Executive Summary

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995, which are subject to various risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. These factors include, but are not limited to: pricing pressures, including cost-containment measures which could adversely affect the price of, or demand for our products; availability of parts on acceptable terms; our ability to design new products and the success of such new products; maintaining our manufacturing and distribution arrangement with Medtronic on acceptable terms; changes in economic conditions that may adversely affect the level of demand for our products; changes in foreign exchange markets; and changes in financial markets and changes in the competitive environment. Other examples of forward-looking statements include statements about expectations about future financial results, future products and future sales of new and existing products, future expenditures, and capital resources to meet anticipated requirements. Generally, words such as expect, believe, anticipate, may, will, plan, intend, estimate, could, and other similar expressions are intended to identify forward-looking statements. The forward-looking statements are based on our future plans, strategies, projections and predictions and involve risks and uncertainties, and our actual results may differ significantly from those discussed in the forward-looking statements. Factors that might cause such a difference could include the availability of capital resources, the availability of third-party reimbursement, government regulation, the availability of raw material components, our dependence on certain key distributors and customers, competition, technological difficulties, general economic conditions and other

risks detailed in our most recent Annual Report on Form 10-K and any subsequent periodic filings we make with the Securities and Exchange Commission (SEC). (Please refer to the section entitled "Risk Factors" in Part II of this Form 10-Q). We do not undertake an obligation to update our forward-looking statements to reflect future events or circumstances.

Registered Trademarks, Trademarks and Service Marks

Vision-Sciences, Inc. and its subsidiaries own the registered trademarks Vision Sciences®, Slide-On® and EndoSheath®.

Our fiscal year-end is on March 31 of each year, and is referred to herein as FY 08 and FY 09 (our current fiscal year), respectively. Q3 09 refers to the period from October 1, 2008 to December 31, 2008 and Q3 08 refers to the period from October 1, 2007 to December 31, 2007.

We design, develop, manufacture and market products for endoscopy - the science of using an instrument, known as an endoscope - to provide minimally invasive access to areas not readily visible to the human eye.

We were incorporated in Delaware in 1987 under the name Machida Incorporated (Machida). Since that time, we acquired by merger Cyberex Corporation (October 1988), Vascu-Care, Inc. (March 1989), and we acquired Opielab, Inc. through a share exchange (September 1990). In December 1990, we changed our name to Vision-Sciences, Inc. and Machida became a wholly owned subsidiary. Another of our subsidiaries, Vision Sciences Ltd., an Israeli corporation, has been inactive since the fiscal year ended March 31, 2002.

Vision-Sciences operates primarily in the medical segment, while Machida operates primarily in the industrial segment. In October, 2007 we purchased the assets of BEST Dysphagia Management Services, Inc., a Florida based speech pathology company, which specialized in providing what is referred to as the Bedside Endoscopic Swallowing Test (BEST) to nursing homes, rehabilitation centers and assisted living, facilities, via our wholly-owned subsidiary BEST DMS Inc. (BEST-DMS). BEST-DMS was our health services segment. In Q3 09 we sold the assets of BEST-DMS, and as part of the asset sale agreement changed the subsidiary name to VSI Services Inc. For more information, please refer to Item 1, Note 5. Discontinued Operations and Asset Sale, above.

Our principal executive offices are currently located at 40 Ramland Road South, Orangeburg, New York 10962. Our telephone number is (845) 365-0600. Our corporate website is www.visionsciences.com. Through a link on the Investor Relations section of our website, we make available all our SEC filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. All such filings are available free of charge.

As of November 1, 2008, due to the asset sale of our health services segment, we are returning to operate in two reportable segments, medical and industrial, in which we operated from April 07 (FY08) in which we operated from April 07 (FY08) through September 30, 2007 (Q2 08). Between October 1, 2007(Q3 08) and October 30, 2008, (Q4 09), we operated in three reportable segments, medical, industrial and health service.

Our medical segmentdesigns, manufactures, and sells our advanced line of endoscopy based products for a variety of specialties, including our state-of-the-art flexible endoscopes and our Slide-On EndoSheath technology.

Our longstanding primary line of high-quality fiber-based flexible endoscopes is now augmented with our first generation CCD (charge coupled device) based flexible digital video endoscope systems, which were announced and cleared for sale by the Food & Drug Administration (FDA) in Q3 and Q4 of FY 08. We expect this new high-performance imaging technology platform to redefine our place in the minimally invasive device market. These flexible video endoscopes are unlike conventional endoscopes, and when utilized with the EndoSheath technology, offer a multitude of benefits and advantages to the healthcare practice.

EndoSheath endoscopy, the differentiating term we give to procedures performed with our unique technology, consists of a reusable flexible endoscope combined with a single-use, sterile, protective disposable sheath, which is placed onto the insertion tube (patient contact area) of the endoscope. The use of the EndoSheath technology gives healthcare providers clinical and economic advantages, as it allows them to avoid the elaborate high level disinfection and sterilization routines required of conventional endoscopes. This design of "always ready" equipment, which allows for a rapid and less caustic cleaning process, provides a multitude of benefits such as: less capital inventory investment, less service and maintenance costs of capital equipment, less staff exposure to toxic chemicals, increased patient scheduling flexibility, improved staff productivity and a more practical implementation of office-based endoscopy.

We believe EndoSheath technology allows for unprecedented practice efficiency in a wide array of healthcare settings, from private practices to busy academic hospitals. In addition, each EndoSheath disposable is a sterile device, providing patients with a

contaminant-free insertion tube for each procedure and reducing the risk of cross-contamination found with the reuse of conventional flexible endoscopes, which are difficult to clean and disinfect and cannot be sterilized.

We target four main areas for our fiber and video scopes and our EndoSheath technology: ENT (ear, nose and throat), urology, gastroenterology (GI) and pulmonology. Within the ENT area, we manufacture ENT endoscopes and sell these scopes exclusively to Medtronic. In March 2007 we completed the sale to Medtronic of our ENT EndoSheath product line, which Medtronic now manufactures and distributes along with our ENT endoscopes. Our TNE (trans-nasal esophagoscopy) endoscopes and EndoSheaths which sold only to ENT physicians are manufactured by us, but they are marketed and distributed by Medtronic. Within the urology area, we manufacture, market and sell our cystoscopes and EndoSheaths to urologists and other uro-gyn related physicians. Within the GI area, we manufacture, market and sell our TNE scopes and EndoSheaths to GI physicians and primary care and other physicians with a GI focus as part of their practice. We intend to manufacture, market and sell our soon expected to be introduced bronchoscopes and EndoSheaths to pulmonologists, oncologists, thoracic surgeons and other pulmonology related physicians.

Our industrial segment,through our wholly-owned subsidiary, Machida, Inc., designs, manufactures and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument using optical fibers for the visual inspection of narrow cavities. Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items. Machida's quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments.

Our former health services segmentconsisted of our wholly-owned subsidiary BEST-DMS, which was established in October 2007. BEST-DMS was a service-based segment, providing the Bedside Endoscopic Swallowing Test (BEST) to nursing homes, rehabilitation centers, and assisted living facilities. (Please refer to Note 5. Discontinued Operations and Asset Sale, above).

Research and Development

At the end of Q1 09 we released our new family of flexible videoscopes, with a miniature digital camera mounted on the distal, or far, end of the insertion tube. This videoscope line includes the ENT-5000 (ear, nose and throat) videoscope, the TNE-5000 videoscope and our urology video-based flexible cystoscope, the CST-5000. We expect to release our video-based bronchoscope for the pulmonology area in the spring.

We continue to develop our next generation of improved family of medical and industrial fiberscopes, which will no longer have any Pentax parts. We anticipate that we will have completed the development and the FDA approval process for our new line of fiberscopes by the end of FY 09. While we believe we have enough Pentax parts inventory until we launch our new 4000 series line of fiberscopes, expected to occur in Q1 10, there can be no assurance that our supply of inventory will be adequate through such time when our new series of fiber scopes is launched.

We are also working on improving our manufacturing processes, which we believe will result in lower costs to produce our endoscopes and EndoSheaths. We are at various stages of exploration of opportunities in, and development of products for use in the medical fields of ENT, urology, gynecology, pulmonology and gastroenterology, among others.

Other Developments

(i) SpineView Development and Supply Agreement

On June 19, 2008 we entered into a Development and Supply Agreement with SpineView, Inc. (the SpineView Agreement), pursuant to which we are to develop and supply a CCD-based video endoscope to SpineView for use with SpineView's products. SpineView is engaged in the development and manufacture of miniature, minimally invasive, disposable spine surgery devices that include reusable endoscopes for visualization and image guidance.

SpineView agreed to pay us $225 for certain non-recurring engineering costs, and to reimburse us for up to $40 of our out-of-pocket costs. After the completion of certain milestones and delivery of a prototype, SpineView has agreed to place an initial firm order with us for 50 video endoscopes at a purchase price of $27 per unit (the Initial Order), for a total of $1,350. Following delivery of the Initial Order, SpineView is to submit a forecast for the following 12 months, of which the first six months will be considered a firm order at a price of $23.5 per video endoscope. Payment for certain of these items is subject to the closing of certain of SpineView's fundraising activities. We are also to be the exclusive supplier to SpineView of visualization means for use with certain future SpineView products. We are currently working with SpineView on the first prototype of CCD-based video endoscope.

The initial term of the SpineView Agreement is for four years from the date of delivery of the Initial Order and will automatically renew for successive one year periods, unless either party gives the other notice of its intention not to renew.

Mr. Lewis C. Pell, the chairman of our Board, is the chairman of the SpineView board of directors and an investor in SpineView. Mr. Ron Hadani, our president and chief executive officer and a member of our Board, and Mr. Katsumi Oneda, a member of our Board, are also investors in SpineView.

Our policy with respect to transactions in which any of our directors or officers may have an interest requires that such transaction be on terms no less favorable to us than could be obtained from unaffiliated third parties and be approved by a majority of the uninterested, outside members of the Board.

At a Board meeting held on May 29, 2008, the Board reviewed the terms of the final draft of the SpineView Agreement, outside of the presence of Mr. Pell, Mr. Oneda and Mr. Hadani. The remaining uninterested members of our Board determined that the SpineView Agreement was fair, properly negotiated, and would be at least as favorable to us as could have been obtained from unaffiliated third parties, and accordingly, after discussion, it was approved.

(ii) Gain on Sale of Product Line to Medtronic

In March of 2007, we completed the sale to Medtronic of certain assets with respect to our ENT EndoSheath business. As part of the transaction, we granted to Medtronic an exclusive, royalty-free worldwide license to certain of our intellectual property, for use in making and selling EndoSheath products solely within the field of ENT. Additionally, as part of the transaction and under a separate transition agreement, we transferred our ENT production lines for the EndoSheath ENT products from our Natick, MA facility to a Medtronic facility in Jacksonville, FL. Medtronic now distributes, markets and sells our ENT endoscope products worldwide, on a co-branded basis, through Medtronic's dedicated sales force.

Under the terms of the agreement, Medtronic paid us $34,000 as follows:

† $27,000 at the closing;

† $3,000 in the quarter ending June 30, 2008, representing the portion of the purchase price that was held back at closing for potential indemnification claims and to ensure that we complied with our obligations under the agreement with Medtronic;

† $4,000 relating to the transition agreement in several installments, based on agreed upon milestones.

The table below summarizes the payment stream since the closing of the transaction.

All payments under this agreement are now complete.

                         Medtronic Transaction Payments



                        10K        10Q        10Q                   10K       10Q       10Q         Total
Date                   FY 07      Sep-08     Dec-08     Mar-08     FY 08    Jun-08    Sep-08     Transaction
Revenues - Asset
Purchase Agreement    $ 27,000   $      -   $      -   $      -   $     -   $ 3,000   $     -   $      30,000
Revenues -
Transition
Agreement                    -        750        250        750     1,750       250     2,000           4,000
Expenses                  (903 )     (163 )     (118 )      (35 )    (316 )     (20 )    (244 )        (1,483 )
Gain on Sale of
Product Line          $ 26,097   $    587   $    132   $    715   $ 1,434   $ 3,230   $ 1,756   $      32,517

All payments were offset by certain expenses related to the transaction, as follows:

† During fiscal 07 (FY 07), upon receipt at the closing of $27,000, we recognized a net gain of $26,097 from the transaction. This gain reflects the initial payment of $27,000 received at the closing, less the net book value of the assets sold to Medtronic. The effect of this was to reduce our basis in the assets sold to Medtronic to zero;

† Total payments of $1,750 received during FY 08, were offset by $316 of expenses, primarily relating to the cost of a new production machine which we purchased and sold to Medtronic, and travel expenses related to the transition agreement, for a net gain of $1,434;

† Total payments of $3,250 received during Q1 09, which were offset by $20 of mainly travel expenses related to the transition agreement for a net gain of $3,230;

† A payment of $2,000 received during Q2 09 which was offset by legal, travel and other transition related expenses related to the transition agreement, for a net gain of $1,756.

Overall, as of the end of Q2 09, we booked a net gain of $32,517 out of total payments of $34,000.

(iii) Termination of a Material Definitive Agreement

On May 1, 2008, we entered into a definitive lease agreement with a landlord, Ramland Realty Associates, L.L.C., for new premises, consisting of approximately 34,795 square feet at One Ramland Road, Orangeburg, New York.

On December 31, 2008, we signed a Surrender and Acceptance Agreement with the landlord which cancelled the lease. We never occupied the facility and no payments were made or received in connection with the lease. (Please refer to Restructuring Charge in this section below).

Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America (see the Notes to the Consolidated Financial Statements included elsewhere herein). Certain of our accounting policies require the application of judgment in selecting the appropriate assumptions for calculating financial estimates. By their nature these judgments are subject to an inherent degree of uncertainty. We periodically evaluate the judgments and estimates used for our critical accounting policies to ensure that such judgments and estimates are reasonable for our interim and year-end reporting requirements. These judgments and estimates are based upon our historical experience, current trends and information available from other sources, as appropriate. If different conditions result from those assumptions used in our judgment, the results could be materially different from our estimates. Our critical accounting policies include the following:

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements.This pronouncement requires that five basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists (2) delivery has occurred or services were rendered (3) the fee is fixed and determinable (4) collectability is reasonably assured and (5) the fair value of undelivered elements, if any, exists. Determination of criterion (4) above is based on management's judgment regarding the collectability of invoices for products and services delivered to customers. Should changes in conditions cause management to determine this criteria is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We recognize revenue when title passes to the customer, generally upon shipment of our products F.O.B. shipping point.

Options Issued

Effective April 1, 2006 we began accounting for compensation expense related to stock options in accordance with SFAS No. 123 (Revised 2004) Share-Based Payment (SFAS 123R). Prior to April 1, 2006, we accounted for stock options according to Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees. We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123R and Emerging Issues Task Force Abstract No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services(EITF 96-18).

Three months ended December 31, 2008(Q3 09)

In accordance with SFAS 123R and EITF 96-18, we recorded $420 and $200 of stock-based compensation expense for Q3 09 and for Q3 08, respectively, in the following expense categories:

          Three Months Ended
             December 31,
            2008         2007
COGS    $         17    $   18
SG&A             177       143
R&D              226        39
Total   $        420    $  200

Nine months ended December 31, 2008(YTD 09)

In accordance with SFAS 123R and EITF 96-18, we recorded $1,266 and $591 of stock-based compensation expense in the statement of operations for YTD 09 and for the nine month period ended December 31, 2007 (YTD 08), in the following expense categories:

          Nine Months Ended
            December 31,
           2008         2007
COGS    $        88    $   48
SG&A            555       438
R&D             623       105
Total   $     1,266    $  591

The total compensation expense for YTD 09, 2008 includes a one-time adjustment of $299, recorded in Q2 09, of which $176 represents expense for FY 07 and FY 08, representing stock based compensation expense for non-employees consultants that should have been calculated and recognized according to EITF 96-18 for the period between September 2006 and June 2008. During Q2 09, we discovered that we had accounted for our non-employees consultants compensation expenses according to SFAS 123R instead of according to EITF 96-18. The adjustment impacted COGS by $23, SG&A by $22 and R&D by $254. We reviewed the impact of these adjustments on the results of operations for FY 07 ($75), FY 08 ($101) and Q1 09 ($123), and found it to be immaterial.

At December 31, 2008, the total value of unamortized stock based compensation was approximately $3,274. We will expense that amount over periods ending through June 30, 2013. We do not expect to realize any tax benefits from future disqualifying dispositions, if any, since we currently have a full valuation allowance on our deferred tax assets.

In the nine months ended December 31, 2008, we granted options to purchase a total of 1,522,958 shares of our common stock, as follows: (i) a total of 1,467,958 options were granted from the 2007 Plan; (ii) 31,000 options were granted from the 2000 Plan and (iii) 54,000 options were granted from our 2003 Plan. The fair value of these options measured at the option grant date was approximately $4,079, determined using the Black-Scholes option-pricing model. This amount is reduced by an estimated forfeiture rate and is being recorded as an expense over the vesting period. Our assumptions used in the Black-Scholes option-pricing model in the period were as follows:

Risk-free interest rate                    1.71% - 3.55 %
Expected dividend yield                               -
Expected life                                6.25 years
Expected volatility                                  82 %
Weighted grant average value per share   $         2.74

We account for options issued to directors, non-employees, consultants and employees in accordance with the provisions of SFAS 123R and EITF 96-18. We grant options with vesting periods ranging from immediate to six years. We use the simplified method of calculating the expected option term, which averages an award's weighted average vesting period and its contractual term. The contractual term of our options is ten years. The risk-free rate is based upon the daily treasury yield curve for a period approximately equal to the expected option term. We used historical data to estimate the expected price volatility and forfeiture rate. The expected dividend yield is 0%, based on our history of not paying dividends.

Income Taxes

We account for income taxes under the liability method, and deferred tax assets or liabilities are computed based on the differences between the financial statement and income tax basis of assets and liabilities as measured by the enacted tax rates. We have recorded a valuation allowance equal to our net deferred tax asset due to the uncertainty of realizing the benefit of this asset.

Results of Operations

Net Sales

Three months ended December 31, 2008 (Q3 09) compared to the three months ended December 31, 2007 (Q3 08)

Net sales for Q3 09 were $3,610, an increase of $1,766, or 96%, compared to sales of $1,844 for Q3 08. During Q3 09 net sales of our medical segment increased by $1,530, or 123%, from $1,246 to $2,776, and net sales of our industrial segment increased by $236, or 39%, from $598 to $834. Our sales growth this quarter is a result of (i) additional fiberscope sales over Q3 08, when our sales were severely impacted by the shortage of parts due to our dispute with Pentax; (ii) the availability of our new videoscopes, which were not available in Q3 08, and (iii) higher unit prices for our videoscope product line than for our fiberscope product line.

Sales by segment and category in Q3 09 and Q3 08 were as follows:

Segment:                                Q3 09     Q3 08     Difference    Percentage
Medical
Scopes                                 $ 1,804   $   456   $      1,348          296 %
EndoSheaths                                327       488           (161 )        (33 )%
Repairs, Peripherals and Accessories       645       302            343          114 %
Total Medical                            2,776     1,246          1,530          123 %

Industrial
Borescopes and Accessories             $   664   $   423   $        241           57 %
Repairs                                    170       175             (5 )         (3 )%
Total Industrial                           834       598            236           39 %

Total Sales                            $ 3,610   $ 1,844   $      1,766           96 %

Medical Sales-Scope Products



Net sales to the medical scope market include products used for ENT (including
TNE), urology and other markets were as follows:



Medical Scope Market    Q3 09    Q3 08     Difference    Percentage
ENT and TNE            $ 1,768   $  311   $      1,457          468 %
Urology and Other           36      145           (109 )        (75 )%
Total Scopes           $ 1,804   $  456   $      1,348          296 %

Overall endoscope sales increased by $1,348, or 296%, from $456 to $1,804, mainly due to sale of ENT videoscopes to Medtronic, which started selling this new product line at the end of Q2 09. Overall sales of ENT and TNE scopes rose by $1,457, or 468%, from $311 in Q3 08 to $1,768 in Q3 09. Sales to our urology and other markets decreased by $109, or 75%, from $145 in Q3

. . .