The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this Report.

Executive Overview

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 have two reportable segments, medical and industrial. Each of these operating segments has unique characteristics and faces different opportunities and challenges.

Our medical segment designs, manufactures, and sells our advanced line of endoscopy-based products, including our flexible endoscopes, and our EndoSheath technology, for a variety of specialties and markets. We target six market spaces:

· Urology - we manufacture, market, and sell our cystoscopes and EndoSheath technology to urologists and other urology-gynecology related physicians. Pursuant to the Stryker agreement, we supply to Stryker our flexible video and fiber cystoscopes and related EndoSheath products.

· Pulmonology (Critical Care) - we manufacture, market, and sell our bronchoscope (an endoscope that allows detailed viewing of the lungs) and EndoSheath technology to intensivists, pulmonologists, thoracic surgeons, and other airway-related physicians.

· Surgery - we manufacture, market, and sell our TNE endoscopes and EndoSheath technology to general surgeons, primarily bariatric and GERD surgeons.

· Gastroenterology - we manufacture, market, and sell our TNE endoscopes and EndoSheath technology to gastroenterologists, ENT physicians and others with a GI focus as part of their practice.

· ENT (ear, nose, and throat) - we manufacture, market, and sell our ENT endoscopes to ENT physicians.

· Spine - we supply to SpineView our flexible video surgical endoscope systems for use with SpineView's products.

We believe our technology delivers significant value to our customers - doctors, clinics and hospitals - through reduced capital, staff and service costs, and increased patient throughput, practice revenue, and profitability. Our EndoSheath technology allows our customers to buy fewer endoscopes to service their patients and enables a higher patient throughput. Our single-use EndoSheath technology provides a sterile barrier between patients and our reusable endoscopes, eliminating the need for time-consuming reprocessing routines necessary with conventional endoscopes. Our endoscopes are therefore typically ready for the next procedure in ten minutes or less, unlike conventional endoscopes which may take from 45 minutes to up to 24 hours to reprocess. We believe our EndoSheath technology is the solution to the challenges and problems with conventional flexible endoscopes, including significantly reducing cross-contamination risk. In November 2011, the ECRI Institute listed cross-contamination from flexible endoscopes as fourth among the top-ten health technology hazards for 2012. With our EndoSheath technology we are able to reduce the steps to reprocess flexible endoscopes from approximately 27 to three, thereby reducing costs and saving time. By offering a technology that provides simpler and quicker endoscope reprocessing and sterility derived from use of a single-use disposable sheath, we have addressed many of the concerns and issues regarding conventional flexible endoscopy.

Our industrial segment 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 that uses 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. Our Machida subsidiary's quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments.

Private Placement

On January 18, 2011, we issued 7 million shares of our common stock at a purchase price of $1.50 per share to a number of investors in a private placement for aggregate gross proceeds of $10.5 million. We are using the proceeds from the private placement for working capital and general corporate purposes. We granted the investors in this private placement piggy-back registration rights, whereby if we decide to file a registration statement relating to an offering of any of our equity securities, other than on Form S-4 or Form S-8, then these investors will have the right, after notice, to include their securities in that registration statement. The investors in this private placement have no right to otherwise require us to register the sale of their shares.

Line of Credit - Related Party

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

This Agreement amends and restates the original Revolving Loan Agreement between the Lender and us dated November 9, 2009 (the "Original Agreement") pursuant to which we borrowed $5 million (the "Original Loan Amount"). Under the Loan Agreement, we may draw up to the New Loan amount until November 9, 2014 or such earlier time as the Loan Agreement is terminated in accordance with its terms. The Loan Agreement extends the Original Loan Amount repayment date to be consistent with the New Loan Amount and extends the expiration date of the stock warrants issued under the Original Agreement to be consistent with the terms of the New Warrant (as defined below).

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

Any amounts drawn against the New Loan (an "Advance") accrue interest at an annual rate of 7.5%. The Lender will receive an availability fee equal to an annual rate of 0.5% on the unused portion of the New Loan calculated based on the difference between the average annual principal amount of the outstanding Advances under the Loan Agreement and the maximum amount of aggregate Advances of $10.0 million.

In connection with the Loan Agreement, the Lender received a warrant to purchase an aggregate of 1,229,105 shares of our common stock at an exercise price of $2.034 per share (the "New Warrant"). The New Warrant vested immediately upon issuance and expires on the later of the fifth anniversary of the New Warrant or one year after the termination of the Loan Agreement (the "Expiration Date") and repayment of all amounts due and payable thereunder. As part of the Original Agreement, the Lender received warrants to purchase up to 272,727 shares of our common stock at an exercise price of $1.375 per share and up to 378,788 shares of our common stock at an exercise price of $1.65 per share. At March 31, 2012, all stock warrants granted to the Lender were outstanding and exercisable.

At March 31, 2012, we had $10.0 million in outstanding borrowings under the Loan, which is reflected as line of credit - related party on our consolidated balance sheet. The $10.0 million revolving loan expires in November 2014, at which time we must repay all outstanding borrowings and interest and fees under the Loan Agreement.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management evaluates these estimates and assumptions on an ongoing basis. Estimates are based on historical experience, when available, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Management believes that, of its significant accounting policies, an understanding of the following critical accounting policies is important in obtaining an overall understanding of the consolidated financial statements.

Revenue Recognition

We recognize revenue in accordance with the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") 605 (Topic 605, Revenue Recognition). ASC 605 requires that five basic criteria must be met before revenue can be recognized: (i) persuasive evidence that an arrangement exists;
(ii) delivery has occurred or services were rendered; (iii) the fee is fixed and determinable; (iv) collectability is reasonably assured; and (v) the fair value of undelivered elements, if any, exists. Determination of criterion (iv) 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 criterion 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. Revenue for service repairs of equipment is recognized after service has been completed, and service contract revenue is recognized ratably over the term of the contract.

For products sold to Stryker we recognize revenue in a two-step process. The first step is recognition of revenue for our cost to manufacture these products when title passes to Stryker, generally upon shipment of our products F.O.B. shipping point. The second step is recognition of revenue for our specified margin of Stryker's gross profit after Stryker sells the products to its end customers, based upon reports received from Stryker monthly. There is no required minimum amount of scopes and EndoSheath products which Stryker is required to purchase from us.

Stock-Based Compensation

We account for stock-based awards issued to employees in accordance with the provisions of ASC 718 (Topic 718, Compensation - Stock Compensation). We recognize stock-based compensation expense on a straight-line uniform basis over the service period of the award, which is generally four years for employees. We use historical data to estimate expected employee behaviors related to option exercises and forfeitures and include these expected forfeitures as a part of the estimate of stock-based compensation expense as of the grant date. For stock-based awards with performance-based vesting conditions, we are also required to estimate the probability of the vesting conditions being met. Stock-based awards issued to consultants are accounted for in accordance with the provisions of ASC 718 and ASC 505-50 (Subtopic 50 "Equity-Based Payments to Non-Employees" of Topic 505, Equity). Options granted to consultants are periodically revalued as the options vest, and are recognized as an expense over the related period of service or the vesting period, whichever is longer.

Income Taxes

We account for income taxes in accordance with ASC 740 (Topic 740, Income Taxes). ASC 740 prescribes that the use of the liability method be used for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Any resulting net deferred tax assets are evaluated for recoverability and, accordingly, a valuation allowance is provided when it is more likely than not that all or some portion of the deferred tax asset will not be realized.

ASC Topic 740 also clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return.

Additionally, ASC Topic 740 provides guidance on the recognition of interest and penalties related to income taxes. We have elected to treat interest and penalties, to the extent they arise, as a component of income taxes.

Deferred Debt Cost

We defer costs associated with securing a line of credit or revolving loan agreement over the applicable term to maturity of the agreement. These costs are amortized as debt cost expense in our consolidated statement of operations. The costs are amortized over the term of the line of credit or revolving loan agreement on a straight-line basis or using the effective interest method.

Out-of-Period Adjustment

Operating results for fiscal 2011 include a reduction of selling, general, and administrative expenses of approximately $0.3 million for the reversal of a provision for sales and use tax related matters to correct a cumulative error from a prior fiscal year. This adjustment was recorded in the fourth quarter of fiscal 2011.

We do not believe this adjustment was material to the consolidated financial statements for the periods in which the error originated and in which it was corrected, and therefore, we have not restated our consolidated financial statements for the period.

Results of Operations (Dollars in thousands, except per share amounts)

Net Sales

In the medical segment, we track sales of endoscopes and EndoSheath disposables
by market. We also track sales of peripherals and accessories which can be sold
to more than one market. Net sales by operating segment and by market/category
for fiscal years 2012 and 2011 were as follows:

                                            Fiscal Year Ended March 31,
Market/Category                              2012                 2011           Change
Urology                                 $        7,167       $        3,731           92 %
ENT / TNE                                        2,874                2,448           17 %
Pulmonology                                        895                  616           45 %
Spine                                              837                   93          800 %
Repairs, peripherals, and accessories            1,962                1,483           32 %
Total medical net sales                 $       13,735       $        8,371           64 %
Borescopes                                       2,204                1,799           23 %
Repairs                                            747                  729            2 %
Total industrial net sales              $        2,951       $        2,528           17 %
Net sales                               $       16,686       $       10,899           53 %

Net sales increased $5.8 million, or 53%, in fiscal 2012 to $16.7 million compared to $10.9 million in fiscal 2011. During fiscal 2012, our medical segment's net sales of $13.7 million increased by $5.4 million, or 64%, primarily attributable to higher sales of our endoscopes and EndoSheath disposables in the urology market as a result of the Stryker Agreement. Our industrial segment's net sales of $3.0 million increased by $0.4 million, or 17%, primarily attributable to increased demand for our borescopes. This operating segment's products are mature, and therefore, we expect future sales to remain relatively flat.

The following table summarizes net sales by market/category and by product for our medical operating segment for fiscal years 2012 and 2011:

                                      Fiscal Year Ended March 31, 2012                      Fiscal Year Ended March 31, 2011
Market/Category               Domestic          International        Worldwide       Domestic          International       Worldwide
Urology
Endoscopes                   $     2,737       $         1,226      $     3,963     $       925       $           665     $     1,590
EndoSheath disposables             1,489                 1,715            3,204           1,019                 1,122           2,141
Total urology market               4,226                 2,941            7,167           1,944                 1,787           3,731

ENT / TNE
Endoscopes                         2,301                   480            2,781           2,111                   284           2,395
EndoSheath disposables                91                     2               93              52                     1              53
Total ENT / TNE markets            2,392                   482            2,874           2,163                   285           2,448

Pulmonology
Endoscopes                           482                   272              754             133                   385             518
EndoSheath disposables                27                   114              141              25                    73              98
Total pulmonology market             509                   386              895             158                   458             616

Spine
Endoscopes                           837                     -              837              93                     -              93

Repairs, peripherals, and
accessories                        1,306                   656            1,962             902                   581           1,483
Total medical sales          $     9,270       $         4,465      $    13,735     $     5,260       $         3,111     $     8,371

Product
Endoscopes                   $     6,357       $         1,978      $     8,335     $     3,262       $         1,334     $     4,596
EndoSheath disposables             1,607                 1,831            3,438           1,096                 1,196           2,292
Repairs, peripherals, and
accessories                        1,306                   656            1,962             902                   581           1,483
Total medical sales          $     9,270       $         4,465      $    13,735     $     5,260       $         3,111     $     8,371

Net sales to the urology market were $7.2 million in fiscal 2012 representing an increase of $3.4 million (92%) over fiscal 2011. The year-over-year growth was due primarily to the expanded U.S. distribution of our flexible video and fiber cystoscopes and related EndoSheath products to Stryker beginning in April 2011 and continued adoption of our EndoSheath technology in the international markets.

Net sales to the ENT and TNE (surgery) markets were $2.9 million in fiscal 2012 representing an increase of $0.4 million (17%) over fiscal 2011. Higher demand for our ENT endoscopes and continued expansion in the GI and bariatric surgery markets contributed to the year-over-year growth.

Net sales to the pulmonology market were $0.9 million in fiscal 2012 representing an increase of $0.3 million (45%) over fiscal 2011. The year-over-year increase was due primarily to continued growth in our U.S. customer base in pulmonology (critical care).

Net sales to SpineView were $0.8 million in fiscal 2012 representing an increase of $0.7 million (800%) over fiscal 2011. We continue to fulfill the initial stocking order of 50 video surgical endoscope systems to SpineView.

Net sales of repairs, peripherals, and accessories were $2.0 million in fiscal 2012 representing an increase of $0.5 million (32%) over fiscal 2011. The increased demand for peripherals and accessories for our urology endoscopes as a result of the Stryker Agreement contributed to the year-over-year growth.

Gross Profit (Net Sales Less Cost of Sales)

Gross profit by operating segment for fiscal years 2012 and 2011 was as follows:

                                Fiscal Year Ended March 31,
Gross Profit                     2012                2011          Change
Medical                      $       4,064       $       2,149          89 %
As percentage of net sales              30 %                26 %         4 %
Industrial                           1,021                 771          32 %
As percentage of net sales              35 %                30 %         5 %
Gross profit                 $       5,085       $       2,920          74 %
Gross margin percentage                 30 %                27 %         3 %

Gross profit was $5.1 million in fiscal 2012 representing an increase of $2.2 million (74%) over fiscal 2011. Gross margin percentage was 30% in fiscal 2012 representing an increase of 3% over fiscal 2011. The year-over-year increase in gross margin is largely driven by a more favorable sales mix towards products with higher gross margins and favorable manufacturing variances as a result of manufacturing efficiencies.

Operating Expenses (Selling, General, and Administrative ("SG&A") and Research and Development ("R&D")

Operating expenses by operating segment for fiscal years 2012 and 2011 were as follows:

                               Fiscal Year Ended March 31,
Operating Expenses              2012                 2011           Change
SG&A expenses
Medical                    $       10,777       $        9,985            8 %
Industrial                          1,268                  786           61 %
Total SG&A expenses                12,045               10,771           12 %
R&D expenses
Medical                             3,155                3,511          -10 %
Industrial                              -                    -            -
Total R&D expenses                  3,155                3,511          -10 %
Total operating expenses   $       15,200       $       14,282            6 %

SG&A Expenses

SG&A expenses were $12.0 million in fiscal 2012 representing an increase of $1.3 million (12%) over fiscal 2011. The increase was primarily attributable to higher stock-based compensation expense, higher sales commissions due to the overall growth of our net sales, and increased spending on sales and marketing consulting activities. Prior year SG&A expenses benefited from the reversal of a provision for sales tax-related matters and the recovery of bad debt expense for a delinquent account, both of which were not repeated in the current fiscal year and also contributed to the year-over-year increase.

R&D Expenses

R&D expenses were $3.2 million in fiscal 2012 representing a decrease of $0.4 million (-10%) over fiscal 2011. The decrease was primarily attributable to lower product development costs associated with our next generation digital processing units as we shifted from the development stage to the product launch phase of the second generation 5000 Series video processor. We released this second generation product, which features upgraded software providing our customers with additional features and superior image quality, in the second quarter of fiscal 2012.

Other (Expense) Income

Other (expense) income for fiscal years 2012 and 2011 was as follows:

                             Fiscal Year Ended March 31,
Other (Expense) Income       2012                  2011           Change
Interest income          $           9         $           8           13 %
Interest expense                  (489 )                (333 )         47 %
Debt cost expense                 (372 )                (141 )        164 %
Other, net                         (48 )                  (6 )        700 %
Other expense, net       $        (900 )       $        (472 )         91 %

Other expense was $0.9 million in fiscal 2012 representing an increase of $0.4 million (91%) over fiscal 2011. The increase was primarily attributable to the interest expense on the outstanding borrowings under the line of credit - related party and the amortization of the deferred debt cost associated with the warrant shares issued in connection with the line of credit - related party.

Income Tax Provision

Income tax provision was $1 thousand in fiscal 2012 representing a decrease of $8 thousand (-89%) over fiscal 2011. We record a tax provision for minimum state income taxes.

Net Loss

Net loss for fiscal years 2012 and 2011 was as follows:

                                             Fiscal Year Ended March 31,
Net Loss                                      2012                 2011           Change
Loss before provision for income taxes   $      (11,015 )     $      (11,834 )         -7 %
Income tax provision                                  1                    9          -89 %
Net loss                                 $      (11,016 )     $      (11,843 )         -7 %

Net loss was $11.0 million in fiscal 2012 representing a decrease of $0.8 million (-7%) over fiscal 2011. The decrease was primarily attributable to a higher gross profit, partially offset by higher SG&A expenses.

Subsequent Event

On April 27, 2012, we entered into a purchase agreement (the "Purchase Agreement") with Lincoln Park Capital Fund, LLC ("LPC"), pursuant to which we have the right to sell to LPC up to $15 million in shares of our common stock from time-to-time over a period of up to three years, subject to certain limitations and conditions set forth in the Purchase Agreement. In consideration for entering into the Purchase Agreement, we issued to LPC 160,000 shares of our common stock. We received $1 million of the $15 million upon signing of the Purchase Agreement for the sale to LPC of 599,880 shares or our common stock at a price of $1.667 per share. In connection with that sale, we also issued to LPC 15,333 additional shares of our common stock, for which we received no cash proceeds. This total maximum amount of $15 million would increase to $21 million if the aggregate market value of shares of our common stock held by non-affiliates reached at least $75 million during the 36-month term of the Purchase Agreement. The Purchase Agreement contains customary representations, warranties and agreements between us and LPC, limitations and conditions to completing future sale transactions, indemnification rights and other obligations of the parties. In connection with the initial purchase under the Purchase Agreement, and any future sales under the Purchase Agreement, the Lender waived the repayment requirement under the Loan Agreement.

Liquidity and Capital Resources

The following table summarizes selected financial information and statistics as of March 31, 2011 and 2012:

                             March 31,       March 31,
                               2012            2011
Cash and cash equivalents   $     2,674     $     9,180
Accounts receivable, net    $     2,132     $     1,592
Inventories, net            $     3,970     $     6,096
Working capital             $     6,022     $     9,033
. . .