral part of these consolidated financial
statements.

F-5

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Vision-Sciences, Inc. (the Company) was organized in 1987 to manufacture
and assemble optical products. The Company's products and accessories,
which provide minimally invasive access to areas not readily visible to the
human eye, are used within one industry segment.

The Company expects to derive a substantial portion of its future revenues
from its disposable Endosheath/reusable endoscope systems. The Company has
invested substantial funds in this product's development. The Company has
incurred losses for the years ended March 31, 1995, 1996 and 1997, and
losses are expected to continue at least through fiscal 1998. The Company
has funded the losses principally with the proceeds of public and private
equity financings. Management will be required to obtain additional funding
or alternate means of financial support; however, there are no assurances
that such funding or financial support will be available or adequate to
allow the Company to continue as a going concern. Management is currently
pursuing various sources of financial support. In the event that these or
other plans are not successful, there is substantial doubt concerning the
Company's ability to continue as a going concern. The Company is also
subject to other risks, including, but not limited to, the successful
marketing of its products, United States Food and Drug Administration (FDA)
clearance and regulation, and dependence on key personnel.

The accompanying consolidated financial statements reflect the application
of certain accounting policies as described below and elsewhere in the
notes to consolidated financial statements. The preparation of the
accompanying consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results in the future could differ from
those estimates.

(a) Principles of Consolidation

The accompanying consolidated financial statements reflect the
accounts of the Company and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated in consolidation.

(b) Net Loss per Common Share

Net loss per common share is based on the weighted average number of
common shares outstanding. Shares of common stock issuable pursuant to
stock options and warrants have not been considered, as their effect
would be antidilutive.

F-6

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

(c) Depreciation and Amortization

The Company provides for depreciation and amortization using the
straight-line method in amounts that allocate the cost of the assets
over their estimated useful lives, as follows:

Estimated
Asset Classification Useful Life

Machinery and equipment 5 Years
Furniture and fixtures 5 Years

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

(d) Revenue Recognition

The Company recognizes revenue upon product shipment.

(e) Inventories

Inventories are stated at the lower of cost or market using the
first-in, first-out (FIFO) method.

The components of inventories are as follows:

March 31,
1996 1997
---- ----

Raw materials $ 573,192 $ 202,833
Work-in-process 217,026 111,538
Finished goods 1,013,502 391,971
----------- ----------

$ 1,803,720 $ 706,342
=========== ==========

Work-in-process and finished goods inventories consist of materials,
labor and manufacturing overhead.

F-7

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

(f) Other Assets

Other assets consist of deposits and patent costs. Patent costs are
amortized on a straight-line basis over 17 years.

(g) Foreign Currency Transactions

The Company charges foreign currency exchange gains or losses in
connection with its purchases of products from vendors in Japan to
operations in accordance with Statement of Financial Accounting
Standards (SFAS) No. 52, Foreign Currency Translation.

(h) Cash and Cash Equivalents

The Company classifies investments with original maturities of three
months or less, consisting of U.S. Government issues and commercial
paper, as cash equivalents. Cash equivalents are stated at amortized
cost, which approximates market value.

(i) Marketable Securities

Marketable securities consist of marketable financial instruments
with original maturities greater than 90 days. The Company has
established guidelines relative to concentration, maturities and
credit ratings which maintain safety and liquidity.

The Company has classified its investments in marketable securities as
available-for-sale securities, in accordance with SFAS No. 115.
Marketable securities as of March 31, 1996 are recorded at market
value, which approximated amortized cost.

As of March 31, 1996, the Company held securities of the U.S.
Government or political subdivisions thereof with a weighted average
maturity of 160 days.

(j) Research and Development Expenses

Research and development expenses are charged to operations as
incurred.

F-8

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

(k) Concentration of Credit Risk

Financial instruments that potentially subject the Company to
concentration of credit risk are principally cash, marketable
securities and accounts receivable. The Company places its cash in
federally insured institutions and invests in marketable securities in
highly rated investment vehicles. Concentration of credit risk with
respect to accounts receivable relates to certain domestic and
international customers to whom the Company makes substantial sales
(see Note 8). To reduce risk, the Company routinely assesses the
financial strength of its customers and obtains letters of credit or
advance payments for most of its international sales; as a
consequence, the Company believes that its accounts receivable credit
risk exposure is limited. The Company maintains an allowance for
potential credit losses, but historically has not experienced any
significant credit losses related to any individual customer or group
of customers in any particular industry or geographic area.

(2) DEBT

The Company has a demand line-of-credit agreement with a bank in support of
general working capital needs and the issuance of commercial and standby
letters of credit. Borrowings under the agreement bear interest at the
bank's prime rate (8.5% at March 31, 1997) and are secured by the Company's
cash and marketable securities held by the bank. The Company may borrow up
to $250,000 (net of any letters of credit) under the line of credit, which
is subject to renewal by the bank on February 15, 2002. Under this
agreement, the Company is also subject to certain covenants. At
March 31, 1997, the Company had acceptances payable and outstanding letters
of credit aggregating $46,251, maturing in April and May 1997.

(3) DEFERRED CREDIT

In connection with the organization of Machida Incorporated, a wholly owned
subsidiary, in 1987, the Company acquired substantially all of the assets
subject to related liabilities of Machida America, Inc. The purchase price
of $849,000 consisted of $305,000 in cash, $432,000 in notes payable and
$112,000 in Cooper Life Science, Inc. common stock (the ultimate parent
entity of Machida America, Inc.), owned by the founders of Machida
Incorporated. In accordance with Accounting Principles Board Opinion
No. 16, Business Combinations (APB 16), the purchase price was allocated
based on the estimated fair values of the net assets acquired and
liabilities assumed. The fair value of the current assets, net of the
liabilities assumed, exceeded the purchase price by $731,000. In accordance
with APB 16, this excess was recorded as a deferred credit, which is being
amortized to operations over its expected benefit period of 10 years.

F-9

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(4) INCOME TAXES

The Company accounts for income taxes under the liability method in
accordance with SFAS No. 109, Accounting for Income Taxes. Under SFAS
No. 109, deferred tax assets or liabilities are computed based on the
differences between the financial statement and income tax bases of assets
and liabilities as measured by the enacted tax rates.

The components of the net deferred tax asset recognized in the accompanying
consolidated balance sheets with the approximate income tax effect of each
type of temporary difference are as follows:

March 31,
1996 1997

Net operating loss carryforwards $ 12,913,000 $ 15,050,000
Nondeductible reserves 1,205,000 1,318,000
Research and development credit
carryforwards 307,000 350,000
Other temporary differences 284,000 305,000
Depreciation (106,000) (31,000)
------------ ------------

14,603,000 16,992,000

Less--Valuation allowance 14,603,000 16,992,000
------------ ------------

Net deferred tax asset $ -- $ --
============ ============

The Company has recorded a valuation allowance equal to its net deferred
tax asset due to the uncertainty of realizing the benefit of this asset.

At March 31, 1997, the Company has operating loss carryforwards available
to offset future federal taxable income of approximately $37,600,000. These
operating loss carryforwards expire at various dates through 2011 and are
subject to review and possible adjustment by the Internal Revenue Service.

The Internal Revenue Code limits the amount of net operating loss
carryforwards that companies may use in any one year in the event of
cumulative changes in ownership over a three-year period in excess of 50%.

F-10

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(5) STOCKHOLDERS' EQUITY

(a) Sale of Common Stock

During fiscal 1996, two of the Company's stockholders/executives
invested $6,500,000 in the Company's common stock at a price per share
equal to the average closing price of the stock on the Nasdaq National
Market during the ten-day trading period ending on the date of sale.
During fiscal 1997, two of the Company's stockholders/executives
invested $2,000,000 in the Company's common stock at a price per share
equal to the closing price of the stock on the Nasdaq National Market
on December 17, 1996. The proceeds of the common stock sales were
received directly by the Company in exchange for newly issued shares
of common stock.

(b) Stock Option Plan

The Company has a stock option plan (the 1990 Plan) under which it may
grant key employees and consultants incentive and nonstatutory stock
options at the fair value of the stock on the date of grant. Options
become exercisable at varying dates ranging up to five years from the
date of grant. The Board of Directors has authorized the issuance of
options for the purchase of up to 2,375,000 shares of common stock
under the 1990 Plan, of which 551,780 shares remain available for
future grant.

A summary of the 1990 Plan activity is as follows:

Weighted
Number Exercise Average
of Shares Price Range Option Price
--------- ----------- ------------

Outstanding, March 31, 1994 1,132,038 $ 2.00-$ 8.125 $ 5.40
Granted 207,517 4.875- 7.125 5.35
Exercised (2,187) 4.00- 5.00 4.57
Canceled (82,463) 4.00- 8.125 6.86
--------- ---------------- ----------
Outstanding, March 31, 1995 1,254,905 $ 2.00-$ 7.50 $ 5.30
Granted 271,397 1.875- 5.438 2.91
Exercised (212,500) 2.00- 4.00 2.31
Canceled (203,430) 3.00- 7.25 5.42
--------- ---------------- ----------
Outstanding, March 31, 1996 1,110,372 $ 1.875-$ 7.50 $ 5.27
Granted 729,000 1.19- 3.00 1.38
Exercised (40,000) 2.00 2.00
Canceled (296,550) 1.875- 7.25 5.58
--------- ---------------- ----------
Outstanding, March 31, 1997 1,502,822 $ 1.19-$ 7.50 $ 3.41
========= ================ ==========

Exercisable, March 31, 1997 760,775 $ 1.19-$ 7.50 $ 4.42
========= ================ ==========

F-11

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

In October 1995, the FASB issued SFAS No. 123, which requires the
measurement of the fair value of stock-based compensation to be included in
the statement of operations or disclosed in the notes to the financial
statements. The Company has determined that it will continue to account for
stock-based compensation for employees under the Accounting Principles
Board Opinion No. 25 and elects the disclosure-only alternative under SFAS
No. 123 for stock-based compensation awarded in the years ended
March 31, 1996 and March 31, 1997 using the Black-Scholes option pricing
model prescribed by SFAS No. 123. The underlying assumptions used are as
follows:

March 31,
1996 1997
---- ----

Risk-free interest rate............................ 6.18% 6.18%
Expected dividend yield............................ -- --
Expected lives..................................... 5 5
Expected volatility................................ 52% 52%
Weighted average value of grants .................. $2.91 $1.38
Weighted average remaining contractual
life of options outstanding (years)............... 7.02 7.09

Had compensation cost for the Company's stock option plans been determined
consistent with SFAS No. 123, pro forma net loss and net loss per share
would have been:

March 31,
1996 1997
---- ----

Net loss --
As reported................................... $(9,408) $(6,188)
Pro forma..................................... (9,418) (6,302)
Net loss per share --
As reported................................... $ (.84) $ (.46)
Pro forma..................................... (.84) (.47)

Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to March 31, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in
future years.

F-12

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(5) STOCKHOLDERS' EQUITY (Continued)

(b) Stock Option Plan (Continued)

Under the 1990 Plan, there remain 2,056,052 shares of common stock
reserved for the exercise of stock options.

On August 16, 1993, the Company adopted another stock option plan (the
1993 Plan) under which it may grant up to 200,000 nonstatutory stock
options to nonemployee directors of the Company at the fair value of
the stock on the date of grant. In the year ended March 31, 1994,
options to purchase 80,000 shares of common stock at an exercise price
of $11.625 per share were granted. In the year ended March 31, 1995,
options to purchase 20,000 shares at an exercise price of $5.50 per
share were granted, and options to purchase 20,000 shares of common
stock at an exercise price of $11.625 were canceled. Options become
exercisable over a four-year period from the date of grant. As of
March 31, 1997, options to purchase 60,000 shares of common stock were
exercisable under the 1993 Plan. The Company has reserved 200,000
shares of common stock for options under the 1993 Plan.

(6) COMMITMENTS AND RELATED PARTY TRANSACTIONS

(a) Operating Lease Commitments

The Company conducts a portion of its operations in certain facilities
leased from a partnership owned in part by certain stockholders.
Rental expense charged to operations for these facilities was
approximately $293,000, $299,000 and $204,000 for the years ended
March 31, 1995, 1996 and 1997, respectively. In addition, the Company
leases a vehicle and other facilities from nonrelated parties under
various agreements that expire through November 2003. Rental expense
charged to operations under leases from nonrelated parties was
approximately $275,000, $281,000 and $283,000 for the years ended
March 31, 1995, 1996 and 1997, respectively. Future minimum lease
commitments under all operating leases are approximately as follows:

Year Ending March 31,

1998 $ 485,000
1999 485,000
2000 487,000
2001 309,000
2002 127,000
Thereafter 211,000
-----------

$ 2,104,000
===========

F-13

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(6) COMMITMENTS AND RELATED PARTY TRANSACTIONS (Continued)

(b) Other Commitments

In fiscal 1991, the Company entered into a consulting agreement,
expiring in June 1997, with a member of the Board of Directors to
provide consulting services in the development of certain endoscopic
products. The future minimum commitment under this agreement is
$12,500.

(7) 401(k) PLAN

The Company has a 401(k) plan (the Plan) whereby employees may contribute a
certain percentage of their annual compensation, up to a defined maximum.
The Company may, but is not obligated to, contribute up to a certain
percentage of each employee's contribution. During the years ended
March 31, 1995, 1996 and 1997, the Company recorded expense of
approximately $70,000, $32,000 and $31,000, respectively, relating to the
Plan.

(8) EXPORT SALES AND SIGNIFICANT CUSTOMERS

Sales to unaffiliated customers outside of the United States were
approximately $1,088,000, $675,000 and $718,000 for the fiscal years ended
March 31, 1995, 1996 and 1997, respectively.

For the fiscal year ended March 31, 1995, one customer accounted for 11% of
net sales, and another customer accounted for 33% of net sales. For the
fiscal year ended March 31, 1996, one customer accounted for 15% of net
sales, and another customer accounted for 10% of net sales. For the fiscal
year ended March 31, 1997, one customer accounted for 36% of net sales.

(9) ACCRUED EXPENSES

Accrued expenses consist of the following:

March 31,
1996 1997
---- ----

Accrued payroll and related expenses $ 714,184 $ 215,098
Accrued other 1,209,098 1,663,540
---------- ----------

$1,923,282 $1,878,638
========== ==========

F-14

VISION-SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1997

(Continued)

(10) NEW ACCOUNTING STANDARD

On March 3, 1997, the FASB issued SFAS No. 128, Earnings Per Share. SFAS
No. 128 establishes standards for computing and presenting earnings per
share, and applies to entities with publicly held common stock or
potential common stock. This statement is effective for fiscal years
ending after December 15, 1997, and early adoption is not permitted. When
adopted, the statement will require restatement of prior years' earnings
per share. The Company will adopt this statement for its fiscal year
ended March 31, 1998. In addition, the Company believes that the adoption
of SFAS No. 128 will not have a material effect on its financial
statements.

SCHEDULE II

VISION-SCIENCES, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED MARCH 31, 1995, 1996 AND 1997

Balance, Charged to Balance,
Beginning Costs and End of
Description of Year Expenses Write-offs Year
----------- ------- -------- ---------- ----

DEDUCTED FROM ASSETS ACCOUNTS:
Allowance for doubtful accounts-
Year ended March 31, 1995 $ 58,045 $ 4,261 $ 32,739 $ 29,567

Year ended March 31, 1996 29,567 26,537 4,104 52,000

Year ended March 31, 1997 $ 52,000 $ 75,000 $ 0 $ 127,000

S-1

EXHIBIT INDEX

Exhibit Description of Exhibit Page
- ------- ---------------------- ----

3.1.(1) Restated Certificate of Incorporation of __
the Company, as amended to date

3.2.(2) By-laws, as amended to date __

*10.1.(4) 1990 Stock Option Plan, as amended __

*10.2.(4) 1993 Director Option Plan __

10.3.(2) Registration Rights Agreement dated as __
of February 28, 1992 among the Registrant
and the persons listed therein

*10.4.(2) Vision-Sciences, Inc. 401(k) Plan, as __
amended

10.5.(2) Supply Agreement between Machida __
Incorporated and Steve Onody dated
August 29, 1991

10.6.(2) Purchase Agreement between Vascu-Care, __
Inc. and Steve Onody dated August 29,
1991

10.7.(2) Lease between Paul D. McKeon, Trustee __
of Six Strathmore Road Trust and V-M
Ventures Incorporated dated October 24,
1990, as amended by Amendment No. 1 to
Lease dated September 1, 1990

10.8.(7) Amendment No. 2 to Lease between __
Paul D. McKeon, Trustee of Six
Strathmore Road Trust and Vision-
Sciences, Inc.

E-1

Exhibit Description of Exhibit Page
- ------- ---------------------- ----

10.9.(7) Amendment No. 3 to Lease between __
Paul D. McKeon, Trustee of Six
Strathmore Road Trust and Vision-
Sciences, Inc.

10.10.(2) Lease between Machida Incorporated and __
J&J Associates dated September 1, 1990

10.11.(7) Renewal to Lease between Machida __
Incorporated and J&J Associates
dated September 1, 1995

10.12.(2) Lease between Machida Incorporated and __
South Bay Club Apartments dated July 12,
1991

10.13.(2) Non-Exclusive License Agreement among __
Opielab, Inc., O.S. Limited Partnership
and Asahi Optical Co., Ltd. dated
September 28, 1988

+10.14.(3) License Agreement between Vision-Sciences, __
Inc. and Advanced Polymers, Inc. dated
June 10, 1993

*10.15.(2) Consulting Agreement between Vision- __
Sciences, Inc. and Fred Silverstein
dated July 1, 1990

10.16.(7) Consulting Agreement between Vision- __
Sciences, Inc. and Fred Silverstein
dated June 6, 1995

10.17.(2) Distributorship Agreement dated __
January 1, 1991 between Storz Instru-

E-2

Exhibit Description of Exhibit Page
- ------- ---------------------- ----

ment Company and Machida Incorporated,
as amended

10.18.(2) Form of Vision-Sciences, Inc. Invention, __
Non-Disclosure and Non-Competition
Agreement for employees

10.19.(2) Supply Agreement between the Company __
and Asahi Optical Co., Ltd. dated
March 16, 1992

10.20.(2) Royalty Agreement between Vision- __
Sciences, Inc. and C.R. Bard, Inc.
dated December 12, 1989

10.21.(2) Consulting Agreement between Vision- __
Sciences, Inc. and Richard Rothstein
dated November 1, 1991

10.22.(2) Agreement, Assumption and Release __
dated as of September 1, 1992 among
Stephen Onody, Vascu-Care, Inc.,
Machida Incorporated and Summit
Technologies, Inc.

10.23.(5) Amendment to License Agreement between __
Vision-Sciences, Inc. and Advanced
Polymers, Inc. dated April 5, 1994

10.24.(7) Amendment to License Agreement between __
Vision-Sciences, Inc. and Advanced
Polymers, Inc. dated April 5, 1995

10.25.(7) Amendment to License Agreement between __
Vision-Sciences, Inc. and Advanced
Polymers, Inc. dated February 14, 1996

E-3

Exhibit Description of Exhibit Page
- ------- ---------------------- ----

10.26.(5) Agreement between Vision-Sciences, Inc. __
and Smith & Nephew Richards, Inc. dated
March 28, 1994

10.27.(6) Commercial Loan Agreement (including __
Security Agreement and Promissory Note)
between Vision-Sciences, Inc. and
The First National Bank of Boston
dated January 24, 1995

10.28.(7) Extension to Commercial Loan Agreement __
between Vision-Sciences, Inc. and
The First National Bank of Boston
dated November 16, 1995

10.29.(7) Lease between Paul D. McKeon, Trustee __
of 14 Burr Street Realty Trust and
Vision-Sciences, Inc. dated April 23, 1993

21.1.(1) Subsidiaries of the Company __

23.1. Consent of Arthur Andersen LLP __

27.1 Financial Data Schedule __

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

* Management contract or compensatory plan or arrangement
filed as an exhibit to this Form pursuant to Items 14(a)
and 14(c) of Form 10-K.

+ Confidential treatment granted as to certain portions.

(1) Incorporated by reference from the Annual Report on Form 10-K from the
fiscal year ended March 31, 1993.

E-4

Exhibit Description of Exhibit Page
- ------- ---------------------- ----

(2) Incorporated by reference from the Registration Statement
on Form S-1 (File No. 33-53490).

(3) Incorporated by reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1993.

(4) Incorporated by reference from the Annual Report on Form 10-K from the
fiscal year ended March 31, 1994.

(5) Incorporated by reference from the Quarterly Report on Form 10-Q/A for
the quarter ended June 30, 1994.

(6) Incorporated by reference from the Annual Report on Form 10-K from the
fiscal year ended March 31, 1995.

(7) Incorporated by reference from the Annual Report on Form 10-K from the
fiscal year ended March 31, 1996.

E-5