10-K

QuickLinks -- Click here to rapidly navigate through this document

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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

For the Fiscal Year Ended March 31, 2002
or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             

Commission File No. 0-20970

Vision-Sciences, Inc.
(Exact name of Registrant as specified in its charter)

DELAWARE (State or other jurisdiction of incorporation or organization)	13-3430173 (I.R.S. Employer Identification Number)
9 Strathmore Road Natick, Massachusetts (Address of principal executive offices)	01760 (Zip Code)

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

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

        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 / /

        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              

.

        Aggregate market value of Common Stock held by non-affiliates of the Registrant as of May 1, 2002 based upon the last sale price of the Common Stock on the Nasdaq SmallCap Market as reported by Nasdaq:    $18,766,087

        Number of shares outstanding of the Registrant's Common Stock as of May 1, 2002: 27,105,355

        Documents incorporated by reference: Portions of the Proxy Statement for the 2002 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

PART I

Item 1.    Business

        This Annual Report on Form 10-K contains forward-looking statements, including statements about new product introductions, expectations as to future sales of the products of Vision-Sciences, Inc. (the "Company"), the availability of supplies, the sufficiency of the Company's capital resources to meet anticipated capital requirements, the Company's intentions to continue selling through its indirect sales force and the Company's expectations as to future expenditures, including research and development expenditures. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects", and similar expressions are intended to identify forward-looking statements. 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. See "Certain Factors That May Affect The Company's Future Operating Results."

        This Business section should be read in conjunction with The Consolidated Financial Statements of the Company and its subsidiaries attached hereto as Appendix A, including the notes thereto.

        The Company develops, manufactures and markets 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. The Company operates in three reportable segments, medical, industrial and corporate.

        The medical segment designs, manufactures and sells an EndoSheath® System ("EndoSheath"), a single-use device that slides on to the insertion tube of a flexible endoscope. The insertion tube is the part of an endoscope that enters the patient's body. The EndoSheath gives health-care providers economic advantages compared to using conventional flexible endoscopes, as utilizing the EndoSheath allows them to avoid the burdensome cleaning required of conventional endoscopes. In addition, the EndoSheath is a sterile device that provides patients with a contaminant-free procedure. The risk of cross-contamination results from the reuse of conventional flexible endoscopes.

        The Company manufactures EndoSheath products primarily for nasopharyngo-laryngoscopes ("ENT endoscopes"), sigmoidoscopes and bronchoscopes. The Company manufactures and sells a Slide-On™ ENT EndoSheath for use on its own flexible ENT endoscope, and Slide-On models for the ENT endoscopes of other major manufacturers of ENT endoscopes. The Slide-On ENT EndoSheath covers all surfaces of the endoscope that come in contact with the patient, but does not contain channels. The Company also manufactures and sells EndoSheaths for its own proprietary sigmoidoscope and bronchoscope. These models of EndoSheaths are designed to cover all surfaces of the endoscope that come in contact with the patient and, in addition, contains the air, water, suction and accessory channels that are integral parts of similar conventional flexible endoscopes. The Company's sigmoidoscope and bronchoscope do not contain these channels, as they are present in each of the EndoSheaths, as required. The Company has designed these endoscopes and complementary EndoSheaths to fit together, resulting in an insertion tube that is approximately the same diameter as conventional endoscopes. In addition to the Slide-On ENT EndoSheath and the EndoSheaths for video and fiber optic sigmoidoscopes and bronchoscopes, the Company has developed a family of disposable EndoSheath/reusable flexible endoscope systems for colonoscopy and gastroscopy.

        In December 1992, the Company began commercial shipments of its first EndoSheath, for use with one of its 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

2

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. In April 1999, the Company received clearance from the FDA to market its Slide-On EndoSheath for use with not only the Company's ENT endoscope, but also for ENT endoscopes of other companies. In April 2002, the Company applied to the FDA for clearance to market its new Slide-On bronchoscope EndoSheath, for use with the Company's proprietary bronchoscope.

        The industrial segment designs, manufactures and markets flexible endoscopes for industrial markets, primarily aircraft maintenance, jet engine manufacturing and defense. In addition, the industrial segment manufactures and repairs flexible endoscopes for the medical segment.

        The corporate segment consists of certain administrative activities beneficial to the Company as a whole, and the management oversight of the Company's investments in 3DV Systems Ltd. ("3DV"), Vision Sciences, Ltd. and the Company's contribution to a University of Georgia research project in Egypt (the "Egypt Project").

        The Company was incorporated in Delaware in 1987 under the name Machida Incorporated. Since that time, the Company has acquired by merger Cyberex Corporation (in October 1988) and Vascu-Care, Inc. (in March 1989), and acquired pursuant to a share exchange Opielab, Inc. (in September 1990). The Company changed its name to Vision-Sciences, Inc. in December 1990. The Company's principal executive offices are located at 9 Strathmore Road, Natick, Massachusetts 01760. Its telephone number is (508) 650-9971.

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.

        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

3

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 manufacture endoscopes for 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 otolaryngology (ear-nose-throat medicine, or "ENT"), gastroenterology, surgery, primary care 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.

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

        Gastrointestinal Endoscopes.    The Company estimates that based on industry sources, 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 70 million Americans) receive a screening sigmoidoscopy every three to five years.

        The most common flexible endoscopes used in gastrointestinal ("GI") 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.

        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 that

4

based on industry sources, approximately 500,000 procedures using flexible bronchoscopes are performed in the United States annually. 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 or 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 impossible to sterilize them, and even 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 physicians using the flexible endoscopes and the nurse assistants cleaning them, 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 Guidelines for Infection Control in Gastrointestinal Endoscopy Settings (the "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 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.

5

•

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, flushed with an alcohol solution and dried again, 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, the Company believes the most important step in the cleaning process is the manual removal of organic material, and therefore, 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 2.4% glutaraldehyde-based disinfectants change the recommended soak time on their instructions for use from 20 minutes to 45 minutes, and increase 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 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.

        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 0.2 parts per million

6

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 primary business strategy is to develop, manufacture and market products for endoscopy which have infection-control and economic advantages over conventional flexible endoscopes. To implement this strategy, the Company has developed, and is marketing and selling, ENT EndoSheaths for use with certain conventional flexible ENT endoscopes currently sold by the Company and by other manufacturers. Health-care providers simply load the Slide-On ENT EndoSheaths on the insertion tube of an ENT endoscope without the aid of other equipment, such as air pumps, and slide them off and dispose of them when the procedure is completed. The ENT endoscope is ready for use in minutes for the next patient. The Slide-On ENT EndoSheath fits snugly on the insertion tube, and has a proprietary clear plastic window that allows viewing the cavity, without glare, from a light source. In addition, the Company has developed, and is marketing and selling, a family of disposable EndoSheath/reusable flexible endoscope systems for gastrointestinal endoscopy and pulmonary endoscopy. This family of products 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. The Company is also developing a Slide-On bronchoscope EndoSheath to replace its current bronchoscope EndoSheath. The primary advantages of the new Slide-On bronchoscope EndoSheaths are expected to be its ease of use and lower cost, compared to the current product.

7

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



•

It increases the number of patients that physicians can examine in a given period of time due to the reduced delay in endoscope processing between procedures.



•

The Slide-On ENT EndoSheath gives physicians mobility, allowing them to examine many patients in a given period of time without having to bring multiple endoscopes to the examination site, or being dependent upon multiple endoscopes at the site.

        During the fiscal years ended March 31, 2000, 2001 and 2002, ("FY 00", "FY 01", "FY 02", respectively) the Company has also pursued a strategy of exploring diversification toward the development of improved endoscopes and related imaging devices. Included in these exploratory areas have been the following:

•

The use of advanced CMOS sensors in video endoscopes, in order to reduce their cost and size over traditional CCD sensored video endoscopes.



•

The use of 3-Dimensional visualization enhancements to improve the perception of endoscopic images for both medical and industrial markets.

        These areas of exploration have been undertaken through an agreement with Imagineering, Ltd. and through an investment in 3DV, two Israeli corporations. The goal of these investigations has been to analyze opportunities to further leverage the Company's core competencies in its current markets, while at the same time analyzing new technologies the Company may develop or acquire to enhance its offerings.

Products and Product Development Programs

        The Company's primary products include the Slide-On ENT EndoSheath, a proprietary flexible ENT endoscope and a family of proprietary flexible endoscopes and EndoSheaths for gastrointestinal and pulmonary applications. In addition, the Company currently manufactures and sells borescopes, which are endoscope devices for industrial applications, and related products.

Medical Segment

ENT EndoSheaths and Endoscopes

        The Company has developed a family of Slide-On ENT EndoSheaths for use with its own ENT endoscope and with ENT endoscopes manufactured by other companies. Slide-On EndoSheaths do not require the use of a pump to inflate the EndoSheath during installation onto an endoscope. Rather,

8

Slide-On EndoSheaths are made of proprietary materials that allow the health-care provider to slide the EndoSheath onto the insertion tube of an ENT endoscope. Slide-On EndoSheaths have proximal connectors that attach to the strain relief of any ENT endoscope, allowing a snug fit. In addition, Slide-On ENT EndoSheaths have an optically clear window that fits securely over the ENT endoscope tip, preventing glare. After the procedure is completed, the health-care provider slides the EndoSheath off the endoscope and disposes of it. In general, ENT endoscopes do not contain air, water, suction or accessory channels, as do endoscopes designed for use in gastroenterology. Therefore, the Company's Slide-On ENT EndoSheaths, designed to be the only component that comes into contact with the patient, do not contain channels. This makes the product simpler and less expensive than EndoSheaths designed for use with endoscopes that do contain channels. The Company has also developed its own ENT endoscope, the ENT-2000. The ENT-2000 has state-of-the-art fiberoptic bundles, is designed for inexpensive repairs and has other features that the Company believes make it competitive with ENT endoscopes of other major manufacturers. In December 1995, the Company received clearance from the FDA to market its own fiberoptic ENT scope, and in April 1999, the Company received clearance from the FDA to market its Slide-On ENT EndoSheath for use with the Company's ENT endoscope and with the endoscopes of other manufacturers.

Gastrointestinal and Pulmonary EndoSheath/Endoscope Systems

        The Company has developed a family of proprietary flexible endoscope systems for GI and pulmonary applications consisting of two main components—proprietary, sterile, disposable EndoSheaths and reusable, flexible endoscopes incorporating the Company's proprietary design. The EndoSheaths and endoscopes included in these systems 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 information from 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

9

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.

        Sales of the medical segment were approximately $3.5 million, or 52% of the Company's net sales, in FY 02. The Company expects that net sales of these products over the next several years will grow and constitute an increasing percentage of the Company's total business.

Industrial Segment

        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 industrial segment products were approximately $3.2 million, or 48% of the Company's net sales, in FY 02. The Company expects that net sales of these products over the next several years will remain relatively constant and will constitute a decreasing percentage of the Company's total business.

Sales and Marketing

Medical Segment

        The customers for the Company's disposable EndoSheaths, flexible endoscopes and related products are otolaryngologists (ENT doctors), gastroenterologists, colon and rectal surgeons, pulmonologists and primary care physicians in hospitals, medical clinics and physicians' offices. As of May 1, 2002, the Company had five sales and marketing employees, and utilized 17 independent sales representatives in the United States and 14 independent distributors in Europe, Australia and Japan. The Company 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.

Industrial Segment

        The Company's borescopes are sold both directly by its Machida subsidiary and through independent sales representatives. Sales of industrial products declined by 8% in FY 02, compared to FY 01. This decline was due to lower demand for repair of borescopes. The Company believes this reduction in sales is due to the events of September 11, 2001 that resulted in lower demand for air travel. The lower demand for air travel lead to jet engines being used less often, resulting in lower demand for maintenance and repairs of those engines.

International Sales and Sales to Major Customers

        Sales to unaffiliated customers outside of the United States were approximately $1,239,000, $1,606,000 and $1,830,000 for FY 00, FY 01 and FY 02, respectively. In FY 02, sales to foreign customers accounted for approximately 34% of the Company's annual net sales of its medical segment and 20% of net annual sales of its industrial segment. The Company experienced increased sales of its

10

medical products to foreign customers in Europe in FY 02. This increase was due to increased demand for the Company's Slide-On ENT EndoSheath arising from concerns regarding cross-infection, specifically about the spread of variant Creutzfeldt-Jacob disease. The Company expects to sell its medical segment products outside of the United States in the fiscal year ending March 31, 2003 ("FY 03") in approximately the same proportion as in FY 02. The Company currently sells certain models of its borescopes and repair services outside of the United States.

        During FY 00, no customer accounted for more than 10% of net sales. During FY 01 and FY 02, Pratt Whitney accounted for 11% and 13%, respectively, of net sales.

Backlog

        The Company had an order backlog of approximately $242,000 at March 31, 2002, compared to a backlog of approximately $523,000 at March 31, 2001. The backlog of the medical segment increased by approximately $106,000, while the backlog of the industrial segment declined by approximately $387,000. The increase in the medical segment backlog is primarily due to improved outreach to customers and the offer of lower prices for initial users of the Slide-On ENT EndoSheath. The lower backlog in the industrial segment is due to lower demand for new borescopes and repair services. The Company expects to fill over 75% of such order backlog in the current fiscal year.

Manufacturing and Suppliers

        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"), 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 EndoSheaths.

        The Company assembles its flexible endoscopes for the medical and industrial segments 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 for all endoscopes manufactured for the medical markets and operator control bodies for sigmoidoscopes, 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 2003, 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 ENT endoscopes or for its 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. The industrial segment purchased approximately $859,000 and $760,000 of products from Pentax, a subsidiary of Asahi, in FY 02 and FY 01, respectively.

11

        The Company's borescopes are assembled using components and subassemblies purchased from independent vendors. While most components and subassemblies are currently available from more than one supplier, certain critical components are currently purchased only from Machida Endoscope Company, Ltd., an unaffiliated Japanese company. 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 purchases light sources, cameras, adapters, accessories and imaging systems for industrial applications from a variety of vendors.

        The Company has negotiated the worldwide, royalty-free exclusive right from a third party to use polymer technology for manufacturing optically clear windows to be included in its EndoSheaths for use with ENT and intubation endoscopes. The Company has also negotiated a non-exclusive license to include the same technology in its EndoSheaths for use in other markets. Currently, the Company is using this technology in its ENT EndoSheaths and in EndoSheaths for its bronchoscopes.

Competition

        The Company believes that the primary competitive factors in the medical market for flexible endoscopes and endosheaths 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 industrial 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. 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 industrial 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 24 U.S. patents and have 8 patent applications pending. In addition, the Company has 17 foreign patents and has 6 patent applications pending. All of these patents relate to its disposable EndoSheaths and reusable flexible endoscopes. These issued patents will expire on various dates in the years 2004 through 2019. In addition to those listed above, the Company has 6 patent applications pending in the U.S. and 6 corresponding foreign applications for CMOS image sensor design patents. There can be no assurance that the Company's pending patent

12

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.

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 Quality System Regulations ("QSR"). 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 that 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

13

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.

        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
April 1999	Slide-On EndoSheath for use with the Company's fiberoptic ENT endoscope
April 1999	Four models of Slide-On EndoSheaths for use with certain other ENT endoscopes

        Effective July 1998, the Company's Natick, Massachusetts facility was certified as having established, and is maintaining, a quality system that meets the requirements of ISO 9001 and EN 46001. In addition, both the Natick and Orangeburg, New York facilities received their EC certificate,

14

indicating they maintain a quality system that conforms to the essential requirements of the Council Directive 93/42/EEC, and apply this system at every stage from design to final controls. In June 2001, the Company's Natick facility was re-certified as maintaining a quality system that meets the requirements of ISO 9001 and EN 46001. The Natick and Orangeburg facilities are registered with the FDA as medical device manufacturers. As a result, these facilities are subject to the FDA's QSR, which regulate their design, 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 and audits by independent authorities to maintain its ISO 9001 status.

        The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with ISO 9001 and the FDA's QSR 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, recalls of products, operating restrictions or 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 a non-approved indication. The Company believes, based upon its knowledge of third-party reimbursement practices, advice from consultants in this area and nine years of selling experience, that third-party reimbursement is available for most procedures that utilize its disposable Slide-On ENT sheath and its EndoSheath/reusable flexible endoscope systems. However, not all third-party payors will reimburse health-care providers for the cost of the Company's EndoSheath.

        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 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 based upon amounts determined by the Centers for Medicare & Medicaid Services ("CMS"), successor to the Health Care Finance Administration ("HCFA"), a governmental agency under the U.S. Department of Health and Human Services. As part of its responsibilities, CMS assigns relative value units ("RVUs") to over 10,000 physician services. An RVU for a specific procedure is comprised of values for work, practice expense and malpractice insurance, and when multiplied by a Conversion Factor, represents a dollar value for a specific procedure. Historically, the practice expense component of an RVU was calculated using a charge-based system. Section 121 of the Social Security Act Amendments of 1994 required CMS to replace the charge-based practice expense RVUs with new resource-based ones. The Balanced Budget Act of 1997 requires a four-year transition from the charge-based system to the resource-based system beginning January 1, 1999. During calendar 2000, the practice expense component of the RVUs was comprised of 50% of the charge-based system and 50% of the resource-based system. In 2002, the practice expense component of the RVUs is based 100% upon the resource-based system.

15

        Under the charge-based system, CMS had a policy of reducing the practice expense RVUs for certain services by 50% when those services were performed in a facility setting. Under the resource-based system, this policy will not be applicable, as CMS has developed practice expense RVUs specific to facility and non-facility settings. Generally, under the resource-based system, the facility practice expense RVUs will be used for services performed in inpatient or outpatient hospital settings, emergency rooms, skilled nursing facilities or ambulatory surgical centers. The non-facility practice expense RVUs will be used for services performed in all other settings. Based upon a review of calendar year 2002 RVUs for flexible sigmoidoscopies, the Company believes health care providers will receive payments totaling 75% more per procedure for performing them in non-facility settings in 2002 compared to performing these services in facility settings. The increase in the RVUs for practice expense is based upon extensive reviews by CMS of actual practice expense data from the Clinical Practice Expert Panel and the American Medical Association's Socioeconomic Monitoring System.

        The Company believes that, based upon the new resource-based practice expense RVU, the number of flexible sigmoidoscopies performed in non-facility settings will increase. This increase will be due primarily to the increased differential in payments that providers will receive for performing these procedures. As these procedures move to non-facility settings, providers will have to contend with the cost and effort required to clean endoscopes. The Company believes its disposable EndoSheath/reusable flexible endoscope systems, which eliminate the time and cost of cleaning endoscopes, will provide a positive economic alternative to the use of conventional equipment. This economic alternative is based upon the provider not having to purchase multiple endoscopes, expensive sterilizing equipment and supplies and not having to spend valuable provider time cleaning endoscopes. In addition, the Company believes that the increase in the population of people over 50 years old will increase the potential number of procedures that providers will be performing. There are approximately 70 million people in the United States between 50 and 79 years old. The American Cancer Society recommends people over the age of 50 receive flexible sigmoidoscopies every three to five years as part of a program for the early detection of colorectal cancer. The Company believes its disposable EndoSheath system combined with the resource-based system for setting values for physician services together represent a sound economic method to screen for colorectal cancer.

        There can be no assurance that third-party reimbursement will continue to 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 has had, and could continue to 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 FY 03. The Company will re-evaluate the adequacy of this coverage when and if its sales level substantially increases. 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.

16

Research and Development

        The Company believes that its future success depends in part upon its ability to develop new products and enhance its existing products. In the past the Company has devoted significant funds and efforts to research and development.

        The Company's research and development expenses, excluding stock-based compensation charges, in FY 00, FY 01 and FY 02 were approximately $262,000, $457,000 and $216,000, respectively. The increase in research and development expenses for FY 01 was due primarily to the costs associated with the Egypt Project. In September 2000, the Company contributed $269,000 to the University of Georgia ("UGA") in support of Phase I of the University of Georgia Hepatitis Project, Proposal No. 022297-01 (the "Egypt Project"). The Egypt Project is designed to determine the occurrence of cross-infection among patients who undergo gastroscopies in Cairo, Egypt. As of May 1, 2002, the Egypt Project had not proceeded far enough to report results of the study. Depending upon the results of Phase I of the Egypt Project and the availability of funds, the Company will determine in FY 03 whether to proceed with funding Phase II of the Egypt Project.

        During FY 00, the research and development efforts focused on continued improvement in the Slide-On ENT EndoSheath, and in completing innovations related to CMOS sensors. The efforts in the CMOS area were undertaken primarily through the Company's relationship with a consultant to Imagineering, Ltd., a corporation with whom the Company has an agreement, and were managed by the Company's corporate segment and its subsidiary, Vision Sciences, Ltd. in Israel. These efforts have resulted in the Company's filing for six patents in the U.S. and for six corresponding foreign patents during FY 01 and FY 02. During FY 01, the research and development efforts focused on filing patent applications related to CMOS sensors, funding the Egypt Project and developing enhancements to the Slide-On ENT EndoSheath. In FY 02 the research and development efforts focused on developing a Slide-On ENT EndoSheath with an attached channel to allow biopsy sampling, and on developing a Slide-On bronchoscope EndoSheath.

Employees

        As of April 30, 2002, the Company had 64 employees. No Company employees are represented by a labor union. The Company believes that its employee relations are good. The Company's success depends in large part upon its ability to attract and retain highly qualified scientific, management, sales and marketing personnel.

Item 2.    Properties

        The operations of the Company's medical segment currently occupy approximately 20,000 square feet of space in Natick, Massachusetts under a lease that expires in October 2003. The operations of the Company's industrial segment, and the offices of the Company's corporate segment are located in Orangeburg, New York under a lease for approximately 10,000 square feet, which expires in August 2005.

        The Company's Natick and Orangeburg facilities are registered with the FDA as medical device manufacturing facilities and, therefore, are subject to the FDA's QSR 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. In addition, the Company's Natick facility is registered as meeting the requirements of ISO 9001, EN 46001 and Council Directive 93/42/EEC, allowing the Company to sell its medical products in Europe.

        The Company believes that its existing facilities are adequate for its current needs.

17

Item 3.    Legal Proceedings

        As of March 31, 2002, there were no material legal proceedings to which the Company or any of its subsidiaries is a party, or to which any of their properties are 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 FY 02.

Executive Officers of the Company

        Katsumi Oneda, age 64, 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. Mr. Oneda is a director of several private companies. He has been a director of the Company since 1987, and is a member of the Executive Committee.

        Lewis C. Pell, age 59, a co-founder of the Company, has been Vice-Chairman of the Board of Directors of the Company since May 1992, and is a member of the Executive Committee. 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, and a director of a number of other privately-held medical device companies.

        Gerald B. Lichtenberger, Ph.D., age 57, has served as Vice President, Business Development since December 1998, and as Secretary since January 1997. From January 1997 to December 1998 he served as Executive Vice President and Chief Operating Officer of the Company. Mr. Lichtenberger has been a director of the Company since 1997. 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. He has been a director of the Company since 1997.

        James A. Tracy, age 53, joined the Company in July 1997 and was elected Vice President Finance in August 1997. From 1994 to 1996 Mr. Tracy was the Vice President Finance at ORS Environmental Systems, a manufacturer of environmental equipment and sensor instrumentation. Mr. Tracy received a CPA certificate in 1975.

        Isao Fujimoto, age 54, has served as Vice President Manufacturing and Engineering of the industrial segment since January 1995. Mr. Fujimoto joined the Company in 1975, and served in a variety of roles in the manufacturing and engineering departments from that date to January 1995.

        Mark S. Landman, age 48, has served as Vice President Operations of the medical segment since July 1999. Mr. Landman joined the Company in January 1991, and served in a variety of roles in product development, project management, manufacturing engineering and material control from that date to July 1999.

        Jitendra Patel, age 49, has served as Vice President Sales and Marketing of the industrial segment since August 2000. From August 1995 to July 2000, he served as the Manager of Sales and Marketing for the industrial segment.

        Thomas Olmstead, age 48, joined the Company on October 1, 2001, as Vice President Sales and Marketing for the medical segment. From April 2000 to August 2001, Mr. Olmstead served as the Marketing Manager for the Pulmonary Endoscopy Products Group of C.R. Bard, a medical device company. From August 1996 to April 2000, Mr. Olmstead served as the General Manager of Mill-Rose Laboratories, Inc., a medical device manufacturer.

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

18

PART II

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

        From December 15, 1992 to October 29, 1997, the Company's Common Stock was quoted on the Nasdaq National Market, and since October 30, 1997, the Company's Common Stock has been traded on the Nasdaq SmallCap Market under the symbol VSCI. The following table sets forth the high and low sale prices for the Common Stock on the Nasdaq SmallCap Market, as reported by Nasdaq during the periods indicated.

Fiscal Year Ended March 31, 2001	High	Low
1st Quarter	2.63	1.13
2nd Quarter	1.63	1.06
3rd Quarter	1.38	.56
4th Quarter	1.38	.63

Fiscal Year Ended March 31, 2002	High	Low
1st Quarter	2.05	.83
2nd Quarter	1.54	.70
3rd Quarter	1.27	.65
4th Quarter	1.82	.81

        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 1, 2002, there were 27,105,355 outstanding shares of Common Stock held by 232 stockholders of record, in addition to which there were approximately 1700 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. In accordance with a demand line-of-credit agreement that the Company has with a bank, the Company is prevented from paying cash dividends on its Common Stock.

        On June 13, 2001, the Company completed a private equity placement with Mr. Alan Baidun, a private investor not previously affiliated with the Company, in an offering exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. The Company sold an aggregate of 582,524 shares of common stock at a price of $1.03 per share, which represented 90% of the average closing price of the common stock on the Nasdaq SmallCap Market during the five trading days ended May 31, 2001. The Company received an aggregate consideration of $600,000 for the newly issued shares of common stock.

19

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,
	1998			1999			2000			2001			2002
	(in thousands, except per share data)
Statement of Operations Data:
Net sales	$	7,998		$	7,476		$	7,055		$	7,209		$	6,713
Gross profit		1,419			1,274			2,262			2,560			2,222
Net loss from operations		(2,902	)		(1,965	)		(1,561	)		(1,173	)		(1,181	)
Net loss		(2,578	)		(2,139	)		(4,778	)		(1,291	)		(1,895	)
Net loss per share		(.17	)		(.12	)		(.24	)		(.06	)		(.07	)
Balance Sheet Data:
Cash, cash equivalents and marketable securities	$	2,891		$	3,195		$	1,581		$	3,812		$	3,142
Total assets		6,172			7,882			4,908			7,195			6,000
Total liabilities		2,355			2,433			1,993			1,969			1,878
Stockholders' equity		3,817			5,450			2,914			5,226			4,122

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 for the medical device and the industrial device markets. The medical segment manufactures and markets unique disposable sheaths that are used by health-care providers to cover the insertion tube of flexible endoscopes, such as Ear-Nose-Throat ("ENT") endoscopes, sigmoidoscopes and bronchoscopes. The EndoSheaths allow the health-care providers to process more patients economically by avoiding the cleaning of the endoscopes after use on each patient. In addition, the sheaths are sterile, thus ensuring each patient a contaminant-free product.

        The industrial segment designs, manufactures and markets flexible endoscopes for industrial users, and manufactures and repairs flexible endoscopes for the medical segment. Industrial users comprise primarily the aircraft maintenance, jet engine manufacturing and defense markets.

        The corporate segment consists of certain administrative activities beneficial to the Company as a whole, and the management oversight of the Company's investments in 3DV, Vision Sciences, Ltd and the Egypt Project.

Critical Accounting Policies and Estimates

        The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. See the Notes to the Consolidated Financial Statements included elsewhere herein. Certain of the Company's 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. The Company periodically evaluates the judgments and estimates used for its critical accounting policies to ensure that such judgments and estimates are reasonable for its interim and year-end reporting requirements. These judgments and estimates are based upon the Company's historical experience, current trends and information available from other sources, as appropriate. If different conditions result from those assumptions used in the Company's judgments, the results could be

20

materially different from the Company's estimates. The Company's critical accounting policies include the following.

Revenue Recognition

        The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended by SAB 101A and 101B. SAB 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criterion (4) is based on management's judgment regarding the collectibility 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.

Income Taxes

        The income tax policy followed by the Company records the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as operating loss and tax credit carryforwards. The Company follows very specific and detailed guidelines regarding the recoverability of any tax assets recorded on the balance sheet and provides any necessary allowances as required.

Fair Value

        Financial instruments, including derivatives and non-qualified options to purchase Company stock, require disclosures of an estimate of their fair values. Fair values are based on listed market prices, where possible. The Company accounts for certain non-qualified options to purchase Company stock in accordance with the Emerging Issues Task Force ("EITF") 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, and carries these contracts at fair value, with any changes in fair value recorded in the results of operations. Fair values for certain non-qualified options are derived from pricing models that consider current market and contractual prices for the underlying financial instruments or commodities, as well as time value and yield curve or volatility factors underlying the positions. Pricing models and their underlying assumptions impact the amount and timing of unrealized gains and losses recognized, and the use of different pricing models or assumptions could produce different financial results.

Results of Operations

Fiscal Years Ended March 31, 2002 and 2001

        Net sales in FY 02 were approximately $6,713,000, a decrease of $496,000, or 7%, compared to FY 01. Sales of the medical and industrial segments declined by $211,000, or 6%, and $285,000, or 8%, respectively. The decrease in sales of the medical segment was primarily due to a lower volume of GI EndoSheaths and lower prices received for ENT EndoSheaths. These reductions were partially offset by higher volume of ENT endoscopes. The Company believes the decrease in sales of the industrial segment was primarily due to a decline in orders from the aircraft industry resulting from the events of September 11, 2001.

        Sales of GI EndoSheaths declined by $375,000, or 42%, in FY 02, compared to FY 01. This decrease was primarily due to lower unit volume of EndoSheaths, resulting from customers switching to conventional endoscopes, believing there are cost advantages to cleaning conventional endoscopes, primarily due to the lack of reimbursement for use of the Company's EndoSheath. Without additional sales of the Company's proprietary sigmoidoscope or changes to the reimbursement procedures, the Company expects sales of its GI EndoSheath to be flat, or decline, in FY 03, compared to FY 02. Sales

21

of ENT EndoSheaths decreased by approximately $92,000, or 4%, compared to FY 01. Sales to domestic users declined by $99,000, while sales to international distributors increased by $7,000. The Company instituted a program of lower unit prices in FY 02 for both domestic and international customers, with the goal of increasing unit volume. The program was partially successful, as unit volume increased by approximately 10% overall to approximately 238,000 units, 5% from domestic customers and 14% from international distributors. However, the increase in unit volume was not sufficient to offset the lower prices. In total, the Company shipped 55% of ENT EndoSheaths units to international distributors, compared to 53% in FY 01, and those units accounted for 38% of total ENT EndoSheath sales dollars, compared to 36% in FY 01.

        In the fourth quarter of FY 02, the Company instituted an additional program of lower unit prices for incremental new sales to domestic customers, combined with a pro-active outreach by Customer Service employees, that also included an increased commission for its independent sales representatives and Customer Service personnel. That program resulted in an increase in unit volume of 21% for the fourth quarter. The Company expects to continue this program for at least the first two fiscal quarters of FY 03.

        Sales of ENT endoscopes increased by approximately $214,000, or 45%, in FY 02, compared to FY 01. The unit volume increased 50% in both the domestic and international markets. The average selling price ("ASP") declined by approximately 6% domestically, and was flat for international sales. The Company believes the increased demand for endoscopes was primarily due to a more effective positioning of the Company's product in the competitive marketplace, and lower prices to the domestic users. In addition, improved product positioning and appropriate changes to the distributor network, especially in Europe, resulted in higher volume to international distributors.

        The Company believes that the lower sales of the industrial segment were primarily due to the events of September 11, 2001. After those events, air travel declined by over 20%, reducing the need to repair jet engines. The Company does not expect sales to this market to recover for at least the first two fiscal quarters of FY 03.

        Gross profit was $2,222,000 in FY 02, a decrease of $338,000, or 13%, compared to FY 01. Gross profit was 33% of sales in FY 02, compared to 36% of sales in FY 01. Gross profit in the medical segment in FY 02 was approximately $1,004,000, or 29% of sales, compared to approximately $1,256,000, or 34% of sales, in FY 01. Gross profit in the industrial segment was approximately $1,218,000, or 37% of sales, in FY 02, compared to approximately $1,304,000, or 37% of sales in FY 01. The gross profit of the industrial segment included reductions in inventory reserves of approximately $219,000 in FY 02 that were established in prior years and no longer required.

        The reduction in gross profit in the medical segment was primarily due to the lower prices received for ENT EndoSheaths and the lower volume of GI EndoSheaths, offset partially by the higher volume of ENT endoscopes. In addition, overhead costs increased, primarily due to higher labor and fringe benefit costs. The reduction in gross profit in the industrial segment was primarily due to the lower sales volume, offset partially by lower costs for facilities and favorable exchange rates for Japanese Yen.

        Selling, general and administrative ("SG&A") expenses were approximately $3,094,000 in FY 02, an increase of approximately $156,000, or 5%, compared to FY 01. SG&A expenses were 46% of sales in FY 02, compared to 41% in FY 01. SG&A expenses increased by approximately $121,000, or 9%, in the medical segment. This increase was primarily due to higher costs for payroll and fringe benefits and travel costs incurred to promote sales. SG&A expenses in the industrial segment decreased by approximately $36,000, primarily due to lower costs for product promotion, especially after September 11, 2001. In addition, the industrial segment had lower facilities costs. SG&A expenses in the corporate segment increased by approximately $71,000, primarily due to higher costs for payroll and fringe benefits.

22

        Research and development ("R&D") expenses were approximately $216,000 in FY 02, a decrease of $241,000, or 53%, compared to FY 01. R&D expenses were 3% and 6% of sales in FY 02 and FY 01, respectively. R&D expenses decreased primarily due to approximately $269,000 of costs for the Egypt Project not recurring in FY 02. The Egypt Project has not progressed as quickly as the Company had planned, and remains in Phase I. The Company's participation in Phase II of the Egypt Project will depend upon the results on Phase I and the expected costs of Phase II. The Company expects to determine its participation in Phase II in FY 03. The Company expects to incur higher costs for R&D in FY 03, primarily due to its participation in Independent Review Boards ("IRB") for its new Slide-On bronchoscope EndoSheath. In addition, the Company expects to continue development efforts to enhance its Slide-On ENT EndoSheath, with the goal of adding a channel to that device that allows ENT doctors to perform procedures in their offices that currently can only be performed in hospitals and clinics.

        Stock-based compensation costs were $94,000 in FY 02, a decrease of $244,000, or 72%, compared to FY 01. The Company follows accounting guidelines issued by the EITF No. 00-19 for valuing non-qualified options at fair value. According to the transition rules established by EITF No. 00-19, the Company recorded a charge of $327,000 in the three months ended June 30, 2001, as a cumulative effect of a change in accounting principle. Subsequent to June 30, 2001, the Company recorded changes in the fair value of those options in its operating costs. In FY 01, all the costs for those options were recorded in the operations of the Company.

        Interest income was approximately $119,000 in FY 02, an increase of $5,000, compared to FY 01. Although interest rates declined in FY 02, compared to FY 01, the Company had larger cash balances on hand during FY 02, primarily due to the sale of common stock in December 2000.

        The equity in losses of 3DV increased to $500,000 in FY 02, compared to $222,553 in FY 01. In March 2001, the Company invested $500,000 in Series A Convertible Subordinated Notes (the "Notes") of 3DV. As of March 31, 2001, the Company owned approximately 24% of the outstanding shares of 3DV. In the three months ended June 30, 2001, 3DV incurred losses of approximately $2,177,000. The Company accounts for its investment in 3DV using the equity method of accounting. As a result, the Company recognized equity in losses of 3DV of $500,000 in the three months ended June 30, 2001, offsetting the Company's investment in 3DV. 3DV is a company in the development stage, and continues to seek new capital.

        The Company does not expect to participate in further investments in 3DV in the same proportion as its ownership of the outstanding shares of 3DV. However, the Company will continue to evaluate its investment in 3DV, and may make further investments if it believes these to be in the best interests of the Company's shareholders.

        The Company's loss per share in FY 02 was $.07, compared to a loss per share of $.06 in FY 01. The operating loss per share in FY 02 was $.04, compared to an operating loss per share of $.05 in FY 01. The lower operating loss per share in FY 02 is primarily due to the larger number of shares outstanding, following the issuance of 5,587,418 shares in a private placement in December 2000.

Fiscal Years Ended March 31, 2001 and 2000

        Net sales in FY 01 were approximately $7,209,000, an increase of $155,000, or 2%, compared to FY 00. The increase in net sales was primarily due to medical sales increasing by $317,000, or 9%, to approximately $3,675,000, while industrial sales decreased by $162,000, or 4%, to approximately $3,534,000. The increase in medical sales was due primarily to higher sales of the Company's Slide-On ENT EndoSheath that increased by approximately $458,000, or 28%, in FY 01. The higher sales of ENT EndoSheaths was due primarily to higher demand by international distributors which resulted in a sales increase of approximately $482,000, offset partially by lower demand from domestic customers which resulted in a sales decline of approximately $24,000. Sales of ENT EndoSheaths to international

23

distributors was approximately $761,000 in FY 01, or 36% of total ENT EndoSheath sales, compared to approximately $279,000 in FY 00. The demand by international distributors for the Company's Slide-On ENT Endosheaths was especially strong in the United Kingdom, Italy and Australia. The increase in sales of ENT EndoSheaths was partially offset by lower sales of sigmoidoscope EndoSheaths which declined in FY 01 by approximately $160,000, or 15%, compared to FY 00 due to lower demand caused by the continued inability of health-care providers to obtain reimbursement for these EndoSheaths. Higher sales of endoscopes and repair services comprised the remainder of the sales increase.

        Unit sales of ENT Slide-On EndoSheaths increased by approximately 74,600, or 52%, in FY 01 compared to FY 00. Unit sales to international distributors accounted for substantially all of this increase and were approximately 53% of total ENT EndoSheath unit sales. Unit sales of ENT EndoSheaths to domestic customers increased slightly in FY 01 compared to FY 00.

        The decrease in sales of industrial products was due primarily to lower demand from the aircraft maintenance and defense markets for new equipment, offset partially by higher demand for repair services.

        Gross profit in FY 01 was approximately $2,560,000, or 36% of sales, compared to approximately $2,262,000 or 32% of sales in FY 00. The gross profit of the medical segment in FY 01 was approximately $1,256,000, or 34% of sales, and included a reduction in inventory reserves of approximately $78,000 that were established in prior years and no longer required. The gross profit of the medical segment in FY 00 was approximately $860,000, or 26% of sales, and included no reduction in inventory reserves. The increase in gross profit of the medical segment was due primarily to more efficient manufacturing operations, resulting from a higher volume of production of ENT EndoSheaths.

        The gross profit of the industrial segment was approximately $1,304,000, or 37% of sales in FY 01, and included a reduction in inventory reserves of approximately $245,000 that were established in prior years and no longer required. The gross profit of the industrial segment in FY 00 was $1,402,000, or 38% of sales, and included a reduction of inventory reserves of approximately $200,000 that were established in prior years and no longer required. The decrease in gross profit of the industrial segment was due primarily to the lower sales volume and the mix of products shipped.

        Selling, general and administrative expenses, including stock-based compensation, for FY 01 were approximately $2,990,000, a decrease of approximately $149,000 from FY 00. These costs were 41% of sales in FY 01, compared to 44% of sales in FY 00. Expenses for selling and marketing decreased in FY 01 by approximately $92,000, or 7%, compared to FY 00. These costs decreased due to lower expenses of approximately $115,000 in the industrial segment for commissions, product promotion and space costs. These reductions were partially offset by an increase of approximately $23,000 in the medical segment, primarily due to higher costs for payroll and product promotion. Administrative expenses declined by approximately $57,000 due primarily to lower costs for payroll, travel and entertainment and other costs.

        Research and development expenses, including stock-based compensation, increased by $59,000, and were 10% of sales in FY 01 and in FY 00. The higher expenses for research and development were due to costs of the Egypt Project, offset partially due to lower costs for stock-based compensation, payroll and fringe benefits. The Company spent approximately $269,000 to fund Phase I of the Egypt Project in FY 01. In addition, during FY 01, the Company incurred higher costs related to applications for patents for the innovations received by the consultant to Imagineering Ltd.

24

        The loss from operations declined by 25% in FY 01 to $1,173,000, after declining 21% in FY 00 to $1,561,000. This improvement was due primarily to the higher volume of ENT EndoSheaths sold in FY 01 that resulted in a higher gross profit, and to control of operating expenses.

        Net interest income declined by $7,000 in FY 01, compared to FY 00, due primarily to interest expense paid for debt incurred to fund improvements to the industrial segment's facility.

        The equity in losses of 3DV decreased to $222,553 in FY 01 from $3,331,347 in FY 00. In the three months ended June 30, 2000, 3DV incurred losses of approximately $2,412,000. The Company's investment in 3DV totaled $222,553 at March 31, 2000, and accordingly, the Company recognized equity in losses of 3DV of the total value of that investment in the three months ended June 30, 2000. The Company recognized no losses in the three-month periods ended September 30, 2000, December 31, 2000 and March 31, 2001. In FY 00, the Company recognized $3,331,347 of the losses of 3DV.

        The Company's loss per share was $.06 in FY 01, compared to a loss per share of $.24 in FY 00. Excluding the equity in losses of 3DV, compensation expense related to an option granted to a non-employee in FY 00 and the expenses of the Egypt Project, the pro forma loss per share would have been $.02 in FY 01, compared to $.05 in FY 00.

Liquidity and Capital Resources

        In FY 02, the amount of cash used in the Company's operations was approximately $913,000. In FY 01 the Company used $562,000 of cash from operations. In FY 02 the medical and industrial segments used cash of approximately $338,000, while the corporate segment used cash of approximately $575,000. The medical segment used cash of approximately $355,000 to fund operations, while the industrial segment generated cash of approximately $17,000 from operations. The corporate segment used cash primarily for operations.

        Cash generated in investing activities was approximately $680,000, comprised of proceeds from the sales of and maturities of marketable securities, partially offset by the purchase of property and equipment. Purchases of property and equipment were primarily for new manufacturing equipment and an upgrade of computer systems for the medical segment.

        The Company expects to complete the installation of the new manufacturing equipment in the first half of FY 03. In addition, the Company expects to upgrade the computer systems of the industrial segment in the first half of FY 03.

        The Company expects the new manufacturing equipment will increase its capacity to manufacture ENT EndoSheaths by approximately 50%, allowing overhead to be spread over a greater volume of parts, thereby reducing the cost to manufacture ENT EndoSheaths. The Company believes that by reducing the cost of the ENT EndoSheaths, it will be able to consider continuing the program of lower unit prices for ENT EndoSheaths beyond the second quarter of FY 03.

        Cash generated from financing activities totaled approximately $554,000. The primary source of this cash was the completion of a private placement of 582,524 shares of the Company's Common Stock in June 2001. See Note 6 to the accompanying financial statements for further discussion.

        Accounts receivable decreased by approximately $314,000 in FY 02. The decrease in accounts receivable is primarily due to lower sales of the industrial segment in the fourth quarter of FY 02, compared to the same period in FY 01. Approximately 65% of this segment's sales have historically been to the aircraft engine manufacturing and repair markets. Subsequent to the events of September 11, 2001, the market for these products dropped precipitously, resulting in lower sales of the industrial segment. In addition, the days sales outstanding declined to 44 at March 31, 2002, compared to 49 at March 31, 2001.

25

        The composition of customers in the medical segment includes domestic hospitals, large and small clinics, individual doctor's offices and international distributors. Many domestic customers experience delays in their cash flow due to the general slowness of payments in the health care industry. The composition of customers in the industrial segment includes large and small industrial companies, and aircraft maintenance companies. To offset the market condition of the medical segment and to be responsive to the needs of customers in both segments, the Company offers payment of invoices using credit cards. This method of payment increased collections to 11% of sales in the fourth quarter of FY 02, compared to 5% of sales in the same period in FY 01. The Company monitors its customer accounts formally on a monthly basis, and more often as necessary. During FY 02, the Company experienced improved collections from its customers, allowing a reduction in the allowance for doubtful accounts. The Company will continue to monitor its receivables and will adjust the allowance for doubtful accounts accordingly.

        The Company currently plans to spend no more than $350,000 on capital equipment in FY 03. These capital expenditures are expected to relate primarily to manufacturing equipment and computer equipment and software. At March 31, 2002, the Company had a remaining commitment for approximately $24,000 to complete payment for the new manufacturing equipment. The Company had sufficient cash on hand at March 31, 2002 to fund this requirement.

        In September 2000, the Company executed a loan of $105,000 from the owner of the facility in which the industrial segment operates to fund leasehold improvements. The loan bears interest at 12%, is payable over a twenty-four month term beginning September 2000 and was personally guaranteed by two of the Company's stockholders/executives. The balance due the owner was $23,989 and $76,920 at March 31, 2002 and 2001, respectively. The Company had sufficient cash on hand at March 31, 2002 to fund this requirement.

        At March 31, 2001, the Company's principal sources of liquidity included $3.1 million in cash, cash equivalents and marketable securities. In addition, the Company has a demand line of credit with a bank under which the Company may borrow up to $250,000 in cash, net of any outstanding letters of credit. At March 31, 2002, the Company had acceptances payable totaling approximately $43,000 that were paid on April 8, 2002 and May 6, 2002. The Company has pledged $250,000 to secure the bank line of credit. The line was renewed in January 2002. Any borrowing under this demand line would bear interest at the prime rate, 4.75% as of March 31, 2002.

        In April 2002, the Company entered into an agreement with another bank. The new bank agreement includes a revolving line of credit under which the Company may borrow up to $1,000,000, net of up to $250,000 of any outstanding letters of credit and banker's acceptances. In addition, the Company may borrow up to 75% of the cost of new equipment to a maximum amount of $250,000. Borrowings under these loan arrangements must be fully cash collateralized. The agreement also stipulates that when the Company achieves positive cash flow, as defined in the agreement, the Company will be eligible to negotiate changes to these loan arrangements that may include changing the borrowing base for revolving loans, and the release of the pledged cash collateral.

        The Company has incurred losses since its inception, and losses are expected to continue in FY 03. The Company has funded the losses principally with the proceeds from public and private equity financings. The Company expects to generate operating income in the medical and industrial segments during the second half of FY 03. There can be no assurance that the Company's strategy will result in an operating income during FY 03, and management of the Company may seek equity capital during FY 03. There can be no assurance that capital will be available on terms acceptable to the Company, if at all.

26

Certain Factors That May Affect The Company's Future Operating Results

        Factors that may affect the Company's future operating results include, without limitation, the following:

        The Company has incurred substantial losses since its inception, and there can be no assurance that the Company will achieve a profitable level of operations in the future. The Company anticipates a negative cash flow during FY 03, due primarily to the funding of capital expenditures and marketing expenses and development of new products in its continued drive to penetrate the ENT and pulmonary markets. The Company had cash and marketable securities totaling $3.1 million as of March 31, 2002. Although the Company does not anticipate the need for additional financing in FY 03, management has decided that new financing may be desirable. However, there can be no assurance that such financing will be available on terms acceptable to the Company, if at all.

        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 will 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 has had, and will continue to have, a materially adverse effect on the Company.

        The Company's products and its manufacturing practices are subject to regulation by the FDA and by other state and foreign regulatory agencies. The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with the FDA's QSR 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, suspensions of clearances, seizures, recalls of products, operating restrictions or criminal prosecutions, and could have a material adverse effect on the Company.

        Certain critical components of the Company's products, such as image bundles, are currently being purchased solely from Pentax, a subsidiary company of a competitor of the Company. These components are being purchased pursuant to a supply agreement, which expires in March 2003, 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 Pentax, 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. In addition, the Company's borescopes are assembled using components and subassemblies purchased from independent vendors. While most components and subassemblies are currently available from more than one supplier, certain critical components are currently purchased only from Pentax and 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 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

27

as Olympus and Pentax. 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 industrial products are Olympus and Welch Allyn. 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.

        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. 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. There can be no assurance that measures taken by the Company to protect its proprietary information will prevent the unauthorized disclosure or use of this information, or that others will not be able to independently develop such information. In addition, in the event that another party infringes the Company's patent rights or other proprietary 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. Moreover, there can be no assurance that claims alleging infringement by the Company of other's proprietary rights will not be brought against the Company in the future or that any such claims will not be successful.

        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 FY 03. 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.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

        The Company, in the normal course of business, is subject to the risks associated with fluctuations in interest rates and changes in foreign currency exchange rates.

Interest and Market Risk

        The Company maintains a portfolio of marketable, primarily fixed income, available-for-sale securities of various issuers, types and maturities. The Company has not used derivative financial instruments in its investment portfolio. The Company attempts to limit its exposure to interest rate and credit risk by placing its investments with high-quality financial institutions and has established investment guidelines relative to diversification and maturities designed to maintain safety and liquidity.

        Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates decline. Due in part to these factors, the Company's future investment income may fall short of expectations due to changes in interest rates or the Company may suffer losses in principal if forced to sell securities which have seen a decline in market value due to changes in interest rates.

28

Foreign Currency Exchange

        The Company faces exposure to adverse movements in the value of the Japanese Yen due to purchases of raw materials from Japanese suppliers. This exposure may change over time, and could have a materially adverse effect on the Company's financial results. The Company may attempt to limit this exposure by purchasing forward contracts, as required. Most of the Company's liabilities are settled within 90 days of receipt of materials. At March 31, 2002, the Company's liabilities relating to Japanese Yen were approximately $43,000.

Item 8.    Financial Statements and Supplementary Data

        The following table contains certain selected quarterly financial data for the fiscal years ended March 31, 2001 and 2002.

	Quarterly Operating Results
	(in thousands, except per share data)
	Q1 2001			Q2 2001			Q3 2001			Q4 2001
Statement of Operations Data:
Net sales	$	1,580		$	1,707		$	1,946		$	1,976
Gross profit		417			596			662			885
Net income (loss) from operations		(612	)		(269	)		(441	)		149
Net income (loss)		(812	)		(248	)		(428	)		197
Net income (loss) per share		(.04	)		(.01	)		(.02	)		.01

	Q1 2002			Q2 2002		Q3 2002			Q4 2002
Net sales	$	1,732		$	1,720	$	1,629		$	1,632
Gross profit		587			661		461			513
Net income (loss) from operations		(91	)		38		(367	)		(761	)
Net income (loss)		(875	)		73		(346	)		(747	)
Net income (loss) per share		(.03	)		.00		(.01	)		(.03	)

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

        Not applicable.

29

PART III

Item 10.    Directors and Executive Officers of the Registrant

        The information required by this Item appears under the headings "Election of Directors" and "Reports Under Section 16(a) of the Exchange Act" in the Company's Proxy Statement for its 2002 Annual Meeting of Stockholders (the "2002 Proxy Statement"), which sections are incorporated herein by reference, and in 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 Named Executive Officers", and "—Compensation Committee Report on Executive Compensation" in the 2002 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 2002 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 2002 Proxy Statement, which section is incorporated herein by reference.

30

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, 2001 and 2002.

        Consolidated Statements of Operations—For the years ended March 31, 2000, 2001 and 2002.

        Consolidated Statements of Stockholders' Equity—For the years ended March 31, 2000, 2001 and 2002.

        Consolidated Statements of Cash Flows—For the years ended March 31, 2000, 2001 and 2002.

        Notes to Consolidated Financial Statements.

2.

Financial Statements. The following financial statements and schedule of 3DV Systems Ltd. are included as Appendix B of this Report:

        Consolidated Balance Sheets—December 31, 1999, 2000 and 2001.

        Consolidated Statements of Operations—For the years ended December 31, 1999, 2000, 2001 and from inception.

        Consolidated Statements of Stockholders' Equity—For the years ended December 31, 1999, 2000, 2001 and from inception.

        Consolidated Statements of Cash Flows—For the years ended December 31, 1999, 2000, 2001 and from inception.

        Notes to Consolidated Financial Statements.

3.

Financial Statement Schedules.

        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.

4.

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.

        None.

31

VISION-SCIENCES, INC.
EXHIBIT INDEX

Exhibit		Description of Exhibit
3.1.(1	)	Amended and Restated Certificate of Incorporation of the Company, as amended to date
3.2.(2	)	By-laws, as amended to date
*10.1.(3	)	1990 Stock Option Plan, as amended
*10.2.(3	)	1993 Director Option Plan
*10.3.(4	)	2000 Stock Incentive Plan
*10.4.(2	)	Vision-Sciences, Inc. 401(k) Plan, as amended
*10.5.(2	)	Form of Vision-Sciences, Inc. Invention, Non-Disclosure and Non-Competition Agreement for employees
10.6.(5	)	Letter Agreement between the Company and James A. Tracy dated July 18, 1997
10.7.		Letter Agreement between the Company and Thomas M. Olmstead dated October 1, 2001
10.8.(2	)	Registration Rights Agreement dated as of February 28, 1992 among the Registrant and the persons listed therein
10.9.(1	)	Piggyback Registration Rights Agreement, dated January 2, 2001, between the Company and the individuals and entities listed therein
10.10.(2	)	Supply Agreement between the Company and Asahi Optical Co., Ltd. dated March 16, 1992
**10.11.(6	)	Investment Agreement dated as of August 6, 1998 among Vision-Sciences, Inc., 3DV Systems Ltd. and RDC Rafael Development Corporation Ltd.
10.12.(2	)	Non-Exclusive License Agreement among Opielab, Inc., O.S. Limited Partnership and Asahi Optical Co., Ltd. dated September 28, 1988
10.13.(7	)	License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated June 10, 1993
10.14.(8	)	Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1994
10.15.(9	)	Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1995
10.16.(9	)	Amendment to License Agreement between Vision-Sciences, Inc. and Advanced Polymers, Inc. dated April 5, 1996
**10.17.(6	)	License and Manufacturing Agreement dated as of August 6, 1998 between Vision-Sciences, Inc. and 3DV Systems Ltd.
**10.18.(6	)	License Agreement dated as of August 6, 1998 between Vision-Sciences, Inc. and Asahi Optical Co., Ltd.
10.19.(9	)	Lease between Paul D. McKeon, Trustee of 14 Burr Street Realty Trust and Vision-Sciences, Inc. dated April 23, 1993
10.20.(4	)	Agreement of Lease between 30 Ramland Road LLC and Vision-Sciences, Inc. dated as of March 23, 2000
**10.21.(6	)	Memorandum of Understanding dated August 6, 1998 between Vision-Sciences, Inc. and Imagineering, Ltd.
10.22.		Business Loan Agreement and Commercial Pledge and Security Agreement among Vision-Sciences, Inc., Machida, Inc. and The First National Bank of Boston dated February 15, 1997
10.23.		Extension to Business Loan Agreement and Commercial Pledge and Security Agreement among Vision-Sciences, Inc., Machida, Inc. and The First National Bank of Boston dated January 7, 2002

32

10.24.		Loan Agreement between Vision-Sciences, Inc. and Citizens Bank of Massachusetts dated April 30, 2002
10.25.		Pledge Agreement between Vision-Sciences, Inc. and Citizens Bank of Massachusetts dated April 30, 2002
21.1.(1	)	Subsidiaries of the Company
23.1.		Consent of Arthur Andersen LLP
23.2.		Consent of Somekh Chaikin
99.1.		Letter from Vision-Sciences, Inc. to the Commission pursuant to Temporary Note 3T to Article 3 of Regulation S-X

*

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, which portions have been deleted and filed separately with the Securities and Exchange Commission.

(1)

Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2001.

(2)

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

(3)

Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 1994.

(4)

Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 2000.

(5)

Incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.

(6)

Incorporated by reference to the Current Report on Form 8-K dated August 20, 1998.

(7)

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

(8)

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

(9)

Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended March 31, 1996.

33

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: May 6, 2002

        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 Katsumi Oneda	President, CEO and Chairman of the Board of Directors (Principal Executive Officer)	May 6, 2002
/s/  JAMES A. TRACY James A. Tracy	Vice President Finance, Chief Financial and Accounting Officer (Principal Financial and Accounting Officer)	May 7, 2002
/s/  KENNETH ANSTEY Kenneth Anstey	Director	May 3, 2002
/s/  WILLIAM F. DOYLE William F. Doyle	Director	May 6, 2002
/s/  GERALD B. LICHTENBERGER Gerald B. Lichtenberger	Director	May 6, 2002
/s/  LEWIS C. PELL Lewis C. Pell	Director	May 6, 2002
/s/  FRED E. SILVERSTEIN Fred E. Silverstein	Director	May 6, 2002
/s/  JOHN J. WALLACE John J. Wallace	Director	May 4, 2002

34

APPENDIX A

VISION-SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2001 AND 2002
TOGETHER WITH AUDITORS' REPORT

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

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and Board of Directors of Vision-Sciences, Inc.:

        We have audited the accompanying consolidated balance sheets of Vision-Sciences, Inc. (a Delaware corporation) and subsidiaries as of March 31, 2001 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 2002. 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 did not audit the financial statements of 3DV Systems Ltd., which statements reflect total assets and total net loss of 7% and 17% in 2001, and 0% and 26% in 2002, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for that entity, is based solely on the report of the other auditors.

        We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 and the report of other auditors provide a reasonable basis for our opinion.

        In our opinion, based on our audits and the report of other auditors 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, 2001 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2002 in conformity with accounting principles generally accepted in the United States.

        As explained in Note 1(m) to the Consolidated Financial Statements, effective June 30, 2001 the Company changed its method of accounting for its derivative instruments.

/s/ Arthur Andersen LLP
Boston, Massachusetts
May 6, 2002

F-1

VISION-SCIENCES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets—March 31, 2001 and 2002

			2001			2002
ASSETS
Current Assets:
	Cash and cash equivalents		$	2,568,724		$	2,890,364
	Marketable securities available for sale			1,243,068			251,445
	Accounts receivable, net of allowance for doubtful accounts of $97,727 and $76,641 in 2001 and 2002, respectively			1,148,092			834,577
	Inventories			1,006,016			1,193,181
	Prepaid expenses and other current assets			66,339			76,932
		Total current assets		6,032,239			5,246,499
Property and Equipment, at cost:
	Machinery and equipment			2,984,511			3,283,341
	Furniture and fixtures			208,934			208,934
	Leasehold improvements			450,396			462,882
				3,643,841			3,955,157
Less—Accumulated depreciation and amortization				3,083,860			3,297,582
				559,981			657,575
Equity Investment in 3DV Systems Ltd. (Note 4)				500,000			—
Other Assets, net of accumulated amortization of $28,405 and $34,746 in 2001 and 2002, respectively				102,441			96,100
Total assets			$	7,194,661		$	6,000,174
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Acceptances payable to a bank		$	38,713		$	43,226
	Current portion of note payable			52,931			23,989
	Accounts payable			287,458			286,730
	Accrued expenses			1,377,455			1,103,156
		Total current liabilities		1,756,557			1,457,101
Note Payable, Net of Current Portion				23,989			—
Potential Obligations to Non-qualified Option Holders (Note 1 m)				188,515			421,110
Commitments (Note 7)
Stockholders' Equity:
	Preferred stock, $.01 par value—
		Authorized—5,000,000 shares Issued and outstanding—none		—			—
	Common stock, $.01 par value—
		Authorized—50,000,000 shares
		Issued and outstanding—26,520,831 shares and 27,105,355 shares at March 31, 2001 and 2002, respectively		265,207			271,052
	Additional paid-in capital			57,601,457			58,386,502
	Accumulated deficit			(52,641,064	)		(54,535,591	)
		Total stockholders' equity		5,225,600			4,121,963
		Total liabilities and stockholders' equity	$	7,194,661		$	6,000,174

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 Fiscal Years Ended March 31, 2000, 2001 and 2002

		2000			2001			2002
Net Sales		$	7,054,595		$	7,209,274		$	6,713,107
Cost of Sales			4,792,542			4,649,180			4,490,729
	Gross profit		2,262,053			2,560,094			2,222,378
Selling, General and Administrative Expenses (1)			2,962,087			2,937,862			3,093,833
Research and Development Expenses (1)			262,297			457,076			215,647
Stock-based compensation			598,823			338,238			93,941
	Loss from operations		(1,561,154	)		(1,173,082	)		(1,181,043	)
Interest Income			109,581			113,615			118,660
Interest Expense			—			(10,716	)		(6,382	)
Equity in Losses of 3DV Systems Ltd. (Note 4)			(3,331,347	)		(222,553	)		(500,000	)
Other Income			5,132			1,716			1,407
	Net loss before cumulative effect of change in accounting principle		(4,777,788	)		(1,291,020	)		(1,567,358	)
Cumulative Effect of Change in Accounting Principle (Note 1m)			—			—			327,169
	Net loss after cumulative effect of change in accounting principle	$	(4,777,788	)	$	(1,291,020	)	$	(1,894,527	)
Basic and Diluted Net Loss per Common Share		$	(.24	)	$	(.06	)	$	(.07	)
Shares Used in Computing Basic and Diluted Net Loss per Common Share			19,954,842			22,355,376			26,988,494
(1) Excludes non-cash stock-based compensation as follows:
Selling, General and Administrative Expenses		$	176,912		$	52,140		$	60,545
Research and Development Expenses			421,911			286,098			33,396
		$	598,823		$	338,238		$	93,941

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 Fiscal Years Ended March 31, 2000, 2001 and 2002

		Common Stock
		Number of Shares	$.01 Par Value		Additional Paid-in Capital			Accumulated Deficit			Total Stockholders' Equity			Total Comprehensive Loss
Balance, March 31, 1999		19,212,021	$	192,119	$	51,830,808		$	(46,573,100	)	$	5,449,827
	Sale of common stock, net	1,443,088		14,431		1,485,569			—			1,500,000
	Exercise of stock options	246,019		2,460		139,258			—			141,718
	Stock option grants to non-employees	—		—		598,823			—			598,823
	Currency translation adjustment	—		—		—			1,906			1,906		$	1,906
	Net loss	—		—		—			(4,777,788	)		(4,777,788	)		(4,777,788	)
Total Comprehensive Loss															(4,775,882	)
Balance, March 31, 2000		20,901,128		209,010		54,054,458			(51,348,982	)		2,914,486
	Sale of common stock, net	5,587,418		55,874		3,397,276			—			3,453,150
	Exercise of stock options	32,285		323		—			—			323
	Stock option grants to non-employees	—		—		338,238			—			338,238
	Currency translation adjustment	—		—		—			(1,062	)		(1,062	)		(1,062	)
	Reclass of potential obligations to non-qualified option holders	—		—		(188,515	)		—			(188,515	)
	Net loss	—		—		—			(1,291,020	)		(1,291,020	)		(1,291,020	)
Total Comprehensive Loss															(1,292,082	)
Balance, March 31, 2001		26,520,831		265,207		57,601,457			(52,641,064	)		5,225,600
	Sale of common stock, net	582,524		5,825		594,175			—			600,000
	Exercise of stock options	2,000		20		2,355			—			2,375
	Reclass of potential obligations to non-qualified option holders	—		—		188,515			—			188,515
	Net loss	—		—		—			(1,894,527	)		(1,894,527	)		(1,894,527	)
Total Comprehensive Loss														$	(1,894,527	)
Balance, March 31, 2002		27,105,355	$	271,052	$	58,386,502		$	(54,535,591	)	$	4,121,963

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 Fiscal Years Ended March 31, 2000, 2001 and 2002

				2000			2001			2002
Cash Flows from Operating Activities:
	Net loss			$	(4,777,788	)	$	(1,291,020	)	$	(1,894,527	)
	Adjustments to reconcile net loss to net cash provided by (used in) operating activities—
		Cumulative effect of adopting EITF 00-19			—			—			327,169
		Depreciation and amortization			290,946			247,665			220,063
		Equity in losses of 3DV Systems Ltd.			3,331,347			222,553			500,000
		Loss on disposal of property and equipment			—			2,773			—
		Stock option grants to non-employees			598,823			338,238			93,941
		Changes in assets and liabilities—
			Accounts receivable		9,781			(68,502	)		313,515
			Inventories		(644,513	)		272,068			(187,165	)
			Prepaid expenses and other current assets		21,949			10,404			(10,593	)
			Accounts payable		(77,694	)		(87,226	)		(728	)
			Accrued expenses		(15,729	)		(208,793	)		(274,299	)
			Deferred development fee		(345,821	)		—			—
		Net cash used in operating activities			(1,608,699	)		(561,840	)		(912,624	)
Cash Flows from Investing Activities:
		Decrease (increase) in marketable securities			970,608			(1,243,068	)		991,623
		Purchase of property and equipment, net of disposals			(162,527	)		(138,281	)		(311,316	)
		Investment in equity of 3DV Systems Ltd.			(1,500,000	)		(500,000	)		—
		Decrease in other assets			13,333			—			—
			Net cash provided by (used in) investing activities		(678,586	)		(1,881,349	)		680,307
Cash Flows from Financing Activities:
		Proceeds from acceptances payable to a bank, net			179			6,201			4,513
		Payment of note payable			—			(28,080	)		(52,931	)
		Proceeds from the sale of common stock, net			1,500,000			3,453,150			600,000
		Proceeds from exercise of stock options			141,718			323			2,375
			Net cash provided by financing activities		1,641,897			3,431,594			553,957
Effect of Exchange Rate Changes on Cash and Cash Equivalents					1,906			(1,062	)		—
Net (Decrease) Increase in Cash and Cash Equivalents					(643,482	)		987,343			321,640
Cash and Cash Equivalents, beginning of year					2,224,863			1,581,381			2,568,724
Cash and Cash Equivalents, end of year				$	1,581,381		$	2,568,724		$	2,890,364
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
		Leasehold improvements acquired in exchange for note payable		$	—		$	105,000		$	—
Supplemental Disclosure of Cash Flow Information:
		Cash paid during the year for interest		$	—		$	10,716		$	6,382

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, 2002

(1) Operations and Significant Accounting Policies

        The consolidated financial statements include the accounts of Vision-Sciences, Inc. (the "Company"), a Delaware corporation, and its wholly-owned subsidiaries. The Company's subsidiaries are as follows: OpieLab, Inc., a Washington corporation; Machida Incorporated, a Delaware corporation; Vascu-Care, Inc., a Delaware corporation; and Vision Sciences Ltd., an Israeli corporation.

        The Company was organized in 1987 to manufacture and assemble optical products. The Company's products and accessories are used within two industry segments, medical and industrial. The medical segment designs, manufactures and markets proprietary single-use sheaths that slide on the insertion tube of flexible endoscopes. The sheaths allow quick, efficient product turnover for health-care providers while ensuring a sterile procedure for each patient. The industrial segment designs, manufactures and markets endoscopes for the industrial market, and manufactures and repairs endoscopes for the medical segment. Endoscopes provide minimally invasive access to areas not readily visible to the human eye. Segment information is presented in Note 9.

        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, 2000, 2001 and 2002, and expects to incur a loss for the year ending March 31, 2003. Management believes the Company will not require additional financial support for fiscal year 2003. However, management may seek additional equity capital during fiscal 2003. The Company is also subject to 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 the 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) Basic and Diluted Net Loss per Common Share

        The Company calculates earnings per share according to Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share. Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding. For the years ended March 31, 2000, 2001 and 2002, diluted net loss per common share is the same as basic net loss per common share as the inclusion of other shares of stock issuable pursuant to stock options, totaling 2,578,047, 3,312,297 and 3,310,369 respectively, would be antidilutive.

F-6

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(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:

Asset Classification	Estimated Useful Life
Machinery and equipment	3-5 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

        In December 1999, the Securities and Exchange Committee issued Staff Accounting Bulletin No. 101 which establishes guidance in applying generally accepted accounting principles to revenue recognition in financial statements and was effective beginning in fiscal 2001. The Company recognizes revenue upon product shipment. The Company has determined that its existing revenue recognition practices comply with the guidance in the bulletin.

(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,
	2001		2002
Raw materials	$	415,853	$	612,827
Work-in-process		177,804		190,686
Finished goods		412,359		389,668
	$	1,006,016	$	1,193,181

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

(f) Other Assets

        Other assets consist of deposits and patent costs. Patent costs are amortized on a straight-line basis over 17 years. The Company follows the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 121 requires that long-lived assets be reviewed for impairment by comparing the fair value of the assets with their carrying amount. Any write-downs are to be treated as permanent reductions in the carrying value of the assets. The Company believes that the carrying values of these assets are fully realizable as of March 31, 2002.

F-7

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(1) Operations and Significant Accounting Policies (Continued)

(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 SFAS No. 52, Foreign Currency Translation. For each of the three years in the period ended March 31, 2002, these amounts were not material. The Company translates the financial statements of its foreign subsidiary in accordance with SFAS No. 52. Accordingly, assets and liabilities are translated at exchange rates in effect at the end of the period, and expenses are translated at average exchange rates during the period. All cumulative translation gains or losses from the translation into the Company's reporting currency are included as a separate component of stockholders' equity in the accompanying consolidated balance sheets.

(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 that are designed to maintain safety and liquidity.

        The Company has classified its investments in marketable securities as available-for-sale securities, in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Marketable securities are recorded at market value, which approximates amortized cost.

        As of March 31, 2002, the Company's marketable securities consisted of commmercial paper and corporate notes with a weighted average maturity of 301 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 (Continued)

March 31, 2002

(1) Operations and Significant Accounting Policies (Continued)

(k) Concentration of Credit Risk

        SFAS No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentration of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. 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 9). To reduce risk, the Company routinely assesses the financial strength of its customers and, when appropriate, obtains letters of credit or advance payments for its international sales; as a consequence, the Company believes that its accounts receivable credit risk exposure is limited. The Company had one customer who individually accounted for 13% of the total accounts receivable balance as of March 31, 2002. The Company had three customers who individually accounted for 19%, 12% and 12%, respectively, of the total accounts receivable balance as of March 31, 2001. 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.

(l) Fair Value of Financial Instruments

        SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of an estimate of the fair value of certain financial instruments. The Company's financial instruments consist of cash equivalents, accounts receivable, acceptances payable, note payable and potential obligations to non-qualified option holders. The estimated fair value of these financial instruments approximates their carrying value at March 31, 2001 and 2002. The estimated fair values have been determined through information obtained from market sources and management estimates.

(m) Accounting for Derivative Instruments

        In September 2000, the Emerging Issues Task Force issued EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, which requires freestanding contracts that are settled in a company's own stock, including common stock options and warrants, to be designated as an equity instrument, asset or a liability. Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value, with any changes in fair value recorded in the results of operations. A contract designated as an equity instrument must be included within equity, and no fair value adjustments are required. In accordance with EITF 00-19, the Company determined that outstanding options as of March 31, 2002 to purchase 1,375,819 shares of the Company's Common Stock should be designated as "Potential obligations to non-qualified option holders", a liability in the Company's accompanying balance sheet.

        Under the transition rules of EITF 00-19, effective June 30, 2001, the Company recorded these options as a liability at fair value with the required adjustment of $327,169 recorded as a cumulative adjustment in its results of operations for the three months ended June 30, 2001. After June 30, 2001, any changes in the fair value were included in the Company's results of operations. For the nine months ended March 31, 2002, the fair value of these outstanding options increased to $421,110. Accordingly, the Company recorded a charge in its results of operations of $93,941 for the nine months ended March 31, 2002.

F-9

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(1) Operations and Significant Accounting Policies (Continued)

(n) Comprehensive Income

        SFAS No. 130, Reporting Comprehensive Income requires companies to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet.

(o) Reclassification

        Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation.

(p) Recently Issued Accounting Standards

        In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires all entities to recognize the fair value of liabilities for an asset retirement in the period in which it is incurred if reasonable estimates of fair value can be made. This statement is effective for all financial statements issued for fiscal years beginning after June 15, 2002. Management does not expect that SFAS No. 143 will have a material impact on the Company's financial statements.

        In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement applies to the accounting for long-lived assets, including reporting the effects of the disposal of a segment of a business. This statement is effective for all financial statements issued for fiscal years beginning after December 15, 2001. Management does not expect that SFAS No. 144 will have a material impact on the Company's financial statements.

(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 (4.75% and 8% at March 31, 2002 and 2001, respectively) 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 was renewed by the bank on January 7, 2002 and continues until an event of default occurs. There was $206,774 of credit available at March 31, 2002. Under this agreement, the Company is also subject to certain covenants, including the prohibition of paying cash dividends on its common stock. At March 31, 2002, the Company had acceptances payable aggregating $43,226, maturing in April and May 2002.

        In September 2000, the Company executed an operating lease with the owners of the facility that, up to March 2000, was owned by a partnership owned in part by certain stockholders/executives of the Company. The lease provided for, among other things, that the Company would reduce the space it leased, and that the new owner would perform work improving the space to be occupied by the Company. The Company executed a loan of $105,000 from the owner to fund the improvements. The loan bears interest at 12%, is payable over a twenty-four month term beginning September 2000 and was personally guaranteed by two of the Company's stockholder/executives. The balance due the owner was $76,920 and $23,989 at March 31, 2001 and 2002, respectively.

F-10

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(3) 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,
	2001			2002
Net operating loss carryforwards	$	17,729,000		$	18,106,000
Nondeductible reserves		703,000			582,000
Research and development credit carryforwards		581,000			531,000
Other temporary differences		383,000			259,000
Depreciation		(116,000	)		24,000
		19,280,000			19,502,000
Less—Valuation allowance		(19,280,000	)		(19,502,000	)
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. The uncertainty is due to current and projected net losses.

        At March 31, 2002, the Company had operating loss carryforwards available to offset future federal taxable income of approximately $44,962,000. These operating loss carryforwards expire at various dates through 2022 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 certain cumulative changes in ownership over a three-year period.

(4) 3DV Systems Ltd.

        3DV Systems Ltd. ("3DV"), is an Israeli company in the development stage. 3DV develops object video sensor chipsets that allow high-end broadcasters, video professionals and video-enabled consumers to attain operational efficiencies and enhanced video delivery. The Company accounts for its investment in 3DV using the equity method of accounting. From August 20, 1998 through December 23, 1999, the Company had committed to finance the working capital needs of 3DV. Accordingly, during that period the Company recorded 100% of the losses of 3DV. On December 23, 1999, 3DV completed a second round of financing which resulted in an amendment to the Investment Agreement between 3DV and the Company signed on August 6, 1998. The effect of that amendment was to eliminate the Company's option to purchase the remaining shares of 3DV under certain conditions, and to exempt the Company from guaranteeing the working capital requirements of 3DV. Subsequent to December 23, 1999 the Company included in its statements of operation only its proportional share of 3DV's losses.

F-11

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(4) 3DV Systems Ltd. (Continued)

        During the three months ended June 30, 2001, 3DV incurred losses of approximately $2,177,000. The Company's investment in 3DV totaled $500,000 at March 31, 2001, and accordingly, the Company recorded equity in losses of 3DV of $500,000, the balance of the Company's investment, in the three months ended June 30, 2001. The Company recognized no losses related to 3DV during the three-month periods ended September 30, 2001, December 31, 2001 and March 31, 2002. During these three-month periods, 3DV incurred losses totaling approximately $5,469,000. In the years ended March 31, 2000, 2001 and 2002, the Company recognized equity in the losses of 3DV of $3,331,347, $222,553 and $500,000, respectively.

        In April and May 2000, 3DV executed a third round of financing with investors other than the Company. In March 2001, 3DV executed a fourth round of financing with all its investors. As part of this round, the Company invested $500,000 in Series A Convertible Subordinated Notes (the "Notes") of 3DV. In September 2001, 3DV executed a fifth round of financing with investors other than the Company, including two employee-directors of the Company. Subsequent to the fifth round of financing, the Company held approximately 24% of the outstanding shares of 3DV, and would hold approximately 18% of the shares of 3DV, if all employee options and Notes were converted to common shares.

        In March 2002, 3DV planned a sixth round of financing with investors other than the Company, including the two employee-directors of the Company. The amount planned to be raised is $4,000,000, payable in two equal installments in March and September 2002.

(5) Egypt Project

        In September 2000, the Company contributed $269,000 to the University of Georgia ("UGA") in support of the University of Georgia Hepatitis Project, Proposal No. 022297-01 (the "Egypt Project"). Payments were comprised of a direct grant of $119,000 contributed by the Company, and $150,000 contributed in the form of a loan (the "Loan") to UGA. The Loan bears no interest and only stipulates that it will be repaid to the Company in the event that the total funds received by UGA for the Egypt Project exceed its first-year budget. In fiscal 2001, the Company expensed approximately $269,000 in research and development expenses to support the Egypt Project.

(6) Stockholders' Equity

(a) Sale of Stock

        During fiscal 2000, two of the Company's stockholders/executives invested $1,500,000 in the Company's common stock at prices per share equal to 80% of the average closing price of the stock on the Nasdaq SmallCap Market during the five-day trading periods preceding each purchase. The proceeds of the common stock sales were received directly by the Company in exchange for newly issued shares of common stock.

F-12

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(6) Stockholders Equity (Continued)

        On December 29, 2000 and January 2, 2001, the Company completed a private equity placement with four members of the Company's Board of Directors, three of whom are employees of the Company, and a group of other private investors (collectively, the "Investors"). The Company sold an aggregate of 5,587,418 shares of common stock at a price of $.62 per share, which represented 80% of the average closing price of the common stock on the Nasdaq SmallCap Market during the five trading days ended December 11, 2000. The members of the Company's Board of Directors purchased 3,468,096 shares and the other investors purchased 2,119,322 shares. The Company received all the proceeds in exchange for newly issued shares of common stock.

        As part of the investment, the Company and the Investors executed a Piggyback Registration Rights Agreement (the "PRRA"). Under the PRRA, the Company will, prior to filing a registration statement with the Securities and Exchange Commission, and subject to agreement with any managing underwriter and certain other limitations, give notice to all the Investors of its intention to do so. If any of the Investors requests registration of their shares, the Company shall use its best efforts to cause those shares to be registered. The Company retains the right to postpone or withdraw any registration without any obligation to the Investors.

        On June 13, 2001, the Company completed a private equity placement with a private investor, not previously affiliated with the Company in an offering exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. The Company sold an aggregate of 582,524 shares of common stock at a price of $1.03 per share, which represented 90% of the average closing price of the common stock on the Nasdaq SmallCap Market during the five trading days ended May 31, 2001. The Company received an aggregate consideration of $600,000 for the newly issued shares of common stock.

(b) Stock Option Plans

        The Company had a stock option plan (the "1990 Plan") under which it could grant key employees and consultants incentive and nonstatutory stock options at the fair value of the stock on the date of grant. Options became exercisable at varying dates ranging up to five years from the date of grant. The Board of Directors had authorized the issuance of options for the purchase of up to 4,375,000 shares of common stock under the 1990 Plan, of which 872,087 were retired as of the expiration date of the 1990 Plan.

        During fiscal year 2001, the 1990 Plan expired and was replaced with the 2000 Stock Incentive Plan, (the "2000 Plan"). The terms of the 2000 Plan are substantially the same as the 1990 Plan. The Board of Directors has authorized the issuance of options for the purchase of up to 4,000,000 shares of common stock under the 2000 Plan, of which 3,444,928 shares remain available for future grant.

F-13

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(6) Stockholders Equity (Continued)

        A summary of the 2000 and 1990 Plans activity is as follows:

	Number Of Shares		Exercise Price Range		Weighted Average Exercise Price
Outstanding, March 31, 1999	1,321,297		$	1.00–$7.50	$	2.24
Granted	1,673,019			.01–1.63		1.48
Exercised	(246,019	)		.01–1.25		.58
Canceled	(230,250	)		1.00–1.63		1.45
Outstanding March 31, 2000	2,518,047			1.13–7.50		1.97
Granted	977,285			.01–1.56		1.16
Exercised	(32,285	)		.01		.01
Canceled	(210,750	)		1.19–4.00		1.43
Outstanding March 31, 2001	3,252,297			1.06–7.50		1.78
Granted	155,072			.01–1.15		.75
Exercised	(2,000	)		1.19		1.19
Canceled	(195,000	)		1.06–4.00		1.51
Outstanding March 31, 2002	3,210,369		$	.01–$7.50	$	1.75
Exercisable, March 31, 2000	2,023,047		$	1.13–$7.50	$	2.08
Exercisable, March 31, 2001	2,143,547		$	1.13–$7.50	$	2.05
Exercisable, March 31, 2002	2,682,869		$	.01–$7.50	$	1.86

        The following table summarizes information about stock options outstanding and exercisable at March 31, 2002:

		Outstanding				Exercisable
Range of Exercise Prices		Number of Shares	Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
$	.01–1.25	1,254,622	6.72	$	1.10	944,622	$	1.11
	1.31–1.88	1,710,000	7.90		1.53	1,492,500		1.56
	3.00–3.63	31,897	3.69		3.25	31,897		3.25
	5.44–7.50	213,850	1.92		7.07	213,850		7.07
		3,210,369	7.00	$	1.75	2,682,869	$	1.86

        On August 16, 1993, the Company adopted the 1993 Director 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. Options become exercisable over a four-year period from the date of grant. The Company has reserved 200,000 shares of common stock for the exercise of stock options under the 1993 Plan. As of March 31, 2002, 100,000 shares were available for future grant under the 1993 Plan.

F-14

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(6) Stockholders Equity (Continued)

        A summary of the 1993 Plan activity is as follows:

	Number Of Shares	Exercise Price Range		Weighted Average Option Price
Outstanding March 31, 1999, 2000 and 2001	60,000	$	1.50–$11.63	$	4.92
Granted	40,000	$	.97–$1.00	$	.99
Outstanding March 31, 2002	100,000	$	.97–$11.63	$	3.34
Exercisable March 31, 2000	40,000	$	1.50–$11.63	$	6.59
Exercisable March 31, 2001	48,000	$	1.50–$11.63	$	5.75
Exercisable March 31, 2002	64,000	$	.97–$11.63	$	4.63

        The following table summarizes information about stock options outstanding and exercisable at March 31, 2002:

	Outstanding		Exercisable
Exercise Price	Number of Shares	Weighted Average Remaining Contractual Life (Years)	Number of Shares
$    .97	20,000	9.76	4,000
1.00	20,000	9.01	4,000
1.50	20,000	5.38	20,000
1.63	20,000	6.38	16,000
11.63	20,000	1.37	20,000
	100,000	6.38	64,000

        In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, 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 consolidated financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under APB Opinion No. 25 and elects the disclosure-only alternative under SFAS No. 123 for stock-based compensation awarded in the years ended March 31, 2000, 2001 and 2002 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The underlying assumptions used are as follows:

	March 31,
	2000	2001	2002
Risk-free interest rate	5.68%–6.58%	4.64%–6.68%	3.91%–6.68%
Expected dividend yield	—	—	—
Expected lives	5 years	5 years	5 years
Expected volatility	89%	72%	86%
Weighted average value of grants per share	$1.127	$.63	$1.04
Weighted average remaining contractual life of options outstanding (years)	7.94	7.77	6.98

F-15

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(6) Stockholders Equity (Continued)

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,
		2000			2001			2002
Net loss—	As reported	$	(4,778,000	)	$	(1,291,000	)	$	(1,895,000	)
	Pro forma		(5,042,000	)		(1,761,000	)		(2,445,000	)
Net loss per share—	As reported	$	(.24	)	$	(.06	)	$	(.07	)
	Pro forma		(.25	)		(.08	)		(.09	)

        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.

        Under the 1990 Plan and the 2000 Plan, there remain 2,655,297 and 4,000,000 shares of common stock, respectively, reserved for the exercise of stock options.

(c) Stock Compensation Agreement

        During the year ended March 31, 1999, the Company entered into an agreement with a consulting firm to provide services that will be paid in non-qualified options to purchase common stock of the Company. The maximum value of services to be rendered, as defined in the contract, is $200,000. The contract was renewed on January 1, 2000, and the Company and consultant intend for the contract to remain in effect until the maximum value of services is reached. The number of shares of common stock to be issued will be based upon the total amount earned during the contract period divided by the lowest closing bid price of the Company's common stock during calendar 1999. During the years ended March 31, 2000, 2001 and 2002, the consulting firm performed services that entitled the firm to receive options to purchase 34,893, 32,285 and 45,072 shares of common stock, exerciseable at $.01 per share, respectively, valued at approximately $49,000, $52,000 and $61,000, respectively. The value of the options granted was calculated using the Black-Scholes option pricing model. All options were granted to the consulting firm during the years ended March 31, 2000 and 2001 were vested 100% upon grant and were exercised. The options granted in the year ended March 31, 2002 were 100% vested upon grant and were exercised in April 2002. The value of the options was recorded as an expense and is included as part of selling, general and administrative expenses in the consolidated statements of operations in the year in which the services were performed.

F-16

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(7) Commitments and Related Party Transactions

        Prior to April 2000, the Company conducted a portion of its operations in certain facilities leased from a partnership owned in part by certain stockholders/executive officers. Rental expense charged to operations for this facility was approximately $197,000 for the year ended March 31, 2000. That partnership sold its interest in those facilities in March 2000. During fiscal 2001, the Company entered into a new lease for a portion of those same facilites from the new owner. This lease and other leases for facilities from nonrelated parties under various agreements expire on various dates through August 2005. Rental expense charged to operations under leases from nonrelated parties was approximately $147,000, $317,000 and $288,000 for the years ended March 31, 2000, 2001 and 2002, respectively. Approximate future minimum lease commitments under all operating leases are as follows, including payments of a note payable in conjunction with certain leasehold improvements capitalized in fiscal year 2002:

Year Ending March 31,	Commitment
2003	$	313,000
2004		239,000
2005		157,000
2006		72,000
2007		2,000
	$	783,000

(8) 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, make a matching contribution up to a certain percentage of each employee's contribution. During the years ended March 31, 2000, 2001 and 2002, the Company recorded matching contributions of approximately $25,000, $29,000 and $30,000, respectively, relating to the Plan.

(9) Segment Information

        The Company has adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. This statement established standards for reporting information about operating segments and related disclosures about products and services, geographic areas and major customers.

        The Company has determined it has three reportable segments—medical, industrial and corporate. The medical segment designs, manufactures and sells endosheaths and sells endoscopes to users in the health care industry. The industrial segment designs, manufactures and sells borescopes to a variety of users, primarily in the aircraft maintenance industry. In addition, the industrial segment manufactures and repairs endoscopes for the medical segment. The corporate segment consists of certain administrative expenses beneficial to the Company as a whole and the management oversight of the Company's investments in 3DV, Vision-Sciences, Ltd. and the Egypt Project.

F-17

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(9) Segment Information (Continued)

        The accounting policies of the segments are described in the summary of significant accounting policies. The Company evaluates segment performance based upon operating income. Identifiable assets are those used directly in the operations of each segment. Corporate assets include cash, marketable securities and the investment in 3DV. The carrying value of the investment in 3DV at March 31, 2002 is $0. Data regarding management's view of the Company's segments is provided in the following tables.

Fiscal Year Ended March 31,	Medical			Industrial			Corporate			Adjustments			Total
2000
Sales to external customers	$	3,358,271		$	3,696,324		$	—		$	—		$	7,054,595
Intersegment sales		—			558,626			—			(558,626	)		—
Operating (loss) income		(845,362	)		330,178			(1,060,591	)		14,621			(1,561,154	)
Interest income, net		—			—			109,581			—			109,581
Depreciation and amortization		265,590			14,576			10,780			—			290,946
Other significant non-cash items:
Equity in losses of 3DV Systems Ltd.		—			—			(3,331,347	)		—			(3,331,347	)
Stock-based compensation		—			—			(598,823	)		—			(598,823	)
Total assets		2,759,068			1,162,088			1,831,675			(844,901	)		4,907,930
Expenditures for fixed assets		150,913			7,050			4,564			—			162,527
2001
Sales to external customers	$	3,675,124		$	3,534,150		$	—		$	—		$	7,209,274
Intersegment sales		—			522,127			—			(522,127	)		—
Operating (loss) income		(378,278	)		401,721			(1,196,525	)		—			(1,173,082	)
Interest income, net		—			(10,716	)		113,615			—			102,899
Depreciation and amortization		218,321			29,335			9			—			247,665
Other significant non-cash items:
Equity in losses of 3DV Systems Ltd.		—			—			(222,553	)		—			(222,553	)
Stock-based compensation		—			—			(338,238	)		—			(338,238	)
Total assets		2,176,210			1,097,940			4,408,244			(487,733	)		7,194,661
Expenditures for fixed assets		114,730			37,946			(14,395	)		—			138,281
2002
Sales to external customers	$	3,464,017		$	3,249,090		$	—		$	—		$	6,713,107
Intersegment sales		—			601,206			—			(601,206	)		—
Operating (loss) income		(747,362	)		351,681			(785,362	)		—			(1,181,043	)
Interest income, net		—			(6,382	)		118,660			—			112,278
Depreciation and amortization		186,111			33,952			—			—			220,063
Other significant non-cash items:
Equity in losses of 3DV Systems Ltd.		—			—			(500,000	)		—			(500,000	)
Stock-based compensation		—			—			(421,110	)		—			(421,110	)
Total assets		1,854,849			975,443			3,233,783			(63,901	)		6,000,174
Expenditures for fixed assets		304,937			6,379			—			—			311,316

F-18

VISION-SCIENCES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

March 31, 2002

(9) Segment Information (Continued)

The following table identifies sales by geographic region. Sales are attributable to geographic regions based upon the location of customers.

	Fiscal Years Ended March 31,
Geographic Region
	2000		2001		2002
Asia and Australia	$	274,250	$	411,248	$	372,037
Canada		96,933		136,543		150,510
Europe		514,368		847,816		1,067,333
Middle East and Africa		96,590		63,404		84,772
South America		256,439		146,852		155,573
United States		5,816,015		5,603,411		4,882,882
Total	$	7,054,595	$	7,209,274	$	6,713,107

        For the fiscal year ended March 31, 2000, no customer accounted for 10% or more of consolidated net sales. For the fiscal years ended March 31, 2001 and 2002, one customer accounted for 11% and 13%, respectively, of consolidated net sales.

(10) Accrued Expenses

        Accrued expenses consist of the following:

	March 31,
	2001		2002
Accrued payroll and related expenses	$	993,425	$	714,235
Accrued other		384,030		388,921
	$	1,377,455	$	1,103,156

(11) Valuation and Qualifying Accounts

Description			Balance, Beginning of Year		Charged to Costs and Expenses		Write-offs		Balance, End of Year
Deducted from Assets Accounts:
	Allowance for doubtful accounts —
		Year ended March 31, 2000	$	130,000	$	41,000	$	15,000	$	156,000
		Year ended March 31, 2001		156,000		—		58,000		98,000
		Year ended March 31, 2002		98,000		—		21,000		77,000

F-19

APPENDIX B

3DV SYSTEMS LTD.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED AUDITED FINANCIAL STATEMENTS
AS AT DECEMBER 31, 2001

Table of Contents

	Page
Report of Independent Auditors	2
Consolidated Balance Sheets	3
Consolidated Statements of Operations	4
Consolidated Statement of Changes in Shareholders' Equity	5
Consolidated Statements of Cash Flows	6
Notes to the Consolidated Financial Statements	8

Report of Independent Auditors to the Board of Directors and Shareholders of 3DV Systems Ltd. (a development stage company)

        We have audited the accompanying consolidated balance sheets of 3DV Systems Ltd. ("the "Company") (a development stage company) and its subsidiary as of December 31, 2001, 2000 and 1999 and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 2001, 2000 and 1999 and the period from July 1996 (inception) to December 31, 2001. These consolidated financial statements are the responsibility of the Company's Board of Directors and of its management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurances about whether the financial statements are free of material misstatement. An audit also 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 the Board of Directors and by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and its subsidiary as of December 31, 2001, 2000 and 1999 and the results of its operations, shareholders' equity and cash flows for the years ended December 31, 2001, 2000 and 1999 and the period from July 1996 (inception) to December 31, 2001, in conformity with generally accepted accounting principles in the United States of America.

Somekh Chaikin
Certified Public Accountants (Isr.)

March 5, 2002

2

3DV Systems Ltd.
(A development stage company)

Consolidated Balance Sheets as of December 31,

		Note	1999		2000		2001
			US$ thousands		US$ thousands		US$ thousands
Current assets
Cash and cash equivalents		1D; 2	2,791		2,904		1,722
Accounts receivable		3	153		215		268
Raw material inventory		1E	—		—		130
			2,944		3,119		2,120
Deposits		4	3		158		214
Amount funded for employees' rights upon retirement		1F; 8	119		191		249
Fixed assets, net		1G; 6	552		1,358		1,164
Total assets			3,618		4,826		3,747
Current liabilities
Short-term bank loan			—		—		506
Current maturities of liabilities for capital lease		4	31		49		26
Accounts payable:		7
	Trade		373		584		448
	Other		307		849		1,043
	Related parties	16B	23		18		11
			734		1,500		2,034
Long-term liabilities
Loans from Parent Company			2,143		—		—
Liabilities for capital lease		5A	142		157		62
Employees' rights upon retirement		8	124		296		351
			2,409		453		413
Liens, Commitments and Contingencies		5
Shareholders' equity		9
Share capital
Series A Preferred Shares NIS 0.01 par value each (500,000 shares authorized; 276,146 shares issued and fully paid at December 31, 2000 and 2001)			—		1		1
Ordinary A shares NIS 0.01 par value each (900,000 authorized; 29,310 shares issued and fully paid at December 31, 2000 and 2001)					—		—
Ordinary Shares, NIS 0.01 par value each (5,170,000 shares authorized; 1,547,913 shares issued and fully paid at December 31, 2000 and 2001)			4		4		4
Additional paid-in capital			8,342		17,633		17,727
Capital reserve			138		—		—
Convertible perpetual debenture			—		—		5,975
Deferred compensation			(105	)	(4	)	—
Deficit accumulated during the development stage			(7,904	)	(14,761	)	(22,407	)
Total shareholders' equity			475		2,873		1,300
Total liabilities and shareholders' equity			3,618		4,826		3,747

The accompanying notes are an integral part of the financial statements.

3

3DV Systems Ltd.
(A development stage company)

Consolidated Statements of Operations for the Year ended December 31,

	Note	1999		2000		2001		Amounts accumulated during the development stage
		US$ thousands		US$ thousands		US$ thousands		US$ thousands
Sales		—		—		267		267
Cost of sales	10	—		—		(179	)	(179	)
Gross profit		—		—		88		88
Research and development costs, net	1N; 11	(2,755	)	(4,341	)	(4,778	)	(15,336	)
Marketing expenses, net	12	(752	)	(1,557	)	(1,486	)	(3,846	)
General and administrative expenses	13	(374	)	(996	)	(873	)	(2,814	)
Operating loss		(3,881	)	(6,894	)	(7,049	)	(21,908	)
Financing income, net	14	20		44		48		153
Capital loss		—		(7	)	(14	)	(21	)
Reorganization costs		—		—		(625	)	(625	)
Net loss before taxes on income		(3,861	)	(6,857	)	(7,640	)	(22,401	)
Taxes on income	15C	—		—		(6	)	(6	)
Net loss		(3,861	)	(6,857	)	(7,646	)	(22,407	)

The accompanying notes are an integral part of the financial statements.

4

3DV Systems Ltd.
(A development stage company)
Consolidated Statement of Changes in Shareholders' Equity

	Series A Preferred Shares
			Ordinary shares(1)							Deficit accumulated during the development Stage
					Additional paid-in capital(2)	Capital reserve		Deferred compensation				Total shareholder's equity
	Shares	Amount	Shares	Amount
								US$ thousands
Balance as of January 1, 1999	—	—	1,219,167	3	3,603	172		(191	)	(4,043	)	(456	)
Changes during the year 1999
Shares issued	—	—	308,950	1	4,621	—		—		—		4,622
Linkage differences on loans received from parent company	—	—	—	—	—	(34	)	—		—		(34	)
Employees' stock options compensation	—	—	—	—	118	—		(118	)	—		—
Amortization and deferred compensation	—	—	—	—	—	—		204		—		204
Net loss	—	—	—	—	—	—		—		(3,861	)	(3,861	)
Balance as of December 31, 1999	—	—	1,528,117	4	8,342	138		(105	)	(7,904	)	475
Changes during the year 2000:
Linkage differences on loans received from parent company	—	—	—	—	—	(71	)	—		—		(71	)
Preferred Shares ($22.63) issued in April	276,146	1	—	—	6,237	—		—		—		6,238
Ordinary Shares ($15.273) issued in October	—	—	49,106	—	750	—		—		—		750
Loans converted into share capital	—	—	—	—	2,279	(67	)	—		—		2,212
Employees' stock options compensation	—	—	—	—	25	—		(25	)	—		—
Amortization of unearned compensation	—	—	—	—	—	—		126		—		126
Net loss	—	—	—	—	—	—		—		(6,857	)	(6,857	)
Balance as of December 31, 2000	276,146	1	1,577,223	4	17,633	—		(4	)	(14,761	)	2,873
Balance as of December 31, 2000	276,146	1	1,577,223	4	17,633	—		(4	)	(14,761	)	2,873
Changes during the year 2001:
Convertible perpetual debenture	—	—	—	—	—	5,975		—		—		5,975
Warrants issued to the bank against loan received	—	—	—	—	94	—		—		—		94
Amortization of unearned compensation	—	—	—	—	—	—		4		—		4
Net loss	—	—	—	—	—	—		—		(7,646	)	(7,646	)
Balance as of December 31, 2001	276,146	1	1,577,223	4	17,727	5,975		—		(22,407	)	1,300
Amounts accumulated during the development stage
Ordinary Shares issued	—	—	1,547,913	4	10,577	—		—		—		10,581
Ordinary A shares issued	—	—	29,310	—	—	—		—		—		—
Preferred shares issued	276,146	1	—	—	6,237	—		—		—		6,238
Convertible perpetual debenture	—	—	—	—	—	5,975		—		—		5,975
Warrants issued to the bank against loan received	—	—	—	—	94	—		—		—		94
Employees' stock options compensation	—	—	—	—	819	—		(819	)	—		—
Amortization of unearned compensation	—	—	—	—	—	—		819		—		819
Deficit accumulated during development stage	—	—	—	—	—	—		—		(22,407	)	(22,407	)
Balance as of December 31, 2001	276,146	1	1,577,223	4	17,727	5,975		—		(22,407	)	1,300

(1)

Includes 29,310 ordinary A shares at a total amount less than US$ 1 thousand.

(2)

Net of issuance costs.

5

3DV Systems Ltd.
(A development stage company)

Consolidated Statements of Cash Flows for the Year ended December 31,

	1999		2000		2001		Amounts accumulated during the development stage
	US$ thousands		US$ thousands		US$ thousands		US$ thousands
Cash flows from operating activities:
Net loss	(3,861	)	(6,857	)	(7,646	)	(22,407	)
Adjustments required to reconcile net loss to net cash used in operating activities:
Interest accrued on long-term loans	—		2		—		2
Severance pay, net	3		100		(3	)	102
Depreciation	122		333		469		1,016
Capital loss	5		7		14		26
Employees' stock options	204		126		4		819
Marketing services against issuance of shares (see A(2))	180		—		—		180
Changes in operating assets and liabilities:
Increase in accounts receivable	(44	)	(62	)	(53	)	(268	)
Increase in inventory	—		—		(130	)	(130	)
Increase in accounts payable	204		722		62		1,456
Increase (decrease) in related parties	20		(5	)	(7	)	11
Increase in car leasing deposit	—		—		—		—
Net cash used in operating activities	(3,167	)	(5,673	)	(7,290	)	(19,193	)
Cash flows from investing activities:
Payments for purchase of fixed assets	(215	)	(1,164	)	(418	)	(2,181	)
Proceeds from disposal of fixed assets	5		47		129		181
Deposits	4		(152	)	(56	)	(214	)
Net cash used in investing activities	(206	)	(1,272	)	(345	)	(2,214	)
Cash flow from financing activities:
Loans from parent company (see A(1))	—		—		—		2,279
Short-term loans from bank, net	—		—		506		506
Receipt on account of warrants issued to the bank	—		—		94		94
Receipt (repayment) of long-term loans to leasing company	(4	)	31		(118	)	(89	)
Convertible perpetual debentures	—		—		5,975		5,975
Shares issued	4,442		6,988		—		14,360
Net cash provided by financing activities	4,438		7,019		6,457		23,125
Effect of exchange rate changes on cash	1		—		(4	)	4
Increase (decrease) in cash and cash equivalents	1,066		113		(1,182	)	1,722
Cash and cash equivalents at beginning of year	1,725		2,791		2,904		—
Cash and cash equivalents at end of year	2,791		2,904		1,722		1,722

The accompanying notes are an integral part of the financial statements

6

A.    Transactions not involving cash flows:

1.

In 2000, the long-term loans from related party of US$ 2,279 thousand was forfeited and converted into additional paid-in capital.



2.

Marketing services were rendered against issuance of Company's capital.

B.    Supplementary cash flow information:

	Year ended December 31 1999	Year ended December 31 2000	Year ended December 31 2001	Amounts accumulated during the development stage
	US$ thousands	US$ thousands	US$ thousands	US$ thousands
Cash paid for interest	—	19	14	33
Income taxes paid	—	22	18	40

The accompanying notes are an integral part of the financial statements.

7

3DV Systems Ltd.
(A development stage company)

Notes to the Consolidated Financial Statements

Note 1—Organization and Summary of Significant Accounting Policies

A.

Description of business

3DV Systems Ltd. (hereinafter—"the Company") incorporated in June 1996, as an Israeli Company and commenced operations in July 1996.

The Company is in the development stage, whereby its principal activities in the reported period are the development of products in the field of 3D laser camera. The Company has not yet generated significant revenues.

The Company is in the development stage and its ability to continue operations in the foreseeable future depends on the Company Management's ability to provide additional financial support.

The high technology industry in which the Company is involved is highly competitive and is characterized by the risks of rapidly changing technologies. Penetration into world market requires investment of considerable resources and continuous development efforts. The Company's future success is dependent upon several factors including the technological quality and price/performance of its products relative to those of its competitors. There can be no assurance that the Company will be able to maintain the high technological quality of its product or to continue to develop or market its new products effectively.

The Company employs 2 key employees who own major intellectual property. Management is of the opinion that if several of the above employees leave, then the Company will be vulnerable to the risk of a severe impact on the Company's know-how in the near term.

B.

Basis of presentation

The accompanying consolidated financial statements include the Company and its wholly-owned subsidiary, 3DV Systems Inc., which commenced marketing activities in the United States in November 2000. All significant intercompany balance and transactions have been eliminated in consolidation.

C.

Functional and reporting currency

The accounting records of the Company are maintained in New Israeli Shekels ("NIS") and U.S. dollars. The Company's functional and reporting currency is the U.S dollar.

Transactions denominated in foreign currencies other than the U.S. dollar are translated into the reporting currency using current exchange rates. Gains and losses from the translation of foreign currency balances are recorded in the statement of operations.

The Company currently has no plans to pay dividends and has not determined the currency in which any dividends would be paid.

D.

Cash and cash equivalents

All highly-liquid investments with original maturities of three months or less from the date of deposit are considered to be cash equivalents.

E.

Inventories

The inventory of the Company consists of raw materials. They are valued at lower of cost or market. Cost is determined using the "moving average" method.

8

F.

Amounts funded for employees' rights upon retirement

Amounts funded for employees' rights upon retirement represent contributions to severance pay funds and cash surrender life insurance policies that are recorded at their current redemption value.

G.

Fixed assets

Fixed assets are stated at stated cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets at the following annual rates:

Computers, software and related equipment	25-33	%
Instruments and laboratory equipment	6-15	%
Motor vehicles	15	%
Office furniture, equipment and leasehold improvement	6-15	%

Motor vehicles

Assets purchased under capital lease agreements are shown as assets of the Company, at the regular purchase prices (not including the financing component) and are depreciated at the usual depreciation rates.

H.

Stock compensation plans

Employees

The Company has adopted the Financial Accounting Standards Board's Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123") which permits entities to recognize as expense over the vesting period, the fair value on the date of grant of all stock-based awards. Alternatively, Statement 123 also allows entities to continue to apply the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees and related interpretations" ("APB Opinion No. 25") and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value based method defined in Statement 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of Statement 123.

The Company applies the intrinsic value-based method prescribed in APB Opinion No. 25 for its stock compensation to employees and directors. As such, the Company computes and records compensation expense for grants whose terms are fixed with respect to the number of shares and option price only if the market price on the date of grant exceeds the exercise price of the stock option.

The compensation cost for both fixed and variable plans is recorded over the period the employee performs the service to which the stock compensation relates.

Non-Employees

The Company applies the fair value-based method of accounting set forth in Statement 123 to account for stock based compensation to non-employees. Using the fair value method, the total compensation

9

expense is computed based on the fair value of the options expected to vest on the date the options are granted to the non-employees.

I.

Concentrations of credit risk Statement of Financial Accounting Standard No. 105, "Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk", requires disclosure of any significant off-balance-sheet risk and credit risk concentrations. The company does not have significant off-balance-sheet risk or credit risk concentrations. With respect to trade account receivables, most of the Company's trade receivables are located in the U.S.A.

J.

Use of estimates

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Actual results could differ from these estimates.

K.

Disclosure of amounts accumulated during the development stage

Under FAS 7, "Accounting and Reporting by Development Stage Enterprises" the Company provides amounts accumulated during the development stage till December 31, 2001, in the statements of operations, cash flows and shareholders' equity.

L.

Impairment of long-lived assets and certain intangibles

The Company accounts for long-lived assets and certain intangible assets in accordance with the provisions of Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and Assets to Be Disposed Of."

The Statement requires that long-lived assets and certain intangible assets be reviewed for impairment whenever events or circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

M.

Revenue recognition

The Company recognizes substantially all of the revenue from the sale upon shipment. The Company's selling agreements with its customers and distributors do not contain product return rights.

N.

Research and Development costs Research and development costs are charged to the statement of operation as incurred.

O.

Government-sponsored Research and Development

The Company records grants from the Office of the Chief Scientist of the Israeli Ministry of Industry and Trade (the "OCS") as a reduction of research and development expenses.

10

P.

Income taxes

The Company accounts for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109 "Accounting for Income Taxes."

Under SFAS 109 deferred tax assets or liabilities are recognized in respect of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts as well as in respect of tax losses and other deductions which may be deductible for tax purposes in future years, based on statutory tax rates as these will be applicable to the periods in which such deferred taxes will be realized. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Deferred tax assets and liabilities are presented as current or long-term items in accordance with the nature of assets or liabilities to which they relate, according to the date of their realization.

Q.

Recently Issued Accounting Standards

The Company examined the recently issued accounting standards SFAS No. 141, No. 142, No. 143 and No. 144 and concluded that the full adoption of those standards will have no impact on the Company's results of operations.

Note 2—Cash and Cash Equivalents

	December 31 1999	December 31 2000	December 31 2001
	US$ thousands	US$ thousands	US$ thousands
Denominated in US dollars	2,280	2,853	1,503
Denominated in New Israeli Shekels	511	51	219
	2,791	2,904	1,722

Cash equivalents in foreign currency include bank deposits, bearing an annual nominal interest rate of 0.25%—1.4%.

The carrying amount of cash equivalents approximates market value.

Note 3—Accounts Receivable

	December 31 1999	December 31 2000	December 31 2001
	US$ thousands	US$ thousands	US$ thousands
Government institutions	76	87	59
Prepaid expenses	76	62	41
Employees	1	1	28
Loan to interested party	—	50	—
Other receivables	—	15	140
	153	215	268

11

Note 4—Deposits

	December 31 1999	December 31 2000	December 31 2001
	US$ thousands	US$ thousands	US$ thousands
Car leasing deposit	3	35	44
Laboratory instruments leasing deposit	—	7	6
Rent deposit	—	116	129
Salary deposit	—	—	35
	3	158	214

Note 5—Liens, Commitments and Contingencies

A.

Capital, operating and rental lease

(1)

The Company signed operating lease contracts with Albar Ltd. (related party) for the rental of vehicles for a period of three years. The rental payments are linked to the U.S. dollar. The Company has deposited amounts representing rental payment for three months in respect of these contracts. The deposit is linked to U.S. dollar, and bears no interest. The Company had paid security deposit of US$ 44 thousand.

(2)

a.    In 1999, the Company subleased its premises from Rafael Development Corporation Ltd. (hereinafter—"RDC Ltd.") (a related party).

b.

In 2000, the Company leased office spaces in Yokneam. The lease is for an eight-year period. The minimum future rental payment for a year is US$ 175 thousand. The rental payment is linked to the Consumer Price Index and increased by 1% each year.

c.

On June 4, 2000, the Company leased office spaces in Herzliya. The original lease is for a two-year period and the company has an option to extend for one additional year. The Company's total liability for lease rentals (including parking) is US$ 36 thousand.

In order to secure compliance with the aforesaid lease obligation, the company has provided the lessor with limited bank guarantee in the amount of NIS 100,000.

d.

On October 1, 2000, The Company leased office spaces in Santa Clara, U.S.A. The original lease is for a five-year period. The Company's total liability for lease rentals for the original five-year period is US$ 526 thousand. In order to secure the lease contract, the Company has paid a security deposit of US$ 82 thousand. The Company has the right to sublet the office spaces under certain conditions.




(3)

a.    During 2000 and 2001, the Company signed lease contracts with a leasing company (see A(1) and A(2)c above). The Company guaranteed its commitments in respect of these contracts. As of December 31, 2000, the guarantees totaled US$ 247 thousand, and of December 31, 2001 the guarantees totaled US$ 173 thousand.

12

b.

Liabilities due to a leasing company were recorded against the purchase of cars. The liabilities are to be repaid in five years, linked to the U.S. dollar and bearing interest of LIBOR + 1.5% p.a. As security for the liabilities, the Company registered liens on all the cars in favor of the leasing company.



c.

On April 10, 2000, the Company entered into a five-year lease agreement with a leasing company for purposes of financing a video equipment acquisition, in the amount of US$ 139 thousand. In order to secure the lease liability, the Company recorded a lien on the acquired equipment to the benefit of the leasing company.




(4)

Future minimum lease payments as of December 31, 2001 are as follows:

	Capital lease	Operating lease
	US$ thousands	US$ thousands
2002	26	512
2003	28	463
2004	27	332
2005	6	293
2006 and thereafter	—	486
	88	2,076

(5)

As security for the liabilities, the Company registered liens on all the cars and the studio equipment in favor of a leasing company. It also registered a first-ranking charge on its intellectual property and a first-ranking floating charge over all its assets, share capital and properties for the repayment of loan to a bank.

B.

Commitments

The Office of the Chief Scientist of the Israeli Ministry of Industry and Trade (the "OCS") approved its participation in a research program. In return for the OCS's participation, the Company will be committed to pay royalties to the Israeli Government at a rate of 3% to 5% of the sales of the approved product, up to 100% of the amount of the grants received, with the addition of interest at LIBOR. The grants are deducted from research and development expenses. The Company is entitled to the grants only upon incurring research and development expenditures. The Company is not obliged to repay any amount received from OCS if the research effort is unsuccessful or if no products are sold. However, under certain limited circumstances, the OCS may withdraw its approval of a research program or amend the terms of its approval. Upon withdrawal of approval, the grant recipient may be required to refund the grant, in whole or in part, with or without interest, as the OCS determines. The Company's total obligation for royalties, based on royalty-bearing government participation, totaled approximately US$ 109 thousand as of December 31, 2001. Royalties payable to the OCS are recorded as part of the research and development cost.

13

Note 6—Fixed Assets at Cost, Less Accumulated Depreciation

	December 31 1999		December 31 2000		December 31 2001
	US$ thousands		US$ thousands		US$ thousands
Computers and software	403		981		1,224
Instruments and laboratory equipment	108		447		529
Motor vehicles	177		112		63
Office furniture and equipment	72		348		302
Total	760		1,888		2,118
Accumulated depreciation	(208	)	(530	)	(954	)
Net book value	552		1,358		1,164

Note 7—Accounts Payable

	December 31 1999	December 31 2000	December 31 2001
	US$ thousands	US$ thousands	US$ thousands
Trade
Open accounts	273	377	388
Checks payable	100	207	60
	373	584	448
Other
Institutions	143	113	108
Liabilities to employees	65	298	211
Accrued expenses	99	438	724
	307	849	1,043
Related parties	23	18	11

Note 8—Employees' Rights Upon Retirement

Under Israeli law and labor agreements the Company is required to pay severance benefits to its dismissed employees and employees leaving its employment under certain circumstances. The Company's liability for severance benefits is covered mainly by deposits with insurance companies in the name of the employee and/or by purchase of insurance policies. The liability is calculated on the basis of the latest salary of the employee multiplied by the number of years of employment as of the balance sheet date. The provision for employee severance benefits included in the balance sheet represents the total liability for such severance benefits, while the assets held for severance benefits included in the balance sheet represents the Company's contributions to severance pay funds and to insurance policies. The Company may make withdrawals from the funds only upon complying with the Israeli severance pay law or labor agreements.

14

Expenses recorded in respect of severance pay for the years ended December 31, 2000 and 2001 are US$ 58 thousand and US$ 45 thousand, respectively.

Note 9—Share Capital

A.

Shareholders' equity

	December 31, 2000		December 31, 2001
	Authorized	Issued and paid for	Authorized	Issued and paid for
	Number of shares	Number of shares	Number of shares	Number of shares
Ordinary Shares of NIS 0.01 each	5,170,000	1,547,913	5,170,000	1,547,913
Preferred A Shares	500,000	276,146	500,000	276,146
Ordinary A Shares of NIS 0.01 each	900,000	29,310	900,000	29,310

Rights attached to shares:

The holders of the Series A Preferred shares shall be entitled to receive, per each Preferred Shares held by them, prior and in preference to the holders of Ordinary and Ordinary A Shares, an amount of US$ 22.633 (the "Preferred Preference"); and after satisfaction of the Preferred Preference, the holders of Ordinary A Shares shall be entitled to receive, pro rata among them according to their respective holding of Ordinary A Shares, prior and in preference to the holders of Ordinary Shares, an aggregate amount of US$ 3 million.

(1)

On inception, the Company issued to RDC Rafael Development Corporation Ltd. 850,000 Ordinary Shares par value NIS 0.01 per share, and to senior employee 15,000 Ordinary A Shares par value NIS 0.01 per share.



(2)

In August 1998, the Company, RDC Rafael Development Corporation Ltd. and Vision Sciences Inc. ("VSI") a Delaware corporation signed an Investment Agreement ("the 1998 Agreement"). According to this 1998 Agreement, the Company issued 338,099 Ordinary Shares, par value NIS 0.01 per share in consideration for US$ 3 million in cash.



(3)

In December 1998, the Company issued to VSI 16,068 Ordinary Shares of the Company, par value 0.01 per share in consideration of their par value. The issuance was executed due to the increase in the number of ordinary A shares that are subject to employee stock option plan.



(4)

On May 29, 1999 and August 26, 1999, the Company issued convertible capital notes of US$500 thousand each to VSI. Each of the notes was unsecured, was linked to the US$, bear no interest and was convertible into 32,739 Ordinary Shares.



(5)

According to a Share Subscription Agreement ("the 1999 Agreement") which was signed on November 8, 1999, the capital notes in the aggregate amount of US$ 1 million mentioned above

15

were converted into 65,474 Ordinary Shares and additional 32,739 Ordinary Shares were issued in consideration of US$ 500 thousand.

Furthermore, the Company issued to foreign investors 130,951 Ordinary Shares in consideration of US$ 2 million and to Israeli investors, 65,476 Ordinary Shares in consideration of US$ 1 million.

All the above considerations were based on a purchase price of US$ 15.273 per share. In addition, the company granted an option to a foreign investor to invest additional US$ 750 thousand under the same terms of the agreement.

In the third quarter of 1999, the Company received film planning and post-production services, which are worth US$ 180 thousand from a supplier. In consideration, the Company issued to the supplier 14,310 Ordinary A Shares of NIS 0.01 each. The price per share of this issuance was US$ 12.58.

(6)

On April 7, 2000, the Company signed a Share Purchase Agreement (the "Agreement") with new investors (the "Investors"), according to which the Company issued a total of 209,871 Preferred shares of a par value of NIS 0.01 each, for the consideration of US$4.75 million. On August 8, 2000, the Company signed a Joinder Agreement, pursuant to the aforementioned Share Purchase agreement. According to the agreement, the Company issued a total of 66,275 Preferred A shares, of a par value of NIS 0.01 each, for the consideration of US$ 1.5 million.



(7)

On October 4, 2000, a foreign investor exercised the option pursuant to the Share Subscription Agreement, dated November 8, 1999 to purchase 49,106 Ordinary shares, par value NIS 0.01 per share, at a price per share of US$ 15.273 for a total consideration of US$ 750,000.



(8)

On August 15, 2001, the Company entered into a Note Purchase Agreement whereas the Company will issue notes convertible into Preferred B shares (hereinafter—"Notes") at a total amount of US$ 4 million. On September 6, 2001, the Company entered into a Joinder Agreement for the issuance of Notes, at the same terms and conditions as set forth in the Note Purchase Agreement, in consideration for US$ 2 million.

The notes will be converted to the Company shares according to a price of US$ 22.633 per share. In the event of capital transaction or acquisition prior to April 1, 2002, the notes will be converted in a discount of up to 10%.

The agreement specify that upon liquidation event, the holders of the Series B Preferred Shares shall be entitled to receive, per each Preferred B Share held by them, prior and in preference to the holders of Preferred A, Ordinary and Ordinary A Shares, an amount in Dollars, equal to US$ 22.633 (the "Preferred B Preference"); after satisfaction of the Preferred B Preference, the holders of the Series A Preferred Shares shall be entitled to receive, per each Preferred A Share held by them, prior and in preference to the holders of Ordinary and Ordinary A Shares, an amount in Dollars, equal to US$ 22.633 (the "Preferred A Preference"); and after satisfaction of the Preferred A Preference, the holders of Ordinary A Shares shall be entitled to receive, pro rata among them according to their respective holding of Ordinary A shares, prior and in preference to the holders of Ordinary Shares, an aggregate amount in Dollars, equal to three (3) million US$ (the "Ordinary A Preference"). Any amount that will be left for distribution

16

among the shareholders, will be distributed according to the proportion of each shareholder in the Company's equity.

B.

Employee Stock Option Plan

The Board of Directors of the Company, at its meeting in August 1997, approved the resolution to adopt the Company's employee stock option plan ("ESOP"), providing for the allotment without consideration of options to employees of the Company, whose eligibility will be determined from time to time by the Company's Board Compensation Committee, for the purchase of up to 135,000 Ordinary A Shares of the Company of par value NIS 0.01 each. Each option will entitle the holder to purchase one Ordinary A Share of par value NIS 0.01 each at an exercise price of NIS 0.01 per option. The options usually vest over a period of two to four years and are exercisable for a period of eight years from the date of grant.

The options will be allotted to a trustee who will hold them in trust on behalf of the employees, in accordance with Section 102 of the Income Tax Ordinance in Israel and related regulations. On May 22, 2000, the Company resolved that the number of its Ordinary A Shares, par value NIS 0.01 per share ("Ordinary A Shares"), reserved for the grant of options under the Company's 1997 Employee Option Plan, as amended (the "Plan"), be increased, following which the total number of shares reserved for option grants under the Plan was 543,577 Ordinary A Shares.

In order to estimate the compensation cost related to options issued before August 25, 1998, management of the Company evaluated the fair value of the Company's Ordinary A Shares based upon the price per Ordinary Share in a private placement, which took place on August 25, 1998. Management's assumption is that the fair value of the Company's Ordinary A Shares grew at a fixed rate commencing with the Company inception until the above private placement date. Accordingly, the Company evaluated the fair value of Ordinary A Shares, issued prior to the private placement, by the straight-line method over the period commencing with the inception of the Company (at such time the Company's price per share is assumed to the US$ 0 (nil)) through the private placement date, in order to compute a discount from the private placement price, for such Ordinary A Shares.

Compensation cost related to options issued after August 25, 1998 was calculated based on the last known share price.

The Company applies APB 25 and recorded in 2001 compensation expense of US$ 4 thousand (US$ 126 thousand in 2000) due to the above options equal to the intrinsic value of the above options.

17

Had compensation expense for stock options granted under the Company's Stock Option Plan been determined based on the fair value at the date of grant, consistent with the method of Statement 123, the Company's net income would have changed to the pro forma amounts indicated below:

	Year ended December 31 1999	Year ended December 31 2000	Year ended December 31 2001
	US$ thousands	US$ thousands	US$ thousands
Net loss as presented—in thousands	3,861	6,857	7,646
Additional expenses due to options granted to employees	63	331	199
Pro forma net loss—in thousands	3,924	7,188	7,845

The fair value of each option granted is estimated on the date of grant, using the minimal value option pricing model using the following weighted average assumptions:

1.

Dividend yield of zero percent.



2.

Risk-free interest rate of 2% (5% In 2000) which represents risk free interest rates to dollar-linked financial instruments as published by the Israeli Stock Exchange.



3.

Expected lives of 7 years as of the date of grant.

The following table summarizes information relating to stock options for Ordinary A Shares outstanding as of December 31, 2001:

	Options Outstanding		Options Exercisable
		Weighted Average Remaining Contractual Life (in years)
Exercise price	Number Outstanding at December 31, 2001		Number Exercisable at December 31, 2001
NIS 0.01	141,889	6.4	72,421
$8.47	52,860	7.3	—
$15.273	133,040	8.1	—
$22.633	9,588	8.9	—
	337,377		72,421

18

The option allotments are as follows:

	Number of Shares		Weighted Average Exercise Price	Weighted Average Grant Date Fair Value
Balance at December 31, 1999	198,174
Granted	164,310		16.49	16.49
Forfeited	(1,847	)	15.2	15.2
Balance at December 31, 2000	360,637
Forfeited	(23,260	)	20.4	20.4
Balance at December 31, 2001	337,377

*

The Company did not record compensation expenses related to the forfeited options since their intrinsic value was zero.

C.

The Board of Directors of the Company at its meeting on December 22, 1998 adopted the Company's Stock Appreciation Plan (the "plan"). The plan shall provide key employees of the Company with special rewards corresponding to the fair market value of a specified number of Vision-Science Inc. (VSI) shares. In order to finance payment of the awards granted under the plan the Company has entered into an Option Agreement with the Parent Company under which the Parent Company granted the Company the option to purchase 75,000 share of common stock of VSI, which shares shall be sold by the Company.

A participant in the plan (an employee of the Company who is awarded according to the plan) may exercise the right to receive payment of any portion of the units awarded to higher credit, at any time and from time to time as from October 6, 1999 and until October 5, 2005 (the "Exercise Period") by delivering to the Company a written notice, stating the number of whole units payment of which is requested. The right to receive payments is limited within the exercise period only and shall subsequently expire. Any income which may accrue to the participant as a result of the plan will not be regarded as part of his salary for the purpose of any pension, severance pay, saving or other benefits applicable to employee-employer relations.

As of December 31, 2001, the Board of Directors did not grant any options under this plans.

19

Note 10—Cost of Sales

					Amounts accumulated during the development stage
	Year ended December 31,
	1999	2000	2001
	US$ thousands	US$ thousands	US$ thousands		US$ thousands
Material and components	—	—	255		255
Salaries, wages and employee benefits	—	—	54		54
Other manufacturing and service costs	—	—	—		—
	—	—	309		309
Increase in inventories	—	—	(130	)	(130	)
	—	—	179		179

Note 11—Research and Development Costs, Net

					Amounts accumulated during the development stage
	Year ended December 31,
	1999		2000	2001
	US$ thousands		US$ thousands	US$ thousands	US$ thousands
Salaries and related expenses (1)	1,385		2,000	2,248	7,416
Patent registration expenses	108		170	194	722
Materials	282		259	218	1,424
Subcontractors	620		1,116	1,012	3,050
Vehicle expenses	108		177	319	763
Communications	11		—	—	—
Overseas travel	6		—	—	—
Depreciation	112		294	418	902
Royalties to the OCS	—		—	8	8
Other	122		325	361	1,167
	2,754		4,341	4,778	15,452
Less: grants received from the Chief Scientist—see Note 6B(1)	(1	)	—	—	(116	)
	2,755		4,341	4,778	15,336
(1) Include compensation expenses in respect of options granted	204		126	4	819

20

Note 12—Marketing Expenses, Net

						Amounts accumulated during the development stage
	Year ended December 31,
	1999	2000		2001
	US$ thousands	US$ thousands		US$ thousands		US$ thousands
Salaries and related expenses	—	26		462		488
Participation in exhibitions	383	1,232		325		1,940
Overseas travel	145	155		125		450
Advertisement	181	—		—		—
Others	43	190		623		1,063
	752	1,603		1,535		3,941
Less: grants from the Fund of the Encouragement of Marketing Abroad	—	(46	)	(49	)	(95	)
	752	1,557		1,486		3,846

Note 13—General and Administrative Expenses

				Amounts accumulated during the development stage
	Year ended December 31,
	1999	2000	2001
	US$ thousands	US$ thousands	US$ thousands	US$ thousands
Salaries and related expenses	139	418	382	1,233
Office services	50	130	103	381
Operating expenses	53	150	138	418
Depreciation	10	39	27	92
Other	122	259	223	690
	374	996	873	2,814

21

Note 14—Financing Income, Net

							Amounts accumulated during the development stage
	Year ended December 31,
	1999		2000		2001
	US$ thousands		US$ thousands		US$ thousands		US$ thousands
Interest income and linkage difference relating to monetary items	34		67		73		225
Bank charges	(14	)	(23	)	(25	)	(72	)
	20		44		48		153

Note 15—Income Taxes

A.

The Israeli tax is computed on the basis of the Company's results in nominal NIS determined for statutory purposes.

The Company is assessed for tax purposes under the Income Tax Law (Inflationary Adjustments 1985), the purpose of which is to prevent taxation on inflationary profits.

Tax benefits under the Law for the Encouragement of Capital Investments (1959):

The Company was awarded "Approved Enterprise" status by the government under the Law for the Encouragement of Capital Investments (1959) (hereinafter—the "Law").

The main benefits to which the Company will be entitled, if it meets all the requirements of the approved program, are tax exemption for a period of 10 years, commencing on the date taxable income is first generated by the Approved Enterprise (limited to the earlier of a maximum period of 12 years from commencing operations or 14 years from the date the approval letter was received). The Company would also be entitled to reduced taxes on income deriving from the Approved Enterprise in Yoqneam, and reduced tax rates on dividends originating from this income.

Dividend distributions originating from the income of the Approved Enterprise will be subject to tax at the rate of 15%, provided that the dividend is distributed during the period stipulated by the Law.

In the event of a dividend distribution (including withdrawals and charges that are deemed to be dividends) out of the income originating from the Approved Enterprise, and on which the Company received a tax exemption, income from which the dividend is distributed will be subject to corporate taxes at rates varying from 10%—25% depending on the percentage of foreign investment holding in the Company as defined by the Law.

Should the Company derive income from sources other than the Approved Enterprise during the relevant period of benefits, such income will be taxable at regular corporate tax rates (36%).

Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969:

The Company is an "industrial company", as defined by this law and, as such, is entitled to certain tax benefits, mainly accelerated depreciation of machinery and equipment, as prescribed by regulations

22

published under the Inflationary Adjustments Law, the right to claim public issuance expenses and amortization of patents and other intangible property rights as a deduction for tax purposes.

B.

As of the balance sheet date the Company accumulated losses for tax purposes are approximately US$ 19 million. These losses are linked to the Israeli Consumer Price Index and may be utilized against future taxable income.

Due to the Company's "Approved Enterprise" status and tax exemption as mentioned above, the Company established a 100% valuation allowance.

C.

The subsidiary is taxed under United States Federal and State tax rules.

In the year ended December 31, 2001, the subsidiary incurred income tax expense of US$ 6 thousand.

Note 16—Related and Interested Parties Transactions and Balances

The Company carries out transactions with related parties as detailed below. All transactions with related parties are carried out under normal business conditions.

		Year ended December 31,
		1999		2000		2001
		US$ thousands		US$ thousands		US$ thousands
A.    Transactions:
	RDC Ltd.	124		102		34
	Rafael	32		13		—
	Vsoft Ltd.	8		7		11
	Leasing from Albar Ltd.	24		47		146
B.    Balance of amounts due to:
	Deposit to Albar Ltd	(4	)	(35	)	(43	)
	Deposit to related party	(4	)	(16	)	—
	Accounts payable—current accounts:
	RDC Ltd.	21		2		9
	Rafael	—		14		—
	Vsoft Ltd.	2		2		2
	Loan to related party	—		50		—

Note 17—Post Balance Sheet Date Events

The Company entered into an agreement with one of its senior employees according to which the Company will pay a finder's fee in the event of an investment in the Company by a non-affiliated party.

23

QuickLinks

PART I
PART II
PART III
Part IV
VISION-SCIENCES, INC. EXHIBIT INDEX
SIGNATURES
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS AS OF MARCH 31, 2001 AND 2002 TOGETHER WITH AUDITORS' REPORT
VISION-SCIENCES, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
VISION-SCIENCES, INC. AND SUBSIDIARIES Consolidated Balance Sheets—March 31, 2001 and 2002
VISION-SCIENCES, INC. AND SUBSIDIARIES Consolidated Statements of Operations for the Fiscal Years Ended March 31, 2000, 2001 and 2002
VISION-SCIENCES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended March 31, 2000, 2001 and 2002
VISION-SCIENCES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows for the Fiscal Years Ended March 31, 2000, 2001 and 2002
VISION-SCIENCES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements March 31, 2002
3DV SYSTEMS LTD. (A DEVELOPMENT STAGE COMPANY) CONSOLIDATED AUDITED FINANCIAL STATEMENTS AS AT DECEMBER 31, 2001
Table of Contents
3DV Systems Ltd. (A development stage company) Consolidated Balance Sheets as of December 31,
3DV Systems Ltd. (A development stage company) Consolidated Statements of Operations for the Year ended December 31,
3DV Systems Ltd. (A development stage company) Consolidated Statements of Cash Flows for the Year ended December 31,
3DV Systems Ltd. (A development stage company) Notes to the Consolidated Financial Statements

EX-10.7

[VISION SCIENCES LOGO]

                                                                   EXHIBIT 10.7

September 20, 2001

Mr. Thomas Olmstead
4114 Meadowbrook Boulevard
University Heights, Ohio  44118

Dear Tom,

I am pleased to offer you employment with Vision-Sciences, Inc. ("the Company"),
pursuant to the following terms and conditions:

Title:              Vice President of Sales & Marketing

Salary:             $120,000 per annum, payable in accordance with the Company's
                    normal payroll schedules.

Effective Date:     October 1, 2001

Benefits:           You will be entitled to participate in the Company's
                    standard benefits package, including health insurance and
                    the Company's 401K plan.

Vacation:           You will be eligible for vacation in accordance with the
                    Company's standard vacation policy.

Options:            You will receive a grant of stock options for 100,000 shares
                    of the common stock of Vision-Sciences, Inc. at an exercise
                    price as of the close of business on October 1, 2001 with
                    vesting as follows:

                    -    25,000 shares vesting on October 1, 2002

                    -    25,000 shares vesting on October 1, 2003

                    -    25,000 shares vesting on October 1, 2004

                    -    25,000 shares vesting on October 1, 2005

In accordance with the terms of the Vision-Sciences 2000 Stock Option plan, in
the event that Vision-Sciences is merged into or acquired by another entity, all
options shall vest immediately. All other provisions of the Vision-Sciences 2000
Stock Option Plan shall apply to this grant.

Yours truly,



/s/ Katsumi Oneda
- -----------------
Katsumi Oneda

President/CEO/Chairman


Accepted:

/s/ Thomas Olmstead                         Date: 10-1-01
- -------------------
Thomas Olmstead

EX-10.22

                                                                   EXHIBIT 10.22

                             BUSINESS LOAN AGREEMENT

================================================================================

BORROWER:  VISION - SCIENCES, INC.; ET. AL.  LENDER:  THE FIRST NATIONAL BANK OF
                                                        BOSTON
           6 STRATHMORE ROAD                          100 FEDERAL STREET
           NATICK, MA  01760                          BOSTON, MA 02110
================================================================================

THIS BUSINESS LOAN AGREEMENT BETWEEN VISION - SCIENCES, INC. AND MACHIDA, INC.
(REFERRED TO IN THIS AGREEMENT INDIVIDUALLY AND COLLECTIVELY AS "BORROWER") AND
THE FIRST NATIONAL BANK OF BOSTON (REFERRED TO IN THIS AGREEMENT AS "LENDER") IS
MADE AND EXECUTED ON THE FOLLOWING TERMS AND CONDITIONS. BORROWER HAS RECEIVED
PRIOR COMMERCIAL LOANS FROM LENDER OR HAS APPLIED TO LENDER FOR A COMMERCIAL
LOAN OR LOANS AND OTHER FINANCIAL ACCOMMODATIONS, INCLUDING THOSE WHICH MAY BE
DESCRIBED ON ANY EXHIBIT OR SCHEDULE ATTACHED TO THIS AGREEMENT. ALL SUCH LOANS
AND FINANCIAL ACCOMMODATIONS, TOGETHER WITH ALL FUTURE LOANS AND FINANCIAL
ACCOMMODATIONS FROM LENDER TO BORROWER, ARE REFERRED TO IN THIS AGREEMENT
INDIVIDUALLY AS THE "LOAN" AND COLLECTIVELY AS THE "LOANS." BORROWER UNDERSTANDS
AND AGREES THAT: (a) IN GRANTING, RENEWING, A EXTENDING ANY LOAN, LENDER IS
RELYING UPON BORROWER'S REPRESENTATIONS, WARRANTIES, AND AGREEMENTS, AS SET
FORTH IN THIS AGREEMENT; (b) THE GRANTING, RENEWING, OR EXTENDING OF ANY LOAN BY
LENDER AT ALL TIMES SHALL BE SUBJECT TO LENDER'S SOLE JUDGMENT AND DISCRETION;
AND (c) ALL SUCH LOANS SHALL BE AND SHALL REMAIN SUBJECT TO THE FOLLOWING TERMS
AND CONDITIONS OF THIS AGREEMENT.

TERM. This Agreement shall be effective as of February 15, 1997, and shall
continue thereafter until all Indebtedness of Borrower to Lender has been
performed in full and the parties terminate this Agreement in writing.

DEFINITIONS. The following words shall have the following meanings when used in
this Agreement. Terms not otherwise defined in this Agreement shall have the
meanings attributed to such terms in the Uniform Commercial Code. All references
to dollar amounts shall mean amounts in lawful money of the United States of
America.

     AGREEMENT. The word "Agreement" means this Business Loan Agreement together
     with all exhibits and schedules attached to this Business Loan Agreement
     from time to time, if any, as amended from time to time.

     BORROWER. The word "Borrower" means individually and collectively Vision -
     Sciences, Inc. and Machida, Inc. and all other persons and entities signing
     Borrowers' Note.

     CERCLA. The word "CERCLA" means the Comprehensive Environmental Response,
     Compensation, and Liability Act of 1980, as amended.

     COLLATERAL. The word "Collateral" means and includes without limitation all
     property and assets granted as collateral security for a Loan, whether real
     or personal property, whether granted directly or indirectly, whether
     granted now or in the future, and whether granted in the form of a security
     interest, mortgage, deed of trust, assignment, pledge, chattel mortgage,
     chattel trust, factor's lien, equipment trust, conditional sale, trust
     receipt, lien, charge, lien or title retention contract, lease or
     consignment intended as a security device, or any other security or lien
     interest whatsoever, whether created by law, contract, or otherwise.

     ERISA. The word "ERISA" means the Employee Retirement Income Security Act
     of 1974, as amended.

     EVENT OF DEFAULT. The words "Event of Default" mean and include without
     limitation any of the Events of Default set forth below in the section
     titled "EVENTS OF DEFAULT."

     GRANTOR. The word "Grantor" means and includes without limitation each and
     all of the persons or entities granting a Security Interest in any
     Collateral for the Indebtedness, including without limitation all Borrowers
     granting such a Security Interest.



                                                                          PAGE 2

                            BUSINESS LOAN AGREEMENT
                                  (CONTINUED)

     GUARANTOR. The word "Guarantor" means and includes without limitation each
     and all of the guarantors, sureties, and accommodation parties in
     connection with any indebtedness.

     INDEBTEDNESS. The word "Indebtedness" means and includes without limitation
     all Loans, together with all other obligations, debts and liabilities of
     Borrower to Lender, or any one or more of them, as well as all claims by
     Lender against Borrower, or any one a more of them; whether now or
     hereafter existing, voluntary or involuntary, due or not due, absolute or
     contingent, liquidated or unliquidated; whether Borrower may be liable
     individually or jointly with others; whether Borrower may be obligated as a
     guarantor, surety, or otherwise; whether recovery upon such indebtedness
     may be or hereafter may become barred by any statute of limitations; and
     whether such Indebtedness may be or hereafter may become otherwise
     unenforceable.

     LENDER. The word "Lender" means THE FIRST NATIONAL BANK OF BOSTON, its
     successors and assigns.

     LOAN. The word "Loan" or "Loans" means and includes without limitation any
     and all commercial loans and financial accommodations from Lender to
     Borrower, whether now or hereafter existing, and however evidenced,
     including without limitation those loans and financial accommodations
     described herein or described on any exhibit or schedule attached to this
     Agreement from time to time.

     NOTE. The word "Note" means and includes without limitation Borrower's
     promissory note or notes, if any, evidencing Borrower's Loan obligations in
     favor of Lender, as well as any substitute, replacement or refinancing note
     or notes therefor.

     PERMITTED LIENS. The word "Permitted Liens" mean: (a) liens and security
     interests securing Indebtedness owed by Borrower to Lender; (b) liens for
     taxes, assessments, or similar charges either not yet due or being
     contested in good faith; (c) liens of materialmen, mechanics, warehousemen,
     or carriers, or other like liens arising in the ordinary course of business
     and securing obligations which are not yet delinquent; (d) purchase money
     liens or purchase money security interests upon or in any property acquired
     or held by Borrower in the ordinary course of business to secure
     indebtedness outstanding on the date of this Agreement or permitted to be
     incurred under the paragraph of this Agreement titled "Indebtedness and
     Liens"; (e) liens and security interests which, as of the date of this
     Agreement, have been disclosed to and approved by the Lender in writing;
     and (f) those liens and security interests which in the aggregate
     constitute an immaterial and insignificant monetary amount with respect to
     the net value of Borrower's assets.

     RELATED DOCUMENTS. The words "Related Documents" mean and include without
     limitation all promissory notes, credit agreements, loan agreements,
     environmental agreements, guaranties, security agreements, mortgages, deeds
     of trust, and all other instruments, agreements and documents, whether now
     or hereafter existing, executed in connection with the indebtedness.

     SECURITY AGREEMENT. The words "Security Agreement" mean and include without
     limitation any agreements, promises, covenants, arrangements,
     understandings or other agreements, whether created by law, contract, or
     otherwise, evidencing, governing, representing, or creating a Security
     Interest.

     SECURITY INTEREST. The words "Security Interest" mean and include without
     limitation any type of collateral security, whether in the form of a lien,
     charge, mortgage, deed of trust, assignment, pledge, chattel mortgage,
     chattel trust, factor's lien, equipment trust, conditional sale, trust
     receipt, lien or title retention contract, lease or consignment intended as
     a security device, or any other security or lien interest whatsoever,
     whether created by law, contract, or otherwise.

     SARA. The word "SARA" means the Superfund Amendments and Reauthorization
     Act of 1986 as now or hereafter amended.



                                                                          PAGE 3

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the Initial
Loan Advance and each subsequent Loan Advance under this Agreement shall be
subject to the fulfillment to Lender's satisfaction of all of the conditions set
forth in this Agreement and in the Related Documents.

     LOAN DOCUMENTS. Borrower shall provide to Lender in form satisfactory to
     Lender the following documents for the Loan: (a) the Note, (b) Security
     Agreements granting to Lender security interests in the Collateral, (c)
     Financing Statements perfecting Lender's Security Interests; (d) evidence
     of Insurance as required below; and (e) any other documents required under
     this Agreement or by Lender or its counsel.

     BORROWER'S AUTHORIZATION. Borrower shall have provided in form and
     substance satisfactory to Lender property certified resolutions, duly
     authorizing the execution and delivery of this Agreement, the Note and the
     Related Documents, and such other authorizations and other documents and
     Instruments as Lender or its counsel, in their sole discretion, may
     require.

     PAYMENT OF FEES AND EXPENSES. Borrower shall have paid to Lender all fees,
     charges, and other expenses which are then due and payable as specified in
     this Agreement or any Related Document.

     REPRESENTATIONS AND WARRANTIES. The representations and warranties set
     forth in this Agreement, in the Related Documents, and in any document or
     certificate delivered to Lender under this Agreement are true and correct.

     NO EVENT OF DEFAULT. There shall not exist at the time of any advance a
     condition which would constitute an Event of Default under this Agreement.

MULTIPLE BORROWERS. This Agreement has been executed by multiple obligors who
are referred to herein Individually, collectively and interchangeably as
"Borrower." Unless specifically stated to the contrary, the word "Borrower" as
used in this Agreement, including without limitation all representations,
warranties and covenants, shall include all Borrowers. Borrower understands and
agrees that, with or without notice to Borrower, Lender may with respect to any
other Borrower (a) make one or more additional secured or unsecured loans or
otherwise extend additional credit; (b) alter, compromise, renew, extend,
accelerate, or otherwise change one or more times the time for payment or other
terms any indebtedness, including increases and decreases of the rate of
Interest on the indebtedness; (c) exchange, enforce, waive, subordinate, fail or
decide not to perfect, and release any security, with or without the
substitution of new collateral; (d) release, substitute, agree not to sue, or
deal with any one or more of Borrower's sureties, endorsers, or other guarantors
on any terms or in any manner Lender may choose; (e) determine how, when and
what application of payments and credits shall be made on any Indebtedness; (f)
apply such security and direct the order or manner of sale thereof, including
without limitation, any nonjudicial sale permitted by the terms of the
controlling security agreement or deed of trust, as Lender in its discretion may
determine; (g) sell, transfer, assign, or grant participations in all or any
part of the indebtedness; (h) exercise or refrain from exercising any rights
against Borrower or others, or otherwise act or refrain from acting; (i) settle
or compromise any indebtedness; and (j) subordinate the payment of all or any
part of any indebtedness of Borrower to Lender to the payment of any liabilities
which may be due Lender or others.

REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as
of the date of this Agreement, as of the date of each disbursement of Loan
proceeds, as of the date of any renewal, extension or modification of any Loan,
and at all times any Indebtedness exists:

     ORGANIZATION. Borrower is a corporation which is duly organized, validly
     existing, and in good standing under the laws of the State of Delaware and
     is validly existing and in good standing in all states in which Borrower is
     doing business. Borrower has the full power and authority to own its
     properties and to transact the businesses in which it is presently engaged
     or presently proposes to engage. Borrower also is duly qualified as a
     foreign corporation and is in good standing in all states in which the
     failure to so quality would have a material adverse effect on its
     businesses or financial condition.

     AUTHORIZATION. The execution, delivery, and performance of this Agreement
     and all Related Documents by Borrower, to the extent to be executed,
     delivered or performed by Borrower, have been duly authorized



                                                                          PAGE 4

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     by all necessary action by Borrower; do not require the consent or approval
     of any other person, regulatory authority or governmental body; and do not
     conflict with, result in a violation of, or constitute a default under (a)
     any provision of its articles of incorporation or organization, or bylaws,
     or any agreement or other instrument binding upon Borrower or (b) any law,
     governmental regulation, court decree, or order applicable to Borrower.

     FINANCIAL INFORMATION. Each financial statement of Borrower supplied to
     Lender truly and completely disclosed Borrower's financial condition as of
     the date of the statement, and there has been no material adverse change in
     Borrower's financial condition subsequent to the date of the most recent
     financial statement supplied to Lender. Borrower has no material contingent
     obligations except as disclosed in such financial statements.

     LEGAL EFFECT. This Agreement constitutes, and any instrument or agreement
     required hereunder to be given by Borrower when delivered will constitute,
     legal, valid and binding obligations of Borrower enforceable against
     Borrower in accordance with their respective terms.

     PROPERTIES. Except as contemplated by this Agreement or as previously
     disclosed in Borrower's financial statements or in writing to Lender and as
     accepted by Lender, and except for property tax liens for taxes not
     presently due and payable, Borrower owns and has good title to all of
     Borrower's properties free and clear of all Security Interests, and has not
     executed any security documents or financing statements relating to such
     properties. All of Borrower's properties are titled in Borrower's legal
     name, and Borrower has not used, or filed a financing statement under, any
     other name for at least the last five (5) years.

     HAZARDOUS SUBSTANCES. The terms "hazardous waste," "hazardous substance,"
     "disposal," "release, and "threatened release," as used in this Agreement,
     shall have the same meanings as set forth in the "CERCLA," "SARA, the
     Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq.,
     the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et
     seq., or other applicable state or Federal laws, rules, or regulations
     adopted pursuant to any of the foregoing. Except as disclosed to and
     acknowledged by Lender in writing, Borrower represents and warrants that:
     (a) During the period of Borrower's ownership of the properties, there has
     been no use, generation, manufacture, storage, treatment, disposal, release
     or threatened release of any hazardous waste or substance by any person on,
     under, about or from any of the properties. (b) Borrower has no knowledge
     of, or reason to believe that there has been (i) any use, generation,
     manufacture, storage, treatment, disposal, release, or threatened release
     of any hazardous waste or substance on, under, about or from the properties
     by any prior owners or occupants of any of the properties, or (ii) any
     actual or threatened litigation or claims of any kind by any person
     relating to such matters. (c) Neither Borrower nor any tenant, contractor,
     agent or other authorized user of any of the properties shall use,
     generate, manufacture, store, treat, dispose of, or release any hazardous
     waste or substance on, under, about or from any of the properties; and any
     such activity shall be conducted in compliance with all applicable federal,
     state, and local laws regulations, and ordinances, including without
     limitation those laws, regulations and ordinances described above. Borrower
     authorizes Lender and its agents to enter upon the properties to make such
     inspections and tests as Lender may deem appropriate to determine
     compliance of the properties with this section of the Agreement. Any
     inspections or tests made by Lender shall be at Borrower's expense and for
     Lender's purposes only and shall not be construed to create any
     responsibility or liability on the part of Lender to Borrower or to any
     other person. The representations and warranties contained herein are based
     on Borrower's due diligence in investigating the properties for hazardous
     waste and hazardous substances. Borrower hereby (a) releases and waives any
     future claims against Lender for indemnity or contribution in the event
     Borrower becomes liable for cleanup or other costs under any such laws, and
     (b) agrees to indemnity and hold harmless Lender against any and all
     claims, losses, liabilities, damages, penalties, and expenses which Lender
     may directly or indirectly sustain or suffer resulting from a breach of
     this section of the Agreement or as a consequence of any use, generation,
     manufacture, storage, disposal, release or threatened release occurring
     prior to Borrower's ownership or interest in the properties, whether or not
     the same was or should have been known to Borrower. The provisions of this
     section of the Agreement, including the obligation to indemnity, shall
     survive the payment of the Indebtedness and the termination or expiration
     of this Agreement and shall not be affected by Lender's acquisition of any
     interest in any of the properties, whether by foreclosure or otherwise.



                                                                          PAGE 5

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     LITIGATION AND CLAIMS. No litigation, claim, investigation, administrative
     proceeding or similar action (including arose for unpaid taxes) against
     Borrower is pending or threatened, and no other event has occurred which
     may materially adversely affect Borrower's financial condition or
     properties, other than litigation, claims, or other events, if any, that
     have been disclosed to and acknowledged by Lender in writing.

     TAXES. To the best of Borrower's knowledge, all tax returns and reports of
     Borrower that are or were required to be filed, have been filed, and all
     taxes, assessments and other governmental charges have been paid in full,
     except those presently being or to be contested by Borrower in good faith
     in the ordinary course of business and for which adequate reserves have
     been provided.

     LIEN PRIORITY. Unless otherwise previously disclosed to Lender in writing,
     Borrower has not entered into or granted any Security Agreements, or
     permitted the filing or attachment of any Security Interests on or
     affecting any of the Collateral directly or indirectly securing repayment
     of Borrower's Loan and Note, that would be prior or that may in any way be
     superior to Lender's Security Interests and rights in and to such
     Collateral.

     BINDING EFFECT. This Agreement, the Note, all Security Agreements directly
     or indirectly securing repayment of Borrower's Loan and Note and all of the
     Related Documents are binding upon Borrower as well as upon Borrower's
     successors, representatives and assigns, and are legally enforceable in
     accordance with their respective terms.

     COMMERCIAL PURPOSES. Borrower intends to use the Loan proceeds solely for
     business or commercial related purposes.

     EMPLOYEE BENEFIT PLANS. Each employee benefit plan as to which Borrower may
     have any liability complies in all material respects with all applicable
     requirements of law and regulations, and (i) no Reportable Event nor
     Prohibited Transaction (as defined in ERISA) has occurred with respect to
     any such plan, (ii) Borrower has not withdrawn from any such plan or
     initiated steps to do so, (iii) no steps have been taken to terminate any
     such plan, and (iv) there are no unfunded liabilities other than those
     previously disclosed to Lender in writing.

     LOCATION OF BORROWER'S OFFICES AND RECORDS. Borrower's place of business,
     or Borrower's Chief executive office, if Borrower has more than one place
     of business, is located at 6 Strathmore Road, Natick, MA 01760. Unless
     Borrower has designated otherwise in writing this location is also the
     office or offices where Borrower keeps its records concerning the
     Collateral.

     INFORMATION. All information heretofore or contemporaneously herewith
     furnished by Borrower to Lender for the purposes of or in connection with
     this Agreement or any transaction contemplated hereby is, and all
     information hereafter furnished by or on behalf of Borrower to Lender will
     be, true and accurate in every material respect on the date as of which
     such information is dated or certified; and none of such information is or
     will be incomplete by omitting to state any material fact necessary to make
     such information not misleading.

     SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Borrower understands and agrees
     that Lender, without independent investigation, is relying upon the above
     representations and warranties in extending Loan Advances to Borrower.
     Borrower further agrees that the foregoing representations and warranties
     shall be continuing in nature and shall remain in full force and effect
     until such time as Borrower's Indebtedness shall be paid in full, or until
     this Agreement shall be terminated in the manner provided above, whichever
     is the last to occur.

AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while
this Agreement is in effect, Borrower will:



                                                                          PAGE 6

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     LITIGATION. Promptly inform Lender in writing of (a) all material adverse
     changes in Borrower's financial condition, and (b) all existing and all
     threatened litigation, claims, investigations, administrative proceedings
     or similar actions affecting Borrower or any Guarantor which could
     materially affect the financial condition of Borrower or the financial
     condition of any Guarantor.

     FINANCIAL RECORDS. Maintain its books and records in accordance with
     generally accepted accounting principles, applied on a consistent basis,
     and permit Lender to examine and audit Borrower's books and records at all
     reasonable times.

     FINANCIAL STATEMENTS. Furnish Lender with, as soon as available, but in no
     event later than one hundred twenty (120) days after the end of each fiscal
     year, Borrower's balance sheet and income statement for the year ended,
     compiled by a certified public accountant satisfactory to Lender. All
     financial reports required to be provided under this Agreement shall be
     prepared in accordance with generally accepted accounting principles,
     applied on a consistent basis, and certified by Borrower as being true and
     correct.

     ADDITIONAL INFORMATION. Furnish such additional information and statements,
     lists of assets and liabilities, agings of receivables and payables,
     inventory schedules, budgets, forecasts, tax returns, and other reports
     with respect to Borrower's financial condition and business operations as
     Lender may request from time to time.

     INSURANCE. Maintain fire and other risk insurance, public liability
     insurance, and such other insurance as Lender may require with respect to
     Borrower's properties and operations, in form, amounts, coverages and with
     insurance companies reasonably acceptable to Lender. Borrower, upon request
     of Lender, will deliver to Lender from time to time the policies or
     certificates of insurance in form satisfactory to Lender, including
     stipulations that coverages will not be cancelled or diminished without at
     least ten (10) days' prior written notice to Lender. Each insurance policy
     also shall include an endorsement providing that coverage in favor of
     Lender will not be impaired in any way by any act, omission or default of
     Borrower or any other person. In connection with all policies covering
     assets in which Lender holds or is offered a security interest for the
     Loans, Borrower will provide Lender with such loss payable or other
     endorsements as Lender may require.

     INSURANCE REPORTS. Furnish to Lender, upon request of Lender, reports on
     each existing insurance policy showing such information as Lender may
     reasonably request, including without limitation the following: (a) the
     name of the insurer; (b) the risks insured; (c) the amount of the policy;
     (d) the properties insured; (e) the then current property values on the
     basis of which insurance has been obtained, and the manner of determining
     those values; and (f) the expiration date of the policy. In addition, upon
     request of Lender (however not more often than annually), Borrower will
     have an independent appraiser satisfactory to Lender determine, as
     applicable, the actual cash value or replacement cost of any Collateral.
     The cost of such appraisal shall be paid by Borrower.

     OTHER AGREEMENTS. Comply with all terms and conditions of all other
     agreements, whether now or hereafter existing, between Borrower and any
     other party and notify Lender immediately in writing of any default in
     connection with any other such agreements.

     LOAN PROCEEDS. Use all Loan proceeds solely for Borrower's business
     operations, unless specifically consented to the contrary by Lender in
     writing.

     TAXES, CHARGES AND LIENS. Pay and discharge when due all of its
     indebtedness and obligations, including without limitation all assessments,
     taxes, governmental charges, levies and liens, of every kind and nature,
     imposed upon Borrower or its properties, income, or profits, prior to the
     date on which penalties would attach, and all lawful claims that, if
     unpaid, might become a lien or charge upon any of Borrower's properties,
     income, or profits. Provided however, Borrower will not be required to pay
     and discharge any such assessment, tax, charge, levy, lien or claim so long
     as (a) the legality of the same shall be contested in good faith by
     appropriate proceedings, and (b) Borrower shall have established on its
     books adequate reserves with respect to such contested assessment, tax,
     charge, levy, lien, or claim in accordance with generally accepted
     accounting practices. Borrower, upon demand of Lender, will furnish to
     Lender



                                                                          PAGE 7

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     evidence of payment of the assessments, taxes, charges, levies, liens and
     claims and will authorize the appropriate governmental official to deliver
     to Lender at any time a written statement of any assessments, taxes,
     charges, levies, liens and claims against Borrower's properties, income, or
     profits.

     PERFORMANCE. Perform and comply with all terms, conditions, and provisions
     set forth in this Agreement and in the Related Documents in a timely
     manner, and promptly notify Lender if Borrower learns of the occurrence of
     any event which constitutes an Event of Default under this Agreement or
     under any of the Related Documents.

     OPERATIONS. Maintain executive and management personnel with substantially
     the same qualifications and experience as the present executive and
     management personnel; provide written notice to Lender of any change in
     executive and management personnel; conduct its business affairs in a
     reasonable and prudent manner and in compliance with all applicable
     federal, state and municipal laws, ordinances, rules and regulations
     respecting its properties, charters, businesses and operations, including
     without limitation, compliance with the Americans With Disabilities Act and
     with all minimum funding standards and other requirements of ERISA and
     other laws applicable to Borrower's employee benefit plans.

     INSPECTION. Permit employees or agents of Lender at any reasonable time to
     inspect any and all Collateral for the Loan or Loans and Borrower's other
     properties and to examine or audit Borrower's books, accounts, and records
     and to make copies and memoranda of Borrower's books, accounts, and
     records. If Borrower now or at any time hereafter maintains any records
     (including without limitation computer generated records and computer
     software programs for the generation of such records) in the possession of
     a third party, Borrower, upon request of Lender, shall notify such party to
     permit Lender free access to such records at all reasonable times and to
     provide Lender with copies of any records it may request, all at Borrower's
     expense.

     COMPLIANCE CERTIFICATE. Unless waived in writing by Lender, provide Lender
     at least annually and at the time of each disbursement of Loan proceeds
     with a certificate executed by Borrower's chief financial officer, or other
     officer or person acceptable to Lender, certifying that the representations
     and warranties set forth in this Agreement are true and correct as of the
     date of the certificate and further certifying that, as of the date of the
     certificate, no Event of Default exists under this Agreement.

     ENVIRONMENTAL COMPLIANCE AND REPORTS. Borrower shall comply in all respects
     with all environmental protection federal, state and local laws, statutes,
     regulations and ordinances; not cause or permit to exist, as a result of an
     intentional or unintentional action or omission on its part or on the part
     of any third party, on property owned and/or occupied by Borrower, any
     environmental activity where damage may result to the environment, unless
     such environmental activity is pursuant to and in compliance with the
     conditions of a permit issued by the appropriate federal, state or local
     governmental authorities; shall furnish to Lender promptly and in any event
     within thirty (30) days after receipt thereof a copy of any notice,
     summons, lien, citation, directive, letter or other communication from any
     governmental agency or instrumentality concerning any intentional or
     unintentional action or omission on Borrower's part in connection with any
     environmental activity whether or not there is damage to the environment
     and/or other natural resources.

     ADDITIONAL ASSURANCES. Make, execute and deliver to Lender such promissory
     notes, mortgages, deeds of trust, security agreements, financing
     statements, instruments, documents and other agreements as Lender or its
     attorneys may reasonably request to evidence and secure the Loans and to
     perfect all Security Interests.

RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in any law,
rule, regulation or guideline, or the interpretation or application of any
thereof by any court or administrative or governmental authority (including any
request or policy not having the force of law) shall impose, modify or make
applicable any taxes (except U.S. federal, state or local income or franchise
taxes imposed on Lender), reserve requirements, capital adequacy requirements or
other obligations which would (a) increase the cost to Lender for extending or
maintaining the credit facilities to which this Agreement relates, (b) reduce
the amounts payable to Lender under this Agreement or the Related Documents, or
(c) reduce the rate of return on Lender's capital as a consequence of Lender's
obligations with respect to the credit facilities to which this Agreement
relates, then Borrower agrees to pay Lender such additional amounts as will
compensate Lender therefor, within five (5) days after Lender's written



                                                                          PAGE 8

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

demand for such payment, which demand shall be accompanied by an explanation of
such imposition or charge and a calculation in reasonable detail of the
additional amounts payable by Borrower, which explanation and calculations shall
be conclusive in the absence of manifest error.

NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this
Agreement is in effect, Borrower shall not, without the prior written consent of
Lender:

     INDEBTEDNESS AND LIENS. (a) Except for trade debt incurred in the normal
     course of business and indebtedness to Lender contemplated by this
     Agreement, create, incur or assume indebtedness for borrowed money,
     including capital leases, (b) except as allowed as a Permitted Lien, sell,
     transfer, mortgage, assign, pledge, lease, grant a security interest in, or
     encumber any of Borrower's assets, or (c) sell with recourse any of
     Borrower's accounts, except to Lender.

     CONTINUITY OF OPERATIONS. (a) Engage in any business activities
     substantially different than those in which Borrower is presently engaged,
     (b) cease operations, liquidate, merge, transfer, acquire or consolidate
     with any other entity, change ownership, change its name, dissolve or
     transfer or sell Collateral out of the ordinary course of business, (c) pay
     any dividends on Borrower's stock (other than dividends payable in its
     stock), provided, however that notwithstanding the foregoing, but only so
     long as no Event of Default has occurred and is continuing or would result
     from the payment of dividends, if Borrower is a "Subchapter S Corporation"
     (as defined in the Internal Revenue Code of 1986, as amended), Borrower may
     pay cash dividends on its stock to its shareholders from time to time in
     amounts necessary to enable the shareholders to pay income taxes and make
     estimated income tax payments to satisfy their liabilities under federal
     and state law which arise solely from their status as Shareholders of a
     Subchapter S Corporation because of their ownership of shares of stock of
     Borrower, or (d) purchase or retire any of Borrower's outstanding shares or
     alter or amend Borrower's capital structure.

     LOANS, ACQUISITIONS AND GUARANTIES. (a) Loan, invest in or advance money or
     assets, (b) purchase, create or acquire any interest in any other
     enterprise or entity, or (c) incur any obligation as surety or guarantor
     other than in the ordinary course of business.

CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to
Borrower, whether under this Agreement or under any other agreement, Lender
shall have no obligation to make Loan Advances or to disburse Loan proceeds if:
(a) Borrower or any Guarantor is in default under the terms of this Agreement or
any of the Related Documents or any other agreement that Borrower or any
Guarantor has with Lender, (b) Borrower or any Guarantor becomes insolvent,
files a petition in bankruptcy or similar proceedings, or is adjudged a
bankrupt; (c) there occurs a material adverse change in Borrower's financial
condition, in the financial condition of any Guarantor, or in the value of any
Collateral securing any Loan; (d) any Guarantor seeks, claims or otherwise
attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any
other loan with Lender; or (e) Lender in good faith deems itself insecure, even
though no Event of Default shall have occurred.

ADDITIONAL TERMS. Borrower authorizes Lender to release and disclose to its
affiliates, subsidiaries, servicing agents and contractors, copies of originals
of any and all financial records, including, without limitation, statements,
notices, financial and operating reports, balance sheets, financial statements,
consultants' reports and any and all other documents and information relating to
Borrower, now or hereafter provided to or generated by or for the benefit of
Lender in connection with any loan transaction now or hereafter existing.

LOAN PROCEEDS. Use all Loan proceeds solely for Borrower's business operations,
including, but not limited to, the acquisition of Letters of Credit for the
account of Borrower, unless specifically consented to the contrary by Lender in
writing. At no time may the total of Loans and Letters of Credit exceed the
amount of this facility and Borrower acknowledges that Letters of Credit shall
be issued at the sole discretion of the Bank.

RIGHT OF SETOFF. BORROWER GRANTS TO LENDER A CONTRACTUAL POSSESSORY SECURITY
INTEREST IN, AND HEREBY ASSIGNS, CONVEYS, DELIVERS, PLEDGES, AND TRANSFERS TO
LENDER ALL BORROWER'S RIGHT, TITLE AND INTEREST IN AND TO, BORROWER'S ACCOUNTS
WITH LENDER (WHETHER CHECKING, SAVINGS, OR SOME OTHER ACCOUNT), INCLUDING
WITHOUT LIMITATION ALL ACCOUNTS HELD JOINTLY WITH SOMEONE ELSE AND ALL ACCOUNTS
BORROWER MAY OPEN IN THE FUTURE, EXCLUDING HOWEVER ALL IRA AND KEOGH ACCOUNTS,
AND ALL TRUST ACCOUNTS FOR WHICH THE GRANT OF A SECURITY



                                                                          PAGE 9

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

INTEREST WOULD BE PROHIBITED BY LAW. BORROWER AUTHORIZES LENDER, TO THE EXTENT
PERMITTED BY APPLICABLE LAW, TO CHARGE OR SETOFF ALL SUMS OWING ON THE
INDEBTEDNESS AGAINST ANY AND ALL SUCH ACCOUNTS.

EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default
under this Agreement:

     DEFAULT ON INDEBTEDNESS. Failure of Borrower to make any payment when due
     on the Loans.

     OTHER DEFAULTS. Failure of Borrower or any Grantor to comply with or to
     perform when due any other term, obligation, covenant or condition
     contained in this Agreement or in any of the Related Documents, or failure
     of Borrower to comply with or to perform any other term, obligation,
     covenant or condition contained in any other agreement between Lender and
     Borrower.

     DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default
     under any loan, extension of credit, security agreement, purchase or sales
     agreement, or any other agreement, in favor of any other creditor or person
     that may materially affect any of Borrower's property or Borrower's or any
     Grantor's ability to repay the Loans or perform their respective
     obligations under this Agreement or any of the Related Documents.

     FALSE STATEMENTS. Any warranty, representation or statement made or
     furnished to Lender by or on behalf of Borrower or any Grantor under this
     Agreement or the Related Documents is false or misleading in any material
     respect at the time made or furnished, or becomes false or misleading at
     any time thereafter.

     DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents
     ceases to be in full force and effect (including failure of any Security
     Agreement to create a valid and perfected Security Interest) at any time
     and for any reason.

     INSOLVENCY. The dissolution or termination of Borrower's existence as a
     going business, the insolvency of Borrower, the appointment of a receiver
     for any part of Borrower's property, any assignment for the benefit of
     creditors, any trust mortgage or any other type of creditor workout, or the
     commencement of any proceeding under any bankruptcy or insolvency laws by
     or against Borrower.

     CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or
     forfeiture proceedings, whether by judicial proceeding, self-help,
     repossession or any other method, by any creditor of Borrower, any creditor
     of any Grantor against any collateral securing the Indebtedness, or by any
     governmental agency. This includes a garnishment, attachment, or levy on or
     of any of Borrower's deposit accounts with Lender. However, this Event of
     Default shall not apply if there is a good faith dispute by Borrower or
     Grantor, as the case may be, as to the validity or reasonableness of the
     claim which is the basis of the creditor or forfeiture proceeding, and if
     Borrower or Grantor gives Lender written notice of the creditor or
     forfeiture proceeding and furnishes reserves or a surety bond for the
     creditor or forfeiture proceeding satisfactory to Lender.

     EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect
     to any Guarantor of any of the Indebtedness or any Guarantor dies or
     becomes incompetent, or revokes or disputes the validity of, or liability
     under, any Guaranty of the Indebtedness. Lender, at its option, may, but
     shall not be required to, permit the Guarantor's estate to assume
     unconditionally the obligations arising under the guaranty in a manner
     satisfactory to Lender, and, in doing so, cure the Event of Default.

     EVENTS AFFECTING CO-BORROWERS. Any of the preceding events occurs with
     respect to any co-borrower of any of the Indebtedness or any co-borrower
     dies or becomes incompetent, or revokes or disputes the validity of, or
     liability under, any of the Indebtedness. Lender, at its option, may, but
     shall not be required to, permit the co-borrower's estate to assume
     unconditionally the obligations on the Indebtedness in a manner
     satisfactory to Lender, and, in doing so, cure the Event of Default.

     CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%)
     or more of the common stock of Borrower.



                                                                         PAGE 10

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     ADVERSE CHANGE. A material adverse change occurs in Borrower's financial
     condition, or Lender believes the prospect of payment or performance of the
     Indebtedness is impaired.

     INSECURITY. Lender, in good faith, deems itself insecure.

     RIGHT TO CURE. If any default, other than a Default on Indebtedness, is
     curable and if Borrower or Grantor, as the case may be, has not been given
     a notice of a similar default within the preceding twelve (12) months, it
     may be cured (and no Event of Default will have occurred) if Borrower or
     Grantor, as the case may be, after receiving written notice from Lender
     demanding cure of such default: (a) cures the default within fifteen (15)
     days; or (b) if the cure requires more than fifteen (15) days, immediately
     initiates steps which Lender deems in Lender's sole discretion to be
     sufficient to cure the default and thereafter continues and completes all
     reasonable and necessary steps sufficient to produce compliance as soon as
     reasonably practical.

EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where
otherwise provided in this Agreement or the Related Documents, all commitments
and obligations of Lender under this Agreement or the Related Documents or any
other agreement immediately will terminate (including any obligation to make
Loan Advances or disbursements), and, at Lender's option, all Indebtedness
immediately will become due and payable, all without notice of any kind to
Borrower, except that in the case of an Event of Default of the type described
in the "Insolvency" subsection above, such acceleration shall be automatic and
not optional. In addition, Lender shall have all the rights and remedies
provided in the Related Documents or available at law, in equity, or otherwise.
Except as may be prohibited by applicable law, all of Lender's rights and
remedies shall be cumulative and may be exercised singularly or concurrently.
Election by Lender to pursue any remedy shall not exclude pursuit of any other
remedy, and an election to make expenditures or to take action to perform an
obligation of Borrower or of any Grantor shall not affect Lenders right to
declare a default and to exercise its rights and remedies.

MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of
this Agreement:

     AMENDMENTS. This Agreement, together with any Related Documents,
     constitutes the entire understanding and agreement of the parties as to the
     matters set forth in this Agreement. No alteration of or amendment to this
     Agreement shall be effective unless given in writing and signed by the
     party or parties sought to be charged or bound by the alteration or
     amendment.

     APPLICABLE LAW. THIS AGREEMENT HAS BEEN DELIVERED TO LENDER AND ACCEPTED BY
     LENDER IN THE COMMONWEALTH OF MASSACHUSETTS. IF THERE IS A LAWSUIT,
     BORROWER AGREES UPON LENDER'S REQUEST TO SUBMIT TO THE JURISDICTION OF THE
     COURTS OF SUFFOLK COUNTY, THE COMMONWEALTH OF MASSACHUSETTS. LENDER AND
     BORROWER HEREBY WAIVE THE RIGHT TO ANY JURY TRIAL IN ANY ACTION,
     PROCEEDING, OR COUNTERCLAIM BROUGHT BY EITHER LENDER OR BORROWER AGAINST
     THE OTHER. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE
     WITH THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS.

     CAPTION HEADINGS. Caption headings in this Agreement are for convenience
     purposes only and are not to be used to interpret or define the provisions
     of this Agreement.

     CONSENT TO LOAN PARTICIPATION. Borrower agrees and consents to Lender's
     sale or transfer, whether now or later, of one or more participation
     interests in the Loans to one or more purchasers, whether related or
     unrelated to Lender. Lender may provide, without any limitation whatsoever,
     to any one or more purchasers, or potential purchasers, any information or
     knowledge Lender may have about Borrower or about any other matter relating
     to the Loan, and Borrower hereby waives any rights to privacy it may have
     with respect to such matters. Borrower additionally waives any and all
     notices of sale of participation interests, as well as all notices of any
     repurchase of such participation interests. Borrower also agrees that the
     purchasers of any such participation interests will be considered as the
     absolute owners of such interests in the Loans and win have all the rights
     granted under the participation agreement or agreements governing the sale
     of such participation Interests. Borrower further waives all rights of
     offset or counterclaim that it may have now or later against Lender or
     against any purchaser of such a participation interest and unconditionally
     agrees that either Lender or such purchaser may enforce Borrower's
     obligation under the Loans irrespective of the failure or insolvency of any
     holder of any interest in the Loans. Borrower further



                                                                         PAGE 11

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

     agrees that the purchaser of any such participation interests may enforce
     its interests irrespective of any personal claims or defenses that Borrower
     may have against Lender.

     COSTS AND EXPENSES. Borrower agrees to pay upon demand all of Lender's
     expenses, including without limitation attorneys' fees, incurred in
     connection with the preparation, execution, enforcement, modification and
     collection of this Agreement or in connection with the Loans made pursuant
     to this Agreement. Lender may pay someone else to help collect the Loans
     and to enforce this Agreement, and Borrower will pay that amount. This
     includes, subject to any limits under applicable law, Lender's attorneys'
     fees and Lender's legal expenses, whether or not there is a lawsuit,
     including attorneys' fees for bankruptcy proceedings (including efforts to
     modify or vacate any automatic stay or injunction), appeals, and any
     anticipated postjudgment collection services. Borrower also win pay any
     court costs, in addition to all other sums provided by law.

     NOTICES. All notices required to be given under this Agreement shall be
     given in writing, may be sent by telefacsimilie, and shall be effective
     when actually delivered or when deposited with a nationally recognized
     overnight courier or deposited in the United States mail, first class,
     postage prepaid, addressed to the party to whom the notice is to be given
     at the address shown above. Any party may change its address for notices
     under this Agreement by giving formal written notice to the other parties,
     specifying that the purpose of the notice is to change the party's address.
     To the extent permitted by applicable law, if there is more than one
     Borrower, notice to any Borrower will constitute notice to all Borrowers.
     For notice purposes, Borrower will keep lender informed at all times of
     Borrower's current address(es).

     SEVERABILITY. If a court of competent jurisdiction finds any provision of
     this Agreement to be invalid or unenforceable as to any person or
     circumstance, such finding shall not render that provision invalid or
     unenforceable as to any other persons or circumstances. If feasible, any
     such offending provision shall be deemed to be modified to be within the
     limits of enforceability or validity; however, if the offending provision
     cannot be so modified, it shall be stricken and all other provisions of
     this Agreement in all other respects shall remain valid and enforceable.

     SUCCESSORS AND ASSIGNS. All covenants and agreements contained by or on
     behalf of Borrower shall bind its successors and assigns and shall inure to
     the benefit of Lender, its successors and assigns. Borrower shall not,
     however, have the right to assign its rights under this Agreement or any
     interest therein, without the prior written consent of tender.

     SURVIVAL. All warranties, representations, and covenants made by Borrower
     in this Agreement or in any certificate or other instrument delivered by
     Borrower to Lender under this Agreement shall be considered to have been
     relied upon by Lender and will survive the making of the Loan and delivery
     to Lender of the Related Documents, regardless of any investigation made by
     Lender or on Lender's behalf.

     WAIVER. Lender shall not be deemed to have waived any rights under this
     Agreement unless such waiver is given in writing and signed by Lender. No
     delay or omission on the part of Lender in exercising any right shall
     operate as a waiver of such right or any other right. A waiver by Lender of
     a provision of this Agreement shall not prejudice or constitute a waiver of
     Lender's right otherwise to demand strict compliance with that provision or
     any other provision of this Agreement. No prior waiver by Lender, nor any
     course of dealing between Lender and Borrower, or between Lender and any
     Grantor, shall constitute a waiver of any of Lender's rights or of any
     obligations of Borrower or of any Grantor as to any future transactions.
     Whenever the consent of Lender is required under this Agreement, the
     granting of such consent by Lender in any instance shall not constitute
     continuing consent in subsequent instances where such consent is required,
     and in all cases such consent may be granted or withheld in the sole
     discretion of Lender.



                                                                         PAGE 12

                             BUSINESS LOAN AGREEMENT
                                   (CONTINUED)

EACH BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN
AGREEMENT, AND EACH BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF
FEBRUARY 15, 1997. THIS AGREEMENT IS EXECUTED UNDER SEAL.

BORROWER:

VISION-SCIENCES, INC.

BY: /s/ Gerald B. Lichtenberger
    --------------------------------------------------
       GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO

MACHIDA, INC., CO-BORROWER

BY: /s/ Gerald B. Lichtenberger
    --------------------------------------------------
       GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO

LENDER:

THE FIRST NATIONAL BANK OF BOSTON

BY:
    --------------------------------------------------
       AUTHORIZED OFFICER







                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT



===============================================================================
BORROWER: VISION - SCIENCES, INC.; ET. AL.      LENDER: THE FIRST NATIONAL
          6 STRATHMORE ROAD                             BANK OF BOSTON
          NATICK, MA  01760                             100 FEDERAL STREET
                                                        BOSTON, MA  02110
GRANTOR:  VISION - SCIENCES, INC.
===============================================================================


THIS COMMERCIAL PLEDGE AND SECURITY AGREEMENT IS ENTERED INTO AMONG VISION -
SCIENCES, INC. AND MACHIDA, INC. (REFERRED TO BELOW INDIVIDUALLY AND
COLLECTIVELY AS "BORROWER"); AND VISION - SCIENCES, INC. (REFERRED TO BELOW AS
"GRANTOR"); AND THE FIRST NATIONAL BANK OF BOSTON (REFERRED TO BELOW AS
"LENDER").

GRANT OF SECURITY INTEREST. FOR VALUABLE CONSIDERATION, GRANTOR GRANTS TO LENDER
A SECURITY INTEREST IN THE COLLATERAL TO SECURE THE INDEBTEDNESS AND AGREES THAT
LENDER SHALL HAVE THE RIGHTS STATED IN THIS AGREEMENT WITH RESPECT TO THE
COLLATERAL, IN ADDITION TO ALL OTHER RIGHTS WHICH LENDER MAY HAVE BY LAW.

DEFINITIONS. The following words shall have the following meanings when used in
this Agreement:

     AGREEMENT. The word "Agreement" means this Commercial Pledge and Security
     Agreement together with all exhibits and schedules attached to this
     Commercial Pledge and Security Agreement from time to time, if any, as
     amended from time to time.

     BORROWER. The word "Borrower" means each and every person or entity signing
     the Note, including without limitation Vision - Sciences, Inc, and Machida,
     Inc.

     COLLATERAL. The word "Collateral" means the following specifically
     described property, which Grantor has delivered or agrees to deliver (or
     cause to be delivered or appropriate book-entries made) immediately to
     Lender, together with all Income and Proceeds as described below:

          ALL OF THE RIGHT, TITLE AND INTEREST OF THE GRANTOR IN SHARES OF THE
          1784 INSTITUTIONAL US TREASURY MONEY MARKET FUND ACCOUNT #: 818064990,
          CUSIP #: 907-2155, INCLUDING ANY ACCOUNT IN WHICH SHARES ARE HELD,
          DIRECTLY OR INDIRECTLY, WHEREVER LOCATED, WHETHER NOW OWNED OR
          HEREAFTER ACQUIRED OR ARISING AND ALL PROCEEDS THEREOF

     In addition, the word "Collateral" includes all property of Grantor, in the
     possession of Lender (or in the possession of a third party subject to the
     control of Lender), whether



                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 2
                                  (Continued)

===============================================================================

     now or hereafter existing and whether tangible or intangible in character,
     including without limitation each of the following:

          (A) ALL PROPERTY TO WHICH LENDER ACQUIRES TITLE OR DOCUMENTS OF TITLE.

          (B) ALL PROPERTY ASSIGNED TO LENDER.

          (C) ALL PROMISSORY NOTES, BILLS OF EXCHANGE, STOCK CERTIFICATES,
          BONDS, SAVINGS PASSBOOKS, TIME CERTIFICATES OF DEPOSIT, INSURANCE
          POLICIES, AND ALL OTHER INSTRUMENTS AND EVIDENCES OF AN OBLIGATION.

          (D) ALL RECORDS RELATING TO ANY OF THE PROPERTY DESCRIBED IN THIS
          COLLATERAL SECTION, WHETHER IN THE FORM OF A WRITING, MICROFILM,
          MICROFICHE, OR ELECTRONIC MEDIA.

     EVENT OF DEFAULT. The words "Event of Default" mean and include without
     limitation any of the Events of Default set forth below in the section
     titled "Events of Default."

     GRANTOR. The word "Grantor" means Vision - Sciences, Inc. Any Grantor who
     signs this Agreement, but does not sign the Note, is signing this Agreement
     only to grant a security interest in Grantor's interest in the Collateral
     to Lender and is not personally liable under the Note except as otherwise
     provided by contract or law (e.g., personal liability under a guaranty or
     as a surety).

     GUARANTOR. The word "Guarantor" means and includes without limitation each
     and all of the guarantors, sureties, and accommodation parties in
     connection with the Indebtedness.

     INCOME AND PROCEEDS. The words "Income and Proceeds" mean all present and
     future income, proceeds, earnings, increases, and substitutions from or for
     the Collateral of every kind and nature, including without limitation all
     payments, interest, profits, distributions, benefits, rights, options,
     warrants, dividends, stock dividends, stock splits, stock rights,
     regulatory dividends, distributions, subscriptions, monies, claims for
     money due and to become due, proceeds of any insurance on the Collateral,
     shares of stock of different par value or no par value issued in
     substitution or exchange for shares included in the Collateral, whether
     voluntary or involuntary, by agreement or by operation of law, and all
     other property Grantor is entitled to receive on account of such
     Collateral, including accounts, documents, instruments, chattel paper, and
     general intangibles.

     INDEBTEDNESS. The word "Indebtedness" means the indebtedness evidenced by
     the Note, including all principal and interest, together with all other
     indebtedness and costs and expenses for which Borrower or Grantor is
     responsible under this Agreement or under any of the Related Documents. In
     addition, the word "Indebtedness" includes all other obligations, debts and
     liabilities, plus interest thereon, of Borrower, or any one or more of
     them, to Lender, as well as all claims by Lender against Borrower, or any
     one or more of them, whether existing now or later; whether they are
     voluntary or involuntary, due or not




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 3
                                  (Continued)

===============================================================================

     due, direct or indirect, absolute or contingent, liquidated or
     unliquidated; whether Borrower may be liable individually or jointly with
     others; whether Borrower may be obligated as guarantor, surety,
     accommodation party or otherwise; whether recovery upon such indebtedness
     maybe or hereafter may become barred by any statute of limitations; and
     whether such indebtedness may be or hereafter may become otherwise
     unenforceable.

     LENDER. The word "Lender" means THE FIRST NATIONAL BANK OF BOSTON, its
     successors and assigns.

     NOTE. The word "Note" means the note or credit agreement dated
     _____________, in the principal amount of $250,000.00 from Borrower to
     Lender, together with all renewals of, extensions of, modifications of,
     refinancings of, consolidations of and substitutions for the note or credit
     agreement.

     OBLIGOR. The word "Obligor" means and includes without limitation any and
     all persons or entities obligated to pay money or to perform some other act
     under the Collateral.

     RELATED DOCUMENTS. The words "Related Documents" mean and include without
     limitation all promissory notes, credit agreements, loan agreements,
     environmental agreements, guaranties, security agreements, mortgages, deeds
     of trust, and all other instruments, agreements and documents, whether now
     or hereafter existing, executed in connection with the Indebtedness.

BORROWER'S WAIVERS AND RESPONSIBILITIES. Except as otherwise required under this
Agreement or by applicable law, (a) Borrower agrees that Lender need not tell
Borrower about any action or inaction Lender takes in connection with this
Agreement; (b) Borrower assumes the responsibility for being and keeping
informed about the Collateral; and (c) Borrower waives any defenses that may
arise because of any action or inaction of Lender, including without limitation
any failure of Lender to realize upon the Collateral or any delay by Lender in
realizing upon the Collateral; and Borrower agrees to remain liable under the
Note no matter what action Lender takes or fails to take under this Agreement.

GRANTOR'S REPRESENTATIONS AND WARRANTIES. Grantor warrants that: (a) this
Agreement is executed at Borrower's request and not at the request of Lender;
(b) Grantor has the full right, power and authority to enter into this Agreement
and to pledge the Collateral to Lender; (c) Grantor has established adequate
means of obtaining from Borrower on a continuing basis information about
Borrower's financial condition; and (d) Lender has made no representation to
Grantor about Borrower or Borrower's creditworthiness.

GRANTOR'S WAIVERS. Grantor waives all requirements of presentment, protest,
demand, and notice of dishonor or non-payment to Grantor, Borrower, or any other
party to the Indebtedness or the Collateral. Lender may do any of the following
with respect to any obligation of any Borrower, without first obtaining the
consent of Grantor: (a) grant any




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 4
                                  (Continued)

===============================================================================

extension of time for any payment, (b) grant any renewal, (c) permit any
modification of payment terms or other terms, or (d) exchange or release any
Collateral or other security. No such act or failure to act shall affect
Lender's rights against Grantor or the Collateral.

If now or hereafter (a) Borrower shall be or become insolvent, and (b) the
Indebtedness shall not at all times until paid be fully secured by collateral
pledged by Borrower, Grantor hereby forever waives and relinquishes in favor of
Lender and Borrower, and their respective successors, any claim or right to
payment Grantor may now have or hereafter have or acquire against Borrower, by
subrogation or otherwise, so that at no time shall Grantor be or become a
"creditor" of Borrower within the meaning of 11 U.S.C. section 547(b), or any
successor provision of the Federal bankruptcy laws.

RIGHT OF SETOFF. GRANTOR HEREBY GRANTS LENDER A CONTRACTUAL POSSESSORY SECURITY
INTEREST IN AND HEREBY ASSIGNS, CONVEYS, DELIVERS, PLEDGES, AND TRANSFERS ALL OF
GRANTOR'S RIGHT, TITLE AND INTEREST IN AND TO GRANTOR'S ACCOUNTS WITH LENDER
(WHETHER CHECKING, SAVINGS, OR SOME OTHER ACCOUNT), INCLUDING ALL ACCOUNTS HELD
JOINTLY WITH SOMEONE ELSE AND ALL ACCOUNTS GRANTOR MAY OPEN IN THE FUTURE,
EXCLUDING, HOWEVER, ALL IRA AND KEOGH ACCOUNTS, AND ALL TRUST ACCOUNTS FOR WHICH
THE GRANT OF A SECURITY INTEREST WOULD BE PROHIBITED BY LAW. GRANTOR AUTHORIZES
LENDER, TO THE EXTENT PERMITTED BY APPLICABLE LAW, TO CHARGE OR SETOFF ALL
INDEBTEDNESS AGAINST ANY AND ALL SUCH ACCOUNTS.

GRANTOR'S REPRESENTATIONS AND WARRANTIES WITH RESPECT TO THE COLLATERAL. Grantor
represents and warrants to Lender that:

     OWNERSHIP. Grantor is the lawful owner of the Collateral free and clear of
     all security interests, liens, encumbrances, registered pledges, adverse
     claims, and any other claims of others except as disclosed to and accepted
     by Lender in writing prior to execution of this Agreement.

     RIGHT TO PLEDGE. Grantor has the full right, power and authority to enter
     into this Agreement and to pledge the Collateral.

     BINDING EFFECT. This Agreement is binding upon Grantor, as well as
     Grantor's heirs, successors, representatives and assigns, and is legally
     enforceable in accordance with its terms.

     NO FURTHER ASSIGNMENT. Grantor has not, and will not, sell, assign,
     transfer, encumber or otherwise dispose of any of Grantor's rights in the
     Collateral except as provided in this Agreement.

     NO DEFAULTS. There are no defaults existing under the Collateral, and there
     are no offsets or counterclaims to the same. Grantor will strictly and
     promptly perform each of the terms, conditions, covenants and agreements
     contained in the Collateral which are to be performed by Grantor, if any.





                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 5
                                  (Continued)

===============================================================================

     NO VIOLATION. The execution and delivery of this Agreement will not violate
     any law or agreement governing Grantor or to which Grantor is a party, and
     its articles or agreements relating to entity incorporation, organization
     or existence do not prohibit any term or condition of this Agreement.

LENDER'S RIGHTS AND OBLIGATIONS WITH RESPECT TO COLLATERAL. Lender may hold the
Collateral unfit all the Indebtedness has been paid and satisfied and thereafter
may deliver the Collateral to any Grantor. Lender shall have the following
rights in addition to all other rights it may have by law:

     MAINTENANCE AND PROTECTION OF COLLATERAL. Lender may, but shall not be
     obligated to, take such steps as it deems necessary or desirable to
     protect, maintain, insure, control, receive, or manage the Collateral,
     including payment of any liens or claims against the Collateral. Lender may
     charge any cost incurred in so doing to Grantor.

     INCOME AND PROCEEDS FROM THE COLLATERAL. Lender may receive all Income and
     Proceeds and add it to the Collateral. Grantor agrees to deliver to Lender
     immediately upon receipt, in the exact form received and without
     commingling with other property, all Income and Proceeds from the
     Collateral which may be received by, paid, or delivered to Grantor or for
     Grantor's account, whether as an addition to, in discharge of, in
     substitution of, or in exchange for any of the Collateral.

     APPLICATION OF CASH. At Lender's option, Lender may apply any cash, whether
     included in the Collateral or received as Income and Proceeds or through
     liquidation, sale, retirement, split up, dividend, distribution, or other
     disposition of the Collateral, to the satisfaction of the Indebtedness or
     such portion thereof as Lender shall choose, whether or not matured.

     TRANSACTIONS WITH OTHERS. Lender may (a) extend time for payment or other
     performance, (b) grant a renewal or change in terms or conditions, or (c)
     compromise, compound or release any obligation, with any one or more
     Obligors, endorsers, or Guarantors of the Indebtedness as Lender deems
     advisable, without obtaining the prior written consent of Grantor, and no
     such act or failure to act shall affect Lender's rights against Grantor or
     the Collateral.

     ALL COLLATERAL SECURES INDEBTEDNESS. All Collateral shall be security for
     the Indebtedness, whether the Collateral is located at one or more offices
     or branches of Lender and whether or not the office or branch where the
     Indebtedness is created is aware of or relies upon the Collateral.

     COLLECTION OF COLLATERAL. Lender, at Lender's option may, but need not,
     collect directly from the Obligors on any of the Collateral all Income and
     Proceeds or other sums of money and other property due and to become due
     under the Collateral, and Grantor authorizes and directs the Obligors, if
     Lender exercises such option, to pay and deliver to



                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 6
                                  (Continued)

===============================================================================

     Lender all Income and Proceeds and other sums of money and other property
     payable by the terms of the Collateral and to accept Lender's receipt for
     the payments.

     POWER OF ATTORNEY. Grantor irrevocably appoints Lender as Grantor's
     attorney-in-fact, with full power of substitution, (a) to demand, collect,
     receive, receipt for, sue and recover all Income and Proceeds and other
     sums of money and other property which may now or hereafter become due,
     owing or payable from the Obligors in accordance with the terms of the
     Collateral; (b) to execute, sign and endorse any and all instruments,
     receipts, checks, drafts and warrants issued in payment for the Collateral;
     (c) to settle or compromise any and all claims arising under the
     Collateral, and in the place and stead of Grantor, execute and deliver
     Grantor's release and acquittance for Grantor; (d) to file any claim or
     claims or to take any action or institute or take part in any proceedings,
     either in Lender's own name or in the name of Grantor, or otherwise, which
     in the discretion of Lender may seem to be necessary or advisable and (e)
     to execute in Grantor's name and to deliver to the Obligors on Grantor's
     behalf, at the time and in the manner specified by the Collateral, any
     necessary instruments or documents.

     PERFECTION OF SECURITY INTEREST. Upon request of Lender, Grantor will
     deliver to Lender any and all of the documents evidencing or constituting
     the Collateral. When applicable law provides more than one method of
     perfection of Lender's security interest, Lender may choose the method(s)
     to be used. Upon request of Lender, Grantor will sign and deliver any
     writings necessary to perfect Lender's security interest. If the Collateral
     consists of securities for which no certificate has been issued, Grantor
     agrees, at Lender's option, either to request issuance of an appropriate
     certificate or to execute appropriate instructions on Lender's forms
     instructing the issuer, transfer agent, mutual fund company, or broker, as
     the case may be, to record on its books or records, by book-entry, initial
     transaction statement, registered pledge, or otherwise, Lenders security
     interest in the Collateral. Grantor hereby appoints Lender as Grantor's
     irrevocable attorney-in-fact for the purpose of executing any documents
     necessary to perfect or to continue the security interest granted in this
     Agreement. THIS IS A CONTINUING SECURITY AGREEMENT AND WILL CONTINUE IN
     EFFECT EVEN THOUGH ALL OR ANY PART OF THE INDEBTEDNESS IS PAID IN FULL AND
     EVEN THOUGH FOR A PERIOD OF TIME BORROWER MAY NOT BE INDEBTED TO LENDER.

EXPENDITURES BY LENDER. If not discharged or paid when due, Lender may (but
shall not be obligated to) discharge or pay any amounts required to be
discharged or paid by Grantor under this Agreement, including without limitation
all taxes, liens, security interests, encumbrances, and other claims, at any
time levied or placed on the Collateral. Lender also may (but shall not be
obligated to) pay all costs for insuring, maintaining and preserving the
Collateral. All such expenditures incurred or paid by Lender for such purposes
will then bear interest at the rate charged under the Note from the date
incurred or paid by Lender to the date of repayment by Grantor. All such
expenses shall become a part of the indebtedness and, at Lender's option, will
(a) be payable on demand, (b) be added to the balance of the Note and be
apportioned among and be payable with any installment payments to become due
during either (i) the term of any applicable insurance policy or (ii) the
remaining term of the Note, or (c) be




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 7
                                  (Continued)

===============================================================================

treated as a balloon payment which will be due and payable at the Note's
maturity. This Agreement also will secure payment of these amounts. Such right
shall be in addition to all other rights and remedies to which Lender may be
entitled upon the occurrence of an Event of Default.

LIMITATIONS ON OBLIGATIONS OF LENDER. Lender shall use ordinary reasonable care
in the physical preservation and custody of the Collateral in Lender's
possession, but shall have no other obligation to protect the Collateral or its
value. In particular, but without limitation, Lender shall have no
responsibility for (a) any depreciation in value of the Collateral or for the
collection or protection of any Income and Proceeds from the Collateral, (b)
preservation of rights against parties to the Collateral or against third
persons, (c) ascertaining any maturities, calls, conversions, exchanges, offers,
tenders, or similar matters relating to any of the Collateral, or (d) informing
Grantor about any of the above, whether or not Lender has or is deemed to have
knowledge of such matters. Except as provided above, Lender shall have no
liability for depreciation or deterioration of the Collateral.

EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default
under this Agreement:

     DEFAULT ON INDEBTEDNESS. Failure of Borrower to make any payment when due
     on the Indebtedness.

     OTHER DEFAULTS. Failure of Borrower or Grantor to comply with or to perform
     any other term, obligation, covenant or condition contained in this
     Agreement or in any of the Related Documents or failure of Borrower to
     comply with or to perform any term, obligation, covenant or condition
     contained in any other agreement between Lender and Borrower.

     DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default
     under any loan, extension of credit, security agreement, purchase or sales
     agreement, or any other agreement, in favor of any other creditor or person
     that may materially affect any of Borrower's property or Borrower's or any
     Grantor's ability to repay the Loans or perform their respective
     obligations under this Agreement or any of the Related Documents.

     FALSE STATEMENTS. Any warranty, representation or statement made or
     furnished to Lender by or on behalf of Borrower or Grantor under this
     Agreement, the Note or the Related Documents is false or misleading in any
     material respect, either now or at the time made or furnished.

     DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents
     ceases to be in full force and effect (including failure of any collateral
     documents to create a valid and perfected security interest or lien) at any
     time and for any reason.

     INSOLVENCY. The dissolution or termination of Borrower or Grantor's
     existence as a going business, the insolvency of Borrower or Grantor, the
     appointment of a receiver for any



                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 8
                                  (Continued)

===============================================================================

     part of Borrower or Grantor's property, any assignment for the benefit of
     creditors, any type of creditor workout, or the commencement of any
     proceeding under any bankruptcy or insolvency laws by or against Borrower
     or Grantor.

     CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or
     forfeiture proceedings, whether by judicial proceeding, self-help,
     repossession or any other method, by any creditor of Borrower or Grantor or
     by any governmental agency against the Collateral or any other collateral
     securing the Indebtedness. This includes a garnishment of any of Borrower
     or Grantor's deposit accounts with Lender. However, this Event of Default
     shall not apply if there is a good faith dispute by Borrower or Grantor as
     to the validity or reasonableness of the claim which is the basis of the
     creditor or forfeiture proceeding and if Borrower or Grantor gives Lender
     written notice of the creditor or forfeiture proceeding and deposits with
     Lender monies or a surety bond for the creditor or forfeiture proceeding,
     in an amount determined by Lender, in its sole discretion, as being an
     adequate reserve or bond for the dispute.

     EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect
     to any Guarantor of any of the Indebtedness or such Guarantor dies or
     becomes incompetent. Lender, at its option, may, but shall not be required
     to, permit the Guarantor's estate to assume unconditionally the obligations
     arising under the guaranty in a manner satisfactory to Lender, and, in
     doing so, cure the Event of Default.

     ADVERSE CHANGE. A material adverse change occurs in Borrower's financial
     condition, or Lender believes the prospect of payment or performance of the
     Indebtedness is impaired.

     INSECURITY. Lender, in good faith, deems itself insecure.

     FAILURE TO REGISTER. Failure of the issuer, transfer agent, mutual fund
     company, or broker, as the case may be, to furnish a written statement to
     Lender recording Lender's security interest to the security, or the
     identification of any adverse claim that may interfere with Lender's
     security interest in the Collateral.

     RIGHT TO CURE. If any default, other than a Default on Indebtedness, is
     curable and if Borrower or Grantor has not been given a prior notice of a
     breach of the same provision of this Agreement, it may be cured (and no
     Event of Default will have occurred) if Borrower or Grantor, after Lender
     sends written notice demanding cure of such default, (a) cures the default
     within fifteen (15) days; or (b), if the cure requires more than fifteen
     (15) days, immediately initiates steps which Lender deems in Lender's sole
     discretion to be sufficient to cure the default and thereafter continues
     and completes all reasonable and necessary steps sufficient to produce
     compliance as soon as reasonably practical.




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 9
                                  (Continued)

===============================================================================

RIGHTS AND REMEDIES ON DEFAULT. If an Event of Default occurs under this
Agreement, at any time thereafter, Lender may exercise any one or more of the
following rights and remedies:

     ACCELERATE INDEBTEDNESS. Declare all Indebtedness, including any prepayment
     penalty which Borrower would be required to pay, immediately due and
     payable, without notice of any kind to Borrower or Grantor.

     COLLECT THE COLLATERAL. Collect any of the Collateral and, at Lender's
     option and to the extent permitted by applicable law, retain possession of
     the Collateral while suing on the Indebtedness.

     SELL THE COLLATERAL. Sell the Collateral, at Lender's discretion, as a unit
     or in parcels, at one or more public or private sales. Unless the
     Collateral is perishable or threatens to decline speedily in value or is of
     a type customarily sold on a recognized market, Lender shall give or mail
     to Grantor, or any of them, notice at least ten (10) days in advance of the
     time and place of any public sale, or of the date after which any private
     sale may be made. Grantor agrees that any requirement of reasonable notice
     is satisfied if Lender mails notice by ordinary mail addressed to Grantor,
     or any of them, at the last address Grantor has given Lender in writing. If
     a public sale is held, there shall be sufficient compliance with all
     requirements of notice to the public by a single publication in any
     newspaper of general circulation in the county where the Lender is located,
     setting forth the time and place of sale and a brief description of the
     property to be sold. Lender may be a purchaser at any public sale.

     REGISTER SECURITIES. Register any securities included in the Collateral in
     Lender's name or in the name of any nominee and exercise any rights
     normally incident to the ownership of securities.

     SELL SECURITIES. Sell any securities included in the Collateral in a manner
     consistent with applicable federal and state securities laws,
     notwithstanding any other provision of this or any other agreement. If,
     because of restrictions under such laws, Lender is or believes it is unable
     to sell the securities in an open market transaction, Grantor agrees that
     Lender shall have no obligation to delay sale until the securities can be
     registered, and may make a private sale to one or more persons or to a
     restricted group of persons, even though such sale may result in a price
     that is less favorable than might be obtained in an open market
     transaction, and such a sale shall be considered commercially reasonable.
     If any securities held as Collateral are "restricted securities" as defined
     in the Rules of the Securities and Exchange Commission (such as Regulation
     D or Rule 144) or state securities departments under state "Blue Sky" laws,
     or if Borrower or Grantor is an affiliate of the issuer of the securities,
     Borrower and Grantor agree that neither Grantor nor any agent of Grantor
     will sell or dispose of any securities of such issuer without obtaining
     Lender's prior written consent.




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 10
                                  (Continued)

===============================================================================

     FORECLOSURE. Maintain a judicial suit for foreclosure and sale of the
     Collateral.

     TRANSFER TITLE. Effect transfer of title upon sale of all or part of the
     Collateral. For this purpose, Grantor irrevocably appoints Lender as its
     attorney-in-fact to execute endorsements, assignments and instruments in
     the name of Grantor and each of them (if more than one) as shall be
     necessary or reasonable.

     OTHER RIGHTS AND REMEDIES. Have and exercise any or all of the rights and
     remedies of a secured creditor under the provisions of the Uniform
     Commercial Code, at law, in equity, or otherwise.

     APPLICATION OF PROCEEDS. Apply any cash which is part of the Collateral, or
     which is received from the collection or sale of the Collateral, to
     reimbursement of any expenses, including any costs for registration of
     securities, commissions incurred in connection with a sale, attorney fees
     as provided below, and court costs, whether or not there is a lawsuit and
     including any fees on appeal, incurred by Lender in connection with the
     collection and sale of such Collateral and to the payment of the
     Indebtedness of Borrower to Lender, with any excess funds to be paid to
     Grantor as the interests of Grantor may appear. Borrower agrees, to the
     extent permitted by law, to pay any deficiency after application of the
     proceeds of the Collateral to the Indebtedness.

     CUMULATIVE REMEDIES. All of Lender's rights and remedies, whether evidenced
     by this Agreement or by any other writing, shall be cumulative and may be
     exercised singularly or concurrently. Election by Lender to pursue any
     remedy shall not exclude pursuit of any other remedy, and an election to
     make expenditures or to take action to perform an obligation of Grantor
     under this Agreement, after Grantor's failure to perform, shall not affect
     Lender's right to declare a default and to exercise its remedies.

MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of
this Agreement:

     AMENDMENTS. This Agreement, together with any Related Documents,
     constitutes the entire understanding and agreement of the parties as to the
     matters set forth in this Agreement. No alteration of or amendment to this
     Agreement shall be effective unless given in writing and signed by the
     party or parties sought to be charged or bound by the alteration or
     amendment.

     APPLICABLE LAW. THIS AGREEMENT HAS BEEN DELIVERED TO LENDER AND ACCEPTED BY
     LENDER IN THE COMMONWEALTH OF MASSACHUSETTS. IF THERE IS A LAWSUIT,
     BORROWER AND GRANTOR AGREE, UPON LENDER'S REQUEST TO SUBMIT TO THE
     JURISDICTION OF THE COURTS OF SUFFOLK COUNTY, THE COMMONWEALTH OF
     MASSACHUSETTS. LENDER, BORROWER AND GRANTOR HEREBY WAIVE THE RIGHT TO ANY
     JURY TRIAL IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM BROUGHT BY EITHER
     LENDER, BORROWER OR GRANTOR AGAINST THE OTHER.




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 11
                                  (Continued)

===============================================================================

     THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE
     LAWS OF THE COMMONWEALTH OF MASSACHUSETTS.

     ATTORNEYS' FEES; EXPENSES. Borrower and Grantor agree to pay upon demand
     all of Lender's costs and expenses, including attorneys' fees and Lender's
     legal expenses, incurred in connection with the enforcement of this
     Agreement. Lender may pay someone else to help enforce this Agreement, and
     Borrower and Grantor shall pay the costs and expenses of such enforcement.
     Costs and expenses include Lender's attorneys' fees and legal expenses
     whether or not there is a lawsuit, including attorneys' fees and legal
     expenses for bankruptcy proceedings (and including efforts to modify or
     vacate any automatic stay or injunction), appeals, and any anticipated
     post-judgment collection services. Borrower and Grantor also shall pay all
     court costs and such additional fees as may be directed by the court.

     CAPTION HEADINGS. Caption headings in this Agreement are for convenience
     purposes only and are not to be used to interpret or define the provisions
     of this Agreement.

     MULTIPLE PARTIES; CORPORATE AUTHORITY. All obligations of Borrower and
     Grantor under this Agreement shall be joint and several, and all references
     to Borrower shall mean each and every Borrower, and all references to
     Grantor shall mean each and every Grantor. This means that each of the
     Borrowers signing below is responsible for all obligations in this
     Agreement.

     NOTICES. All notices required to be given under this Agreement shall be
     given in writing, may be sent by telefacsimilie, and shall be effective
     when actually delivered or when deposited with a nationally recognized
     overnight courier or deposited in the United States mail, first class,
     postage prepaid, addressed to the party to whom the notice is to be given
     at the address shown above. Any party may change its address for notices
     under this Agreement by giving formal written notice to the other parties,
     specifying that the purpose of the notice is to change the party's address.
     To the extent permitted by applicable law, if there is more than one
     Borrower or Grantor, notice to any Borrower or Grantor will constitute
     notice to all Borrower and Grantors. For notice purposes, Borrower and
     Grantor will keep Lender informed at all times of Borrower and Grantor's
     current address(es).

     SEVERABILITY. If a court of competent jurisdiction finds any provision of
     this Agreement to be invalid or unenforceable as to any person or
     circumstance, such finding shall not render that provision invalid or
     unenforceable as to any other persons or circumstances. If feasible, any
     such offending provision shall be deemed to be modified to be within the
     limits of enforceability or validity; however, if the offending provision
     cannot be so modified, it shall be stricken and all other provisions of
     this Agreement in all other respects shall remain valid and enforceable.




                    COMMERCIAL PLEDGE AND SECURITY AGREEMENT             PAGE 12
                                  (Continued)

===============================================================================

     SUCCESSOR INTERESTS. Subject to the limitations set forth above on transfer
     of the Collateral, this Agreement shall be binding upon and inure to the
     benefit of the parties, their successors and assigns.

     WAIVER. Lender shall not be deemed to have waived any rights under this
     Agreement unless such waiver is given in writing and signed by Lender. No
     delay or omission on the part of Lender in exercising any right shall
     operate as a waiver of such right or any other right. A waiver by Lender of
     a provision of this Agreement shall not prejudice or constitute a waiver of
     Lender's right otherwise to demand strict compliance with that provision or
     any other provision of this Agreement. No prior waiver by Lender, nor any
     course of dealing between Lender and Grantor, shall constitute a waiver of
     any of Lender's rights or of any of Grantor's obligations as to any future
     transactions. Whenever the consent of Lender is required under this
     Agreement, the granting of such consent by Lender in any instance shall not
     constitute continuing consent to subsequent instances where such consent is
     required and in all cases such consent may be granted or withheld in the
     sole discretion of Lender.

BORROWER AND GRANTOR ACKNOWLEDGE HAVING READ ALL THE PROVISIONS OF THIS PLEDGE
AND SECURITY AGREEMENT, AND BORROWER AND GRANTOR AGREE TO ITS TERMS. THIS
AGREEMENT IS DATED ___________. THIS AGREEMENT IS EXECUTED UNDER SEAL.

BORROWER:

VISION - SCIENCES, INC.

BY: /S/ GERALD B. LICHTENBERGER
   -----------------------------------------------
   GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO


MACHIDA, INC., CO-BORROWER

BY: /S/ GERALD B. LICHTENBERGER
   -----------------------------------------------
   GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO


GRANTOR:

VISION - SCIENCES, INC.

BY: /S/ GERALD B. LICHTENBERGER
   -----------------------------------------------
   GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO



===============================================================================






                      RIDER TO COMMERCIAL PLEDGE AGREEMENT

================================================================================

BORROWER: VISION - SCIENCES, INC.; ET. AL.           LENDER: THE FIRST NATIONAL
          6 STRATHMORE ROAD                                  BANK OF BOSTON
          NATICK, MA  01760                                  100 FEDERAL STREET
                                                             BOSTON, MA  02110
GRANTOR:  VISION - SCIENCES, INC.
          6 STRATHMORE ROAD
          NATICK, MA  01760

================================================================================

This Rider is entered into between The First National Bank of Boston ("Lender")
and Vision -Sciences, Inc. ("Grantor"), is contemporaneous with and amends the
Commercial Pledge Agreement dated _____________ between Lender and Grantor. It
is the Intention of Lender and Grantor that, upon execution, this Rider shall
constitute a part of the Commercial Pledge Agreement.

IN CONSIDERATION OF the mutual covenants and promises as hereinafter set forth,
Lender and Grantor hereby agree as follows:

TERMS. All capitalized terms used in this Rider shall, unless otherwise defined,
have the meanings set forth in the Assignment.

Grantor agrees that this Agreement is entered into in order to induce Lender to
provide financial or other accommodations to Obligor which will directly or
indirectly benefit Grantor. Notwithstanding any provision in the Agreement b the
contrary, Grantor authorizes Lender and appoints Lender as its attorney-in-fact
to enter into transactions with third parties or take any action in connection
with the Collateral whether or not an Event of Default has occurred and is
continuing provided that such transactions are entered into or actions are taken
in good faith in the reasonable belief that such transactions or actions are
necessary to protect the Collateral or preserve its value.

In addition to the Events of Default as set forth above, Lender may declare, in
its sole discretion, an Event of Default (i) if it shall receive any adverse
credit information or rating concerning Grantor from any commercially recognized
credit information source or bureau or (ii) in the event of any material
overdraft or series of overdrafts in any demand deposit account.

Grantor agrees to provide any financial information as may be reasonably
requested by Lender. Grantor further authorizes Lender to release and disclose
to its affiliates, subsidiaries, servicing agents and contractors, copies of
originals of any and all financial records, including, without limitation,
statements, notices, financial and operating reports, balance sheets, financial
statements, consultants' reports and any and all other documents and information
relating to Grantor, now or hereafter provided to or generated by or for the
benefit of Lender in connection with any loan transaction now or hereafter
existing.





FURTHER AGREEMENTS. The Grantor agrees that the aggregate collateral value of
all stocks, bonds or other securities pledged as Collateral hereunder shall not
be less than one hundred percent (100%) of the outstanding amounts due under the
Note ("Minimum Aggregate Collateral Value") provided, however, that for the
purpose of determining the collateral value ("Collateral Value") of the stocks,
bonds or other securities, the following formula shall apply:

(i.)  For any Collateral consisting of shares of a mutual fund the Collateral
      Value shall be 95% of the then current market value of such shares
      based upon their net asset value as reported in any widely distributed
      standard price quotation.

In the event the aggregate Collateral Value of all stocks, bonds or other
securities pledged as Collateral hereunder is less than the Minimum Aggregate
Collateral Value as determined at any time by the Lender, Lender shall advise
Grantor. Within five (5) days of such advice, Grantor shall pledge additional
stocks, bonds or other securities which shall be subject to the terms and
conditions of this Agreement or pay down the outstanding amounts due under the
Note such that the aggregate Collateral Value shall be equal to or greater than
the Minimum Aggregate Collateral Value. A failure by Grantor to satisfy the
conditions of this paragraph shall constitute an Event of Default under this
Agreement.

THE TERMS AND CONDITIONS OF THIS RIDER SHALL PREVAIL WHERE THERE MAY BE
CONFLICTS OR INCONSISTENCIES WITH THE TERMS AND CONDITIONS OF THE COMMERCIAL
PLEDGE AGREEMENT.

IN WITNESS WHEREOF, Lender and Grantor, by their duly authorized
representatives, have executed and delivered this Rider which is intended to
take effect as a seated instrument as of the date of the Commercial Pledge
Agreement.

GRANTOR:

VISION - SCIENCES, INC.

BY:
   --------------------------------------------------
     GERALD B. LICHTENBERGER, EXECUTIVE VP AND COO

ACCEPTED AT BOSTON, MASSACHUSETTS

THE FIRST NATIONAL BANK OF BOSTON

BY:
   -----------------------------------------------

TITLE:
      --------------------------------------------

EX-10.23

                                                                   EXHIBIT 10.23

                   [FLEET SMALL BUSINESS SERVICES LETTERHEAD]

                                     January 7, 2002

Mr. Jim Tracey
VISION-SCIENCES INC
6 STRATHMORE RD
NATICK, MA 017600000

Re: Line of Credit          Obligor #31036825          Obligation #18

Dear Mr. Tracey:

I am pleased to inform you that your Line of Credit indicated above, in the
principal amount of $250,000 has undergone a successful credit review. Your fine
credit standing and payment history with Fleet Bank enables us to offer the
benefits available to our best customers.

Based on your successful credit review, your Line of Credit will continue in
effect, subject to your continued good credit standing, until an event of
default occurs, as stated in your Line of Credit document, or we demand payment.
You need not submit annual financial statements unless we specifically request
them.

As a reminder, as stated in your Line of Credit documents, the terms of your
Line of Credit are as follows:

       Amount:                  $250,000
       Interest Rate:           Prime Plus 0%
       Annual Fee:              $100.00
       Collateral:              $250M Galaxy Inst Treasury Money Market Fund
       Term:                    On Demand
       Other Conditions:        N/A
       Guarantor(s):

The payments of interest will continue to be required monthly, with the entire
outstanding principal balance due on demand.

We will auto-deduct or bill you directly for the annual fee, effective with your
March, 2002 billing. This is just another step in Fleet Bank's continuing
efforts to make your banking easier and more convenient. If you have any
questions about your Line of Credit, please call me at (508) 770-7036. In
addition, please feel free to visit Fleet's web site at smallbiz.fleet.com.

Thank you for banking with Fleet.

Sincerely,

/s/ David Gerbereux

David Gerbereux
Vice President

cc:    Mary DeLesLin

EX-10.24

                                                                   EXHIBIT 10.24

                                 LOAN AGREEMENT

                                                    April 30, 2002

     VISION SCIENCES, INC., a Massachusetts corporation with offices at 9
Strathmore Road, Natick, Massachusetts 01760 (the "Borrower") has applied to
CITIZENS BANK OF MASSACHUSETTS, a banking corporation organized under the laws
of the Commonwealth of Massachusetts, with a banking office at 53 State Street,
Boston, Massachusetts, for certain loans and other financial accommodations to
be secured by security interests in certain property now or hereafter owned by
the Borrower, or in which the Borrower now or hereafter has an interest. The
Bank has agreed to grant to the Borrower the financial accommodations described
in this Loan Agreement (this "Loan Agreement") on the terms and conditions more
fully set forth below.

                     ARTICLE I- AMOUNT AND TERMS OF THE LOAN

     SECTION 1.01. THE LOANS. The Borrower has requested that the Bank make
available to it a revolving line of credit (the "Line of Credit") for general
working capital purposes of the Borrower and a term loan for the acquisition of
equipment (the "Term Loan"). Loans and other advances of credit under the Line
of Credit are hereinafter referred to as the "Revolving Loans" and the Term Loan
and the Revolving Loan(s) are collectively referred to herein as the "Loans".
The Bank has agreed to provide the Borrower with the Loans on the terms and
conditions set forth herein, provided that the Bank shall not be obligated to
make any Loans at any time that there is a continuing Event of Default.

     (a) THE LINE OF CREDIT. Subject to all of the terms and conditions set
forth in this Loan Agreement, the Bank hereby establishes the Line of Credit in
the Borrower's favor pursuant to which Bank shall, at Borrower's request from
time to time made after the date hereof until April 29, 2003 (the "Expiration
Date"), make Revolving Loans (including Letters of Credit and Banker's
Acceptances) to Borrower in an aggregate amount up to the lesser of (x)
$1,000,000.00 (the "Credit Limit"), or (y) the Borrowing Base. Up to $250,000 of
the Line of Credit shall be available to the Borrower for issuance of letters of
credit ("Letter(s) of Credit") and/or banker's acceptances ("Banker's
Acceptances"). All Revolving Loans are due and payable on the Expiration Date
and no Letter of Credit or other extension of credit may have an expiry after
the Expiration Date unless secured by cash or cash equivalents at 100.0% of the
face amount of such Letter of Credit. Payments (and prepayments) of principal in
full or in part may be made at any time and from time to time without premium or
penalty, and shall be made on the Loans from time to time in accordance with the
provisions of this Loan Agreement. All Revolving Loans shall be Prime Rate Loans
and shall bear interest, calculated on the basis of actual days elapsed and a
360-day year and payable monthly in arrears on the first Business Day of each
month at a fluctuating per annum rate of interest equal to the Prime Rate. The
effective interest rate applicable to Borrower's Loans shall change on the date
of each change in the Prime Rate.



     (b) THE TERM LOAN. In addition to the Revolving Loans, the Bank has agreed,
on the terms and conditions set forth herein to make a Term Loan to the Borrower
in the maximum amount of up to $250,000.00 to finance the acquisition of
machinery and Equipment by the Borrower. Advances under the Term Loan may be
requested by the Borrower from the date hereof until September 30, 2002 (the
"Conversion Date"), each advance to be in the minimum amount of $50,000.00 and
in an amount no greater than 75.0% of the actual purchase price of machinery and
Equipment purchased by Borrower. THE OUTSTANDING PRINCIPAL BALANCE OF THE TERM
LOAN SHALL bear interest in arrears at a fluctuating per annum rate equal to the
sum of one half percent (.50%) plus the Prime Rate and payable on a monthly
basis on the last Business Day of each month commencing April 30, 2002 until
paid in full. Payments of principal, each in the amount of 1/12th of the
outstanding principal balance of the Term Note on the Conversion Date shall be
paid quarterly commencing December 31, 2002 and on the last Business Day of each
quarter thereafter through and including September 30, 2005 ( the "Maturity
Date") at which time all amounts outstanding shall be due and payable, all as
provided in the Loan Agreement. the Term Loan shall bear interest, calculated on
the basis of actual days elapsed and a 360-day year. The effective interest rate
applicable to Borrower's Loans shall change on the date of each change in the
Prime Rate.

     (c) OTHER FEES AND CHARGES. Any Letter of Credit issued under the Line of
Credit shall be subject to a letter of credit fee in the amount of 1/4% of the
face amount of the Letter of Credit (minimum of $95.00) in addition to the
Bank's customary set-up and processing fees. Any Banker's Acceptance issued
under the Line of Credit shall be subject to a banker's acceptance fee at the
rate of 1.50% per annum above the Banker's Acceptance rate of the Bank (minimum
of $145.00) in addition to the Bank's customary set-up and processing fees.

     SECTION 1.02. CHARGE TO ACCOUNTS. The Borrower hereby irrevocably
authorizes the Bank, if and to the extent payment of any installment of
principal and/or interest on the Notes or any fees or other amounts from time to
time due hereunder is not promptly made, to charge against the Borrower's
account(s) with the Bank an amount equal to the accrued principal, interest,
fees and such other amounts from time to time due and payable to the Bank under
the Note or hereunder.

     SECTION 1.03. COMMITMENT FEE. In addition to all other amounts due
hereunder, the Borrower shall pay to the Bank a Commitment Fee equal to one
quarter percent per annum (.25%) of the unused Line of Credit. For purposes of
calculation of such fee, the "unused Line of Credit" shall mean the difference
between the Credit Limit and the actual daily average of Revolving Loans and
other advances of credit outstanding. The Commitment Fee shall be payable in
arrears on the first Business Day of each quarter for the immediately preceding
quarter.

                        ARTICLE II-CONDITIONS OF LENDING

     The Bank's commitment to make the Loan is subject to the performance by the
Borrower of all of Borrower's obligations under this Agreement and under the
Security Documents, and the

                                        2


satisfaction of the condition precedent that the Bank shall have received on or
by the date of this Loan Agreement all documents required by the Bank in the
Bank's sole discretion in form and substance satisfactory to the Bank. The
Bank's agreement to modify the Borrowing Base after the occurrence of a Trigger
Event is subject to the execution by the Borrower and Bank of documents,
instruments and agreements to amend and restate the Loan documents, including
without limitation the granting of guaranties and security agreements by
Borrower and its affiliates, Machida Incorporated, and Opie Labs, Inc.

                        ARTICLE III-SECURITY FOR THE NOTE

     In addition to the Bank's rights of set-off, the security, if any, for the
Borrower's obligations under this Agreement and the Note is a pledge of a
certificate of deposit as provided in the Pledge Agreement of even date
herewith. After occurrence of a Trigger Event, the security for the Borrower's
obligations shall be a first priority perfected security interests in the
business assets of Borrower and its affiliates Machida Incorporated, and Opie
Labs, Inc.

                    ARTICLE IV-REPRESENTATIONS AND WARRANTIES

SECTION 4.01. REPRESENTATIONS AND WARRANTIES OF THE BORROWER. (a) The Borrower
represents and warrants to the Bank as follows:

     (i) The Borrower is a corporation duly incorporated, validly existing and
in good standing under the laws of its state of incorporation, is duly qualified
to do business in every other jurisdiction where the nature of its activities
requires such qualification except where the failure to so qualify would have a
material adverse effect upon the Borrower, has all requisite power and
authority, corporate or otherwise, to conduct its businesses, to own its
properties, to execute, deliver, and perform all of its obligations under this
Agreement, the Security Documents and the Notes.

     (ii) The execution, delivery and performance by the Borrower of this
Agreement, the Security Documents and the Notes have been duly authorized by all
necessary corporate action and do not and will not require any consent or
approval of the stockholders of the Borrower which has not been obtained or
violate any provision of the charter documents of the Borrower.

     (b) The Borrower additionally represents and warrants to the Bank as
follows:

     (i) The execution, delivery and performance by the Borrower of this
Agreement, the Security Documents and the Notes do not and will not (x) violate
any provision of any law, rule, regulation (including, without limitation,
Regulation U of the Board of Governors of the Federal Reserve System), order,
writ, judgment, injunction, decree, determination or award presently in effect
having applicability to the Borrower, (y) except for license agreements which by
their

                                        3


terms restrict the pledge of or an encumbrance or assignment of the license,
result in a breach of or constitute a default under any indenture or loan or
credit agreement or any other agreement, lease or instrument to which the
Borrower is a party or by which the Borrower or the Borrower's properties may be
bound or affected, or (z) except as may be provided by this Agreement, the
Security Documents and/or the Notes, result in the creation or imposition of any
lien, charge or encumbrance of any nature whatsoever on any Assets or properties
of the Borrower.

     (ii) The Borrower is not in material default under any law, rule,
regulation, order, writ, judgment, injunction, decree, determination or award or
any indenture, agreement, lease or instrument by which it is bound, which
default would result in a material adverse consequence to the Borrower.

     (iii) No authorization, consent, approval, license, exemption of or filing
or registration with any court or governmental department, commission, board,
bureau, agency or instrumentality, domestic or foreign, is or will be necessary
to the valid execution, delivery or performance by the Borrower of this
Agreement, the Security Documents or the Notes except for the perfection of
liens granted under certain of the Security Documents.

     (iv) The most recent balance sheet of the Borrower, the related statement
of income and retained earnings of the Borrower and all other financial
information of the Borrower furnished to the Bank, fairly present the financial
condition of the Borrower as of the date thereof and the results of the
operations of the Borrower for the periods ending on such date, subject in each
instance to any applicable year end adjustments, all in accordance with GAAP
applied on a consistent basis, and since such date, there has been no material
adverse change in such condition or operations and there has been no declaration
or payment of dividends or distributions to any stockholders or members of the
Borrower except as expressly permitted by this Agreement.

     (v) Except as disclosed to the Bank in writing, there are no actions, suits
or proceedings pending or, to the knowledge of the Borrower, threatened against
or affecting the Borrower or any properties or assets of the Borrower before any
court or governmental department, commission, board, bureau, agency or
instrumentality, domestic or foreign, which, if determined adversely to the
Borrower would have a material adverse effect on the financial condition,
Assets, or operations of the Borrower.

     (vi) The Borrower is not engaged in the business of extending credit for
the purpose of purchasing or carrying margin stock (within the meaning of
Regulation U of the Board of Governors of the Federal Reserve System), and no
part of the proceeds of the Loan will be used to purchase or carry any margin
stock or to extend credit to others for the purpose of purchasing or carrying
any margin stock.

     (vii) The Borrower is not a party to any indenture, loan or credit
agreement or any lease or

                                        4


other agreement or instrument or subject to any restriction of any kind which
would have a material adverse effect on the business, properties, assets,
operations or condition, financial or otherwise, of the Borrower or on the
ability of the Borrower to carry out its obligations under this Agreement, the
Security Documents or the Notes, except for license agreements which by their
terms restrict the pledge of or an encumbrance or assignment of the license.

                       ARTICLE V-COVENANTS OF THE BORROWER

     SECTION 5.01. AFFIRMATIVE COVENANTS OF THE BORROWER OTHER THAN REPORTING
REQUIREMENTS. From the date hereof and thereafter for so long as the Borrower is
indebted to the Bank, whether under the Notes or otherwise, the Borrower will,
unless the Bank shall otherwise consent in writing:

     (a) PAYMENT OF TAXES, ETC. Pay and discharge all taxes, assessments and
governmental charges or levies imposed upon the Borrower or upon the Borrower's
income or profits, or upon any Assets or properties belonging to the Borrower,
prior to the date on which penalties attach thereto, and all lawful claims
which, if unpaid, might become a lien or charge upon any of the Borrower's
properties or Assets provided that the Borrower shall not be required to pay any
such tax, assessment, charge, levy or claim which is being contested in good
faith and by proper proceedings and as to which Borrower shall have set aside
adequate reserves in accordance with GAAP.

     (b) MAINTENANCE OF INSURANCE. Maintain insurance with responsible and
reputable insurance companies acceptable to the Bank in such amounts and
covering such risks as is usually carried by companies engaged in similar
businesses and owning similar properties in the same general area in which the
Borrower operates. The Borrower shall provide the Bank with such evidence as the
Bank may reasonably request from time to time as to the maintenance of all such
insurance.

     (c) EXISTENCE AND ASSETS. Do or cause to be done all things necessary to
preserve, renew and keep in full force and effect its corporate or limited
liability existence, if applicable, and any of the Borrower's rights, licenses,
patents, copyrights, trademarks, trade names, permits and franchises and comply
with all applicable laws and regulations, except where failure to do so would
not likely result in a material adverse consequence to the Borrower; at all
times maintain, preserve and protect any of the Borrower's franchises and trade
names and preserve all the remainder of the Borrower's Assets and property used
or useful in the conduct of the Borrower's business and keep the same in good
repair, working order and condition, and from time to time, make, or cause to be
made, all needful and proper repairs, renewals, replacements, betterments and
improvements thereto, so that the business carried on in connection therewith
may be properly and advantageously conducted at all times.

     (d) COMPLIANCE WITH LAWS, ETC. Comply with the requirements of all present
and future

                                        5


applicable laws, rules, regulations and orders of any governmental authority,
non-compliance with which would materially and adversely affect the Borrower's
business, Assets or credit.

     (e) KEEPING OF RECORDS AND BOOKS OF ACCOUNT. Keep adequate records and
books of account, in which complete entries will be made in accordance with GAAP
consistently applied, reflecting all financial transactions of the Borrower.

     (f) PRINCIPAL DEPOSITORY. Use the Bank as the principal depository of
Borrower's funds, all such deposits to be subject to the Bank's normal and usual
service charges.

     (g) FINANCIAL REPORTING. Provide the Bank with copies of the Borrower's
10-Q reports within 45 days of each fiscal quarter end of the Borrower and to
provide the Bank with a copy of its 10-K report within 90 days of Borrower's
fiscal year end, together with a compliance certificate at each quarter end
certifying Borrower's compliance with the financial covenants and other
provisions of this Loan Agreement and ancillary documents.

     SECTION 5.02. NEGATIVE COVENANTS OF THE BORROWER. From the date hereof and
thereafter for so long as the Borrower is indebted to the Bank, the Borrower
will not, without the prior written consent of the Bank, which will not
unreasonably be withheld in the absence of a material adverse effect upon the
Collateral or the ability of the Borrower to pay and perform the Obligations:

     (a) LIENS, ETC. Create, incur, assume or suffer to exist any mortgage, deed
of trust, pledge, lien, security interest, or other charge or encumbrance
(including the lien or retained security title of a conditional vendor) of any
nature, upon or with respect to any of the Collateral;

     (b) MERGERS, ETC. Dissolve, liquidate, merge, consolidate with or otherwise
acquire all or substantially all of the assets of any other Person or any of the
capital stock of or ownership interest in any other Person, or sell, assign,
lease or otherwise dispose of all or substantially all of the Borrower's Assets
to any Person.

                          ARTICLE VI-EVENTS OF DEFAULT

     The Borrower shall be in default under this Agreement upon the occurrence
of any of the following events ("Events of Default"):

     (a) The non-payment when due of any of the Obligations which continues for
two (2) days, or the failure of the Borrower to perform any other Obligation
hereunder (other than b, c or d below), under the Notes or any of the Security
Documents which continues for fifteen days (15) from dispatch of written notice
thereof to the Borrower by the Bank; or

     (b) Any representation or warranty made by the Borrower in this Agreement,
by the Borrower

                                        6


in any of the Security Documents or in any written certificate, agreement,
instrument or statement contemplated by or made or delivered pursuant to or in
connection with this Agreement, the Notes or any of the Security Documents,
shall prove to have been incorrect in any material respect when made; or

     (c) Borrower's liquidation, termination, dissolution or ceasing to carry on
actively any substantial part of its current business;

     (d) commencement by Borrower of a voluntary proceeding seeking relief with
respect to itself or its debts under any bankruptcy, insolvency or other similar
law, or seeking appointment of a trustee, receiver, liquidator or other similar
official for it or any substantial part of its assets; or its consent to any of
the foregoing in an involuntary proceeding against it; or if Borrower shall
generally not be paying its debts as they become due or admit in writing its
inability to do so; or an assignment for the benefit of, or the offering to or
entering into by Borrower of any composition, extension, reorganization or other
agreement or arrangement with, its creditors generally; or commencement of an
involuntary proceeding against Borrower seeking relief with respect to it or its
debts under any bankruptcy, insolvency or other similar law, or seeking
appointment of a trustee, receiver, liquidator or other similar official for it
or any substantial part of its assets, which proceeding remains undismissed and
unstayed for forty-five (45) days; or entry of an order for relief against
Borrower in any such proceeding.

                          ARTICLE VII-REMEDIES OF BANK

     Upon the occurrence and during the continuance of any one or more Events of
Default and at any time thereafter:

     (a) The Bank or any other holder of the Notes or any other Indebtedness of
the Borrower to the Bank may, by notice to the Borrower, declare the entire
unpaid principal amount of the Notes and/or any other Indebtedness of the
Borrower to the Bank or such holder and all commitment fees, interest and other
sums accrued and unpaid thereon to be forthwith due and payable, whereupon the
Notes and/or any such Indebtedness and all such accrued commitment fees and
interest shall become and be forthwith due and payable, without presentment,
demand, protest or further notice of any kind, all of which are hereby expressly
waived by the Borrower.

     (b) The Bank may exercise any and all of the rights, powers, privileges and
remedies as a secured party under this Agreement, the Notes and any of the
Security Documents or otherwise available at law or in equity.

                  ARTICLE VIII-DEFINITIONS AND ACCOUNTING TERMS

     SECTION 8.01. CERTAIN DEFINED TERMS. As used in this Agreement, the
following terms shall

                                        7


have the following meanings (such meanings to be equally applicable to both the
singular and plural forms of the terms defined):

     "Account(s) Receivable" means all Borrower's (and to the extent Machida,
Incorporated has become a party to financing arrangements between the Borrower
and the Bank, Machida's) accounts, accounts receivable, rental and lease
payments receivable, contract rights, promissory notes, bills, drafts,
acceptances, instruments, documents, chattel paper and all other debts,
obligations and liabilities in whatever form owing to Borrower from any Person
(as defined below) for goods sold by it or for services rendered by it, or
however otherwise established or created, all guaranties and security therefor,
all right, title and interest of Borrower in the goods or services which gave
rise thereto, including rights to reclamation and stoppage in transit and all
rights of an unpaid seller of goods or services; whether any of the foregoing be
now existing or hereafter arising, now or hereafter received by or owing or
belonging to Borrower (and to the extent Machida, Incorporated has become a
party to financing arrangements between the Borrower and the Bank, to Machida.).

     "Affiliate" means any shareholder of or beneficial owner of any interest in
the Borrower and any entity or corporation controlling or controlled by the
Borrower or any shareholder of or owner of an interest of five percent (5.0%) or
more in the Borrower.

     "Assets" means any and all of the Borrower's presently owned or hereafter
acquired tangible and intangible property and the proceeds, products,
accessions, replacements and substitutions therefor.

     "Borrowing Base" means the sum of the following: (1) Prior to occurrence of
a Trigger Event and amendment and restatement of the Loan Documents:

     (a) One hundred percent (100.0%) of the amount on deposit in a certificate
of deposit account of the Borrower with the Bank and pledged to the Bank
pursuant to the Pledge Agreement between Borrower and Bank of even date
herewith(the "Pledge Agreement"); and

     (2) After the occurrence of a Trigger Event and amendment and restatement
of the Loan Documents:

     (a) Eighty percent (80.0%) of the unpaid face amount of all Eligible
Accounts (as defined below) of Borrower; PLUS

     (b) the lesser of (i) $250,000, or (ii) Twenty-five percent (25.0%) of the
amount of Eligible Inventory (as defined below) of the Borrower.

     "Capital Expenditures" means expenditures by the Borrower for the purchase
or lease of equipment and other goods which must be accounted for as capital
items, and not as expenses,

                                        8


pursuant to GAAP.

     "Collateral" shall have the meaning ascribed to it in the Pledge Agreement.

     "Eligible Account" means an Account Receivable which initially and at all
times until collected in full:

     (a) is not more than ninety (90) days from the date of invoice;

     (b) arose in the ordinary course of business from the performance of
services or the outright sale, lease or rental of goods in the United States or
Canada; such services have been performed or such goods have been shipped to or
otherwise delivered for the use of the account debtor; and in the case of goods,
Borrower has possession of or has delivered to Bank shipping and delivery
receipts evidencing shipment;

     (c) is not owed by an account debtor who is an employee or parent,
subsidiary or other affiliate of Borrower, unless the Bank has approved such
account debtor in writing, which approval shall not unreasonably be withheld in
the event that all transactions with such account debtor are on arm's length
market terms;

     (d) is not evidenced by a promissory note or other instrument, is subject
to a perfected security interest in favor of Bank and is not subject to any
other Lien (other than a Permitted Lien);

     (e) is a non-contingent obligation that is not subject to a claim or
threatened claim of set-off, credit, defense, warranty claim, allowance or
adjustment by the account debtor except normal discount allowed in the ordinary
course for prompt payment, and such account debtor has not complained as to its
liability thereon nor returned any of the subject goods;

     (f) did not arise out of any sale made on an advanced billing, bill and
hold, dating or delayed shipment basis, and are not billings for customer
deposits;

     (g) is owed by an account debtor as to which Borrower has received no
notice and has no knowledge of bankruptcy, insolvency or other facts which make
collection doubtful, and has not been turned over to a collection agency or
attorney;

     (h) the account debtor is not located in any state denying creditors access
to its courts in the absence of such creditor's qualification to conduct
business as a foreign corporation in such state or complying with other filing
or reporting requirements unless Borrower has filed all legally required filings
and reports, obtained any necessary authorities or certificates to do business,
and paid any applicable taxes and/or fees to the applicable state agency in such
state, or is not required to do so;

                                        9


     (i) if owed by the United States of America, has upon Bank's request
therefor been properly assigned to the Bank pursuant to the Federal Assignment
of Claims Act, and is not subject to any right of offset or other claims;

     (j) has not been designated by Bank in its reasonable discretion and in
good faith based upon Bank's customary and reasonable credit practices as
unacceptable for any reason by written notice to Borrower; and

     (k) is not owed by an account debtor located outside the United States of
America or Canada, unless such account is insured by a credit insurance company
acceptable to the Bank on terms and conditions acceptable to the Bank or unless
such account is fully supported by a letter of credit drawn on a US bank
acceptable to the Bank.

     No Accounts Receivable due from an account debtor shall be deemed Eligible
Accounts if more than twenty-five percent (25.0%) of Accounts Receivable due
from such account debtor are more than ninety (90) days from the invoice date of
such Accounts Receivable, until such time as less than twenty-five percent
(25.0%) of Accounts Receivable due from such account debtor are more than ninety
(90) days from the invoice date. The amount of Accounts Receivable from an
account debtor in excess of twenty-five percent (25.0%) of all outstanding
Accounts Receivable from all account debtors shall not be deemed to be Eligible
Accounts.

     Accounts Receivable payable by Borrower to an account debtor and all
deposits paid by such account debtor shall be netted against Eligible Accounts
due from such account debtor and the difference (if positive) shall constitute
Eligible Accounts from such account debtor for purposes of determining the
Borrowing Base. Characterization of any Account Receivable due from an account
debtor as an Eligible Account shall not be deemed a determination by Bank as to
its actual value nor in any way obligate Bank to accept any Account Receivable
subsequently arising from such account debtor to be, or to continue to deem such
Account Receivable to be, an Eligible Account; it is Borrower's responsibility
to determine the creditworthiness of account debtors and all risks concerning
the same and collection of Accounts Receivable are with Borrower. All Accounts
Receivable which are not Eligible Accounts also constitute Collateral.

     "Eligible Inventory" means Borrower's Inventory of finished goods and raw
materials which initially and at all times until sold:

     (a) is new or reconditioned in accordance with Borrower's historical sales
practices, merchantable and saleable through normal trade channels, and is not
held for rental by the Borrower;

     (b) is at one of the Borrower's business locations which has been
identified in writing to Bank, which for the Borrower is 9 Strathmore Road,
Natick, Massachusetts 01760 and for Machida is 40 Ramland Road South,
Orangeburg, New York 10962;

                                       10


     (c) is subject to a perfected first priority security interest in favor of
Bank and owned by Borrower free and clear of any Lien except in favor of Bank;

     (d) is not obsolete; not scrap, waste, defective goods and the like;

     (e) has been produced by Borrower in accordance with the Federal Fair Labor
Standards Act of 1938, as amended, and all rules, regulations and orders
promulgated thereunder;

     (f) is not stored with a bailee, warehouseman, processor or similar party
unless Bank has given its prior written consent thereto and Borrower has caused
each such bailee, warehouseman, processor or similar party to issue and deliver
to Bank warehouse receipts and lien waivers in Bank's name for such inventory,
and in the case of processors, unless such are goods segregated and labeled as
belonging to Borrower or Borrower has perfected its interest therein by
retaining a security interest therein and filing financing statements against
such processor pursuant to Section 9-315 of the Uniform Commercial Code;

     (g) has not been designated by Bank in its reasonable discretion and in
good faith, based upon Bank's customary credit practices, as unacceptable for
any reason by written notice to Borrower;

     (h) is and has been since the date of this Loan Agreement valued for
financial reporting purposes on a basis consistent with the basis applied for
prior financial periods; and

     (i) not held on consignment by a customer unless Borrower has perfected its
interest therein by filing financing statements against such customer and by
prior notification of other secured parties of such customer as required by the
Uniform Commercial Code.

     Eligible Inventory shall be net of such reserves as may be required by the
Bank from time to time in good faith based upon circumstances then existing.

     "ERISA" means Title IV of the Employee Retirement Income Security Act of
1974, as amended.

     "Equipment" means Borrower's machinery, equipment, furnishings, fixtures
and other goods (as defined in Article 9 of the Uniform Commercial Code) whether
now owned or thereafter acquired by Borrower and wherever located, all
replacements and substitutions therefor or accessions thereto and all proceeds
thereof, and including, also without limitation, all proceeds of fire or other
insurance covering the aforesaid property;

     "GAAP" means generally accepted accounting principles.

                                       11


     "Indebtedness" of a Person means (i) all indebtedness or other obligations
of such Person for borrowed money or for the deferred purchase price of property
or services, (ii) all indebtedness or other obligations of any other Person for
borrowed money or for the deferred purchase price of property or services the
payment or collection of which such Person has guaranteed or in respect of which
such Person is liable, contingently or otherwise, including, without limitation,
liable by way of agreement to purchase, to provide funds for payment, to supply
funds to or otherwise to invest in such other Person, or otherwise to assure a
creditor against loss, (iii) all indebtedness or other obligations of any other
Person for borrowed money or for the deferred purchase price of property or
services secured by any mortgage, deed of trust, pledge, lien, security interest
or other charge or encumbrance upon or in the Assets and/or property owned by
such Business Entity, whether or not such Person has assumed or become liable
for the payment of such indebtedness or obligations, (iv) Capitalized Lease
Obligations of such Person and (v) all other liabilities or obligations of such
Person which would, in accordance with GAAP, be classified as liabilities of
such Person.

     "Inventory" means all inventory of whatever name, nature, kind or
description, all goods held for sale or lease or to be furnished under contracts
of service, finished goods, work in process, raw materials, materials used or
consumed by Borrower, parts, supplies, all wrapping, packaging, advertising,
labeling, and shipping materials, devices, names and marks, all contracts rights
and documents relating to any of the foregoing, whether any of the foregoing be
now existing or hereafter arising, wherever located, now owned or hereafter
acquired by Borrower.

     "Multi-Employer Plan" shall have the same meaning assigned to that term in
ERISA.

     "Person" means an individual, corporation, limited liability company,
partnership, joint venture, trust or unincorporated organization, or a
government or any agency or political subdivision thereof.

     "Prime Rate" means the rate per annum from time to time announced by
Citizens Bank as its Prime Rate, it being understood that such rate is a
reference rate, not necessarily the lowest, established from time to time which
serves as the basis upon which effective interest rates are calculated for loans
making reference thereto.

     "Reportable Event" shall have the meaning assigned to that term in ERISA.

     "Security Documents" means the Borrower's Pledge Agreement, such financing
statements as the Bank may require to perfect the security interests granted
under the Pledge Agreement and all other documents, instruments or agreements
required by the Bank to further perfect or establish the attachment, priority or
ability to enforce such security interests.

     "Trigger Event" means the satisfaction by the Borrower of the following
conditions: (i)

                                       12


Borrower having earned and reported to the Bank two consecutive quarters where
its "cash flow" for each quarter exceeded the sum of its term debt principal
payments, capital lease payments and Capital Expenditures for such quarter by at
least $25,000.00 and (ii) its Current Ratio at the end of each such quarter was
3.25:1.0 or greater (the "Release Conditions"). For purposes of the foregoing,
"cash flow" for any quarter shall mean Borrower's net profit plus depreciation,
amortization and any non-cash stock-based compensation recorded for such
quarter. In no event shall a Trigger Event be deemed to have occurred until the
Borrower has provided written notice to the Bank that it has satisfied the
Release Conditions, together with such financial information as the Bank shall
require to verify such satisfaction and the Bank shall have confirmed in writing
to the Borrower that the Release Conditions have been satisfied. The Bank shall
cancel the Pledge Agreement with respect to the Collateral promptly after its
confirmation of the Borrower's satisfaction of the Release Conditions and
negotiation and consummation of new financing terms acceptable to Bank and
Borrower.

     SECTION 8.02. ACCOUNTING AND UCC TERMS. All capitalized accounting terms
not specifically defined herein shall be defined in accordance with GAAP and all
financial data submitted pursuant to this Agreement shall be prepared in
accordance with such principles. References in this Agreement to the "UCC" are
to the Uniform Commercial Code of the Commonwealth of Massachusetts. Terms
contained within the definition of the term "Assets" which are defined in the
UCC and are not otherwise defined herein have the same meanings as defined in
the UCC.

                            ARTICLE IX-MISCELLANEOUS

     SECTION 9.01. NO WAIVER; CUMULATIVE REMEDIES. No failure or delay on the
part of the Bank, or any other holder of the Notes in exercising any right,
power or remedy under this Agreement, the Notes and/or any of the Security
Documents shall operate as a waiver thereof; nor shall any single or partial
exercise of any such right, power or remedy preclude any other or further
exercise thereof or the exercise of any other right, power or remedy hereunder.
The remedies herein provided are cumulative and not exclusive of any remedies
provided by law.

     SECTION 9.02. AMENDMENTS, ETC. No amendment, modification, termination, or
waiver of any provision of this Agreement or of the Notes or any of the Security
Documents nor consent to any departure by the Borrower therefrom, shall in any
event be effective unless the same shall be in writing and signed by the Bank
and then such waiver or consent shall be effective only in the specific instance
and for the specific purpose for which given.

     SECTION 9.03. ADDRESSES FOR NOTICES, ETC. All notices, demands, requests,
consents or other communications hereunder or in connection herewith ("Notices")
shall be in writing and shall be mailed postage prepaid, delivered or sent by
facsimile to the applicable party at its address first set forth above.

                                       13


     SECTION 9.04. COSTS, EXPENSES AND TAXES. The Borrower agrees to pay on
demand all out-of-pocket costs and expenses of the Bank (and any participant of
all or any portion of the Loan) in connection with the preparation execution and
delivery of this Agreement, the Security Documents, the Notes, and the other
instruments and documents to be delivered hereunder, including the reasonable
fees and out-of-pocket expenses of counsel for the Bank with respect thereto and
all costs and expenses, if any, in connection with the enforcement of this
Agreement, any of the Security Documents, the Notes and the other instruments
and documents to be delivered hereunder. The Bank acknowledges that it has
received a deposit in the amount of $3,000.00 which will be applied by Bank
against such costs and expenses.

     SECTION 9.05. BINDING EFFECT; ASSIGNMENT. This Agreement shall be binding
upon and inure to the benefit of the Borrower and the Bank and their respective
heirs, personal representatives, successors and assigns, except that the
Borrower shall not have the right to assign the Borrower's rights hereunder or
any interest herein without the prior written consent of the Bank. The Bank may
assign, negotiate or pledge all or any portion of its rights under this
Agreement or any of its rights or security with respect to the Notes and the
Security Documents, and, in case of such assignment, negotiation or pledge, the
Borrower shall accord full recognition thereto.

     SECTION 9.06. SET-OFFS, ETC. Regardless of the adequacy of any collateral
or other means of obtaining repayment of the Loan, the Bank is hereby authorized
at any time and from time to time, without notice to the Borrower and to the
fullest extent permitted by law, to set off and apply deposits (general,
special, time or demand, provisional or final) of the Borrower against the
payment of any of the obligations of the Borrower hereunder, whether or not the
Bank shall have made any demand for payment of such obligations.

     SECTION 9.08. GOVERNING LAW. This Agreement, the Notes and the Security
Documents shall be governed by, and construed in accordance with, the laws of
the Commonwealth of Massachusetts.

     SECTION 9.09. INTEGRATION. This Agreement supersedes Borrower's application
for credit, any commitment and proposal letters in respect hereof, and all other
prior dealings between the parties hereto and their respective agents, employees
or officers with respect to the credit facilities extended hereby, and this
Agreement, together with the Notes and the Security Documents, constitutes the
entire agreement of the parties hereto with respect to the subject matter
hereof.

     SECTION 9.10. CURRENT RATIO. The Borrower will not permit the ratio of its
Current Assets to its Current Liabilities to be less than 2.5:1.0 at any time.

     IN WITNESS WHEREOF, the parties hereto have executed this Agreement or
caused this Agreement to be executed by their proper representatives thereunto
duly authorized, under seal, as of the date first above written.

                                       14


WITNESS                                  VISION SCIENCES, INC.

/s/ Amy Pace                             By:   /s/ James A. Tracy
- -------------------------                   ---------------------------------
                                               Vice President Finance, Treasurer

CITIZENS BANK OF MASSACHUSETTS

By:  /s/ Scott Haskell
   ---------------------------
     Vice President

                                       15

EX-10.25

                                                                   EXHIBIT 10.25

                                PLEDGE AGREEMENT

          THIS AGREEMENT ENTERED INTO AT BOSTON, MASSACHUSETTS AS OF APRIL 30,
2002 BETWEEN VISION SCIENCES, INC., WITH AN ADDRESS OF 9 STRATHMORE ROAD,
NATICK, MASSACHUSETTS 01760 (THE "PLEDGOR") AND CITIZENS BANK OF MASSACHUSETTS,
A MASSACHUSETTS BANKING CORPORATION WITH AN ADDRESS OF 53 STATE STREET, BOSTON,
MASSACHUSETTS 02109 (THE "BANK").

          1.    PLEDGE. In consideration of the Bank's extending credit and
other financial accommodations to the Pledgor, the Pledgor hereby grants to the
Bank a security interest in all of the Pledgor's Collateral. The security
interest granted by this Agreement is given to and shall be held by the Bank as
security for the payment and performance of all Obligations. The Bank shall have
the unrestricted right from time to time to apply or to change any application
already made of the proceeds of any of the Collateral to any of the Obligations,
as the Bank in its sole discretion may determine.

          2.    DEFINITIONS. The following definitions shall apply:

                (1)     "Collateral" shall mean all the Pledgor's present and
                future right, title and interest in and to any and all of the
                property listed on SCHEDULE A, attached hereto, whether such
                property is now existing or hereafter created, and all products,
                proceeds, substitutions, additions, interest, dividends, and
                other distributions in respect thereto, and all books, records,
                and paper relating to the foregoing.

                (2)     "Obligation(s)" means all loans, advances, indebtedness,
                notes, liabilities and amounts, liquidated or unliquidated,
                owing by the Pledgor to the Bank at any time, of each and every
                kind, nature and description, whether arising under this
                Agreement or under the Loan Agreement between Pledgor and Bank
                of even date herewith (the "Loan Agreement") and whether secured
                or unsecured, direct or indirect, absolute or contingent, due or
                to become due, now existing or hereafter contracted. Said term
                expressly includes all interest and other charges chargeable to
                the Pledgor or due from the Pledgor to the Bank from time to
                time and all costs and expenses referred to in this Agreement
                and in the Loan Agreement.

                (3)     "Person" or "party" shall include individuals, firms,
                corporations



                and all other entities.

                (4)     "Event of Default" shall mean the occurrence of any one
                or more of the following events:

          (1)   default of any liability, obligation or undertaking of the
          Pledgor to the Bank hereunder; and

          (2)   occurrence of an Event of Default under the Loan Agreement.

     All words and terms used in this Agreement other than those specifically
defined herein or in the Loan and Security Agreement between the Pledgor and the
Bank of even date herewith (the "Loan Agreement"), shall have the meanings
ascribed to them in the Massachusetts Uniform Commercial Code as amended from
time to time (herein the "Code").

          3.    COSTS AND EXPENSES. The Pledgor shall pay to the Bank any and
all costs and expenses (including, without limitation, reasonable attorneys'
fees, court costs, litigation and other expenses) incurred or paid by the Bank
in establishing, maintaining, protecting or enforcing any of the Bank's rights
or the Obligations, including, without limitation, any and all such costs and
expenses incurred or paid by the Bank in defending the Bank's security interest
in, title or right to the Collateral or in collecting or attempting to collect
or enforcing or attempting to enforce payment of the Collateral.

          4.    TITLE. The Pledgor represents that the Collateral is held and
owned by the Pledgor free and clear of all liens, encumbrances, attachments,
security interests, pledges, and charges, and if the Collateral is securities,
is fully paid for and nonassessable.

          5.    AFFIRMATIVE COVENANTS. The Pledgor shall:

                (1)     execute all such instruments, documents, and papers, and
                will do all such acts as the Bank may reasonably request from
                time to time to carry into effect the provisions and intent of
                this Agreement, including, without limitation, the execution of
                stock transfer orders, stock powers, notifications to obligors
                on the Collateral, the providing of notification in connection
                with book entry securities or general intangibles and the
                providing of instructions to the issuers of uncertificated
                securities or financial intermediaries, and will do all such
                other acts as the Bank may request with respect to the
                perfection and protection of the security interest granted
                herein and the assignment effected hereby;

     (2)        keep the Collateral free and clear of all liens, encumbrances,
attachments, security interests, pledges and charges;



                (3)     deliver to the Bank, if and when received by the
                Pledgor, any item representing or constituting any of the
                Collateral, including without limitation, all cash dividends and
                all stock certificates whether now existing or hereafter
                received as a result of any stock dividends, stock splits or
                otherwise;

                (4)     upon the request of the Bank, cause the issuer of any
                uncertificated securities comprising any of the Collateral to
                issue certificates with respect thereto;

                (5)     upon the request of the Bank, cause certificated
                securities comprising any of the Collateral to be issued in the
                name of the Bank, as pledgee;

                (6)     not cause or permit any of the Collateral presently
                evidenced by a written certificate to be converted to
                uncertificated securities;

                (7)     not exercise any right with respect to the Collateral
                which would dilute or adversely affect the Bank's rights in the
                Collateral;

                (8)     not file any affidavit for replacement of lost stock
                certificate or bonds with respect to the Collateral; and

                (9)     not vote the Collateral in favor of or consent to any
                resolution which might: (i) impose any restrictions upon the
                sale, transfer, or disposition of the Collateral; or (ii) result
                in the issuance of any additional shares of stock of any class;
                or (iii) vest additional powers, privileges, preferences, or
                priorities to any other class of stock.

          6.    POWER OF ATTORNEY. The Pledgor hereby irrevocably constitutes
and appoints the Bank as the Pledgor's true and lawful attorney, with full power
of substitution at the sole cost and expense of the Pledgor but for the sole
benefit of the Bank, to endorse in favor of the Bank any of the Collateral;
cause the transfer of any of the Collateral in such name as the Bank may, from
time to time, determine; cause the issuance of certificates for book entry
and/or uncertificated securities; provide notification in connection with book
entry securities or general intangibles and/or provide instructions to the
issuers of uncertificated securities or financial intermediaries, as necessary;
to renew, extend, or roll over any Collateral; and make demand and initiate
actions to enforce any of the Collateral. The Bank may take such action with
respect to the Collateral as the Bank may reasonably determine to be necessary
to protect and preserve its interests in the Collateral. The Bank shall also
have and may exercise at any time all rights, remedies, powers, privileges, and
discretions of the Pledgor with respect to and under the Collateral, provided,
however, the Bank shall have no right until an Event of Default has occurred to
exercise any voting rights available to the Pledgor at any time the Collateral
is held



by the Bank solely as pledgee hereunder. Except as limited above, all the
rights, remedies, powers, privileges and discretions included in this Paragraph
may be exercised by the Bank whether or not any of the Obligations are then due
and whether or not an Event of Default has occurred. The within designation,
being coupled with an interest, is irrevocable until the within Agreement is
terminated by a written instrument executed by a duly authorized officer of the
Bank. The power of attorney shall not be affected by subsequent disability or
incapacity of the Pledgor. The Bank shall not be liable for any act or omission
to act pursuant to this Paragraph except for any act or omission to act which is
in actual bad faith.

          7.    DEFAULT. If an Event of Default shall occur, at the election of
the Bank, all Obligations shall become immediately due and payable without
notice or demand, except with respect to Obligations payable on demand, which
shall be due and payable on demand, whether or not an Event of Default has
occurred.

     The Bank is hereby authorized, at its election, after an Event of Default
or after demand, without any further demand or notice except to such extent as
notice may be required by applicable law, to sell or otherwise dispose of all or
any of the Collateral at public or private sale and/or enforce and collect the
Collateral (including, without limitation, the right to require the issuer of
any deposit account or certificate of deposit to pay the interest and proceeds
thereof and funds represented by such to the Bank); and the Bank may also
exercise any and all other rights and remedies of a secured party under the Code
or which are otherwise accorded to it by applicable law, all as the Bank may
determine. If notice of a sale or other action by the Bank is required by
applicable law, the Pledgor agrees that ten (10) days' written notice to the
Pledgor, or the shortest period of written notice permitted by law, whichever is
larger, shall be sufficient notice; and that to the extent permitted by law, the
Bank, its officers, attorneys and agents may bid and become purchasers at any
such sale, if public, and may purchase at any private sale any of the Collateral
that is of a type customarily sold on a recognized market or which is the
subject of widely distributed standard price quotations. Any sale (public or
private) shall be free from any right of redemption, which the Pledgor hereby
waives and releases. No purchaser at any sale (public or private) shall be
responsible for the application of the purchase money. Any balance of the net
proceeds of sale remaining after paying all Obligations of the Pledgor to the
Bank shall be returned to the Pledgor or to such other party as may be legally
entitled thereto; and if there is a deficiency, the Pledgor shall be responsible
for the same, with interest. The Pledgor acknowledges that any exercise by the
Bank of the Bank's rights upon default may be subject to compliance by the Bank
with any statute, regulation, ordinance, directive, or order of any federal,
state, municipal, or other governmental authority, and may impose, without
limitation, any of the foregoing restricting the sale of securities. The Bank,
in its sole discretion at any such sale, may restrict the prospective bidders or
purchasers as to their number, nature of business and investment intentions, and
may impose, without limitation, a requirement that the persons making such
purchases represent and agree, to the satisfaction of the Bank, that they are
purchasing the Collateral for their own account, for investment, and not with a
view to the distribution or resale thereof. The proceeds of any collection or of
any sale or disposition of the Collateral held pursuant to this Agreement shall
be applied towards the Obligations in such order



and manner as the Bank determines in its sole discretion, any statute, custom,
or usage to the contrary notwithstanding.

          8.    SAFE CUSTODY AND EXCLUSIVITY. The Bank shall have no duty as to
the Collateral or protection of the Collateral or any income or distribution
thereon, beyond the safe custody of such of the Collateral as may come into the
possession of the Bank and shall have no duty as to the preservation of rights
against prior parties or any other rights pertaining thereto. The Bank's Rights
and Remedies (as defined herein) may be exercised without resort or regard to
any other source of satisfaction of the Obligations.

          9.    INDEMNIFICATION. The Pledgor shall indemnify, defend, and hold
the Bank harmless of and from any claim brought or threatened against the Bank
by the Pledgor, any guarantor or endorser of the Obligations, or any other
person (as well from attorneys' reasonable fees and expenses in connection
therewith) on account of the Bank's relationship with the Pledgor, or any
guarantor or endorser of the Obligations, each of which may be defended,
compromised, settled, or pursued by the Bank with counsel of the Bank's
election, but at the expense of the Pledgor. The within indemnification shall
survive payment of the Obligations, and/or any termination, release, or
discharge executed by the Bank in favor of the Pledgor.

          10.   WAIVERS. The Pledgor waives notice of nonpayment, demand,
presentment, protest or notice of protest of the Collateral, and all other
notices, consents to any renewals or extensions of time of payment thereof, and
generally waives any and all suretyship defenses and defenses in the nature
thereof. No delay or omission of the Bank in exercising or enforcing any of its
rights, powers, privileges, remedies, immunities or discretions ("the Bank's
Rights and Remedies") hereunder shall constitute a waiver thereof; and no waiver
by the Bank of any default of the Pledgor hereunder or of any demand hereunder
shall operate as a waiver of any other default hereunder or any other demand
hereunder. No term or provision hereof shall be waived, altered or modified
except with the prior written consent of the Bank, which consent makes explicit
reference to this Agreement. Except as provided in the preceding sentence, no
other agreement or transaction, of whatsoever nature, entered into between the
Bank and the Pledgor at any time (whether before, during or after the effective
date or term of this Agreement) shall be construed in any particular as a
waiver, modification or limitation of any of the Bank's Rights and Remedies
under this Agreement, nor shall anything in this Agreement be construed as a
waiver, modification or limitation of any of the Bank's Rights and Remedies
under any such other agreement or transaction, but all the Bank's Rights and
Remedies not only under the provisions of this Agreement but also under any such
other agreement or transaction shall be cumulative and not alternative or
exclusive, and may be exercised by the Bank at such time or times and in such
order of preference as the Bank in its sole discretion may determine.

          11.   SEVERABILITY. If any provision of this Agreement or portion of
such provision or the application thereof to any person or circumstance shall to
any extent be held invalid or unenforceable, the remainder of this Agreement (or
the remainder of such provision) and the application thereof to other persons or
circumstances shall not be affected thereby.



          12.   BINDING EFFECT OF AGREEMENT. This Agreement shall be binding
upon and inure to the benefit of the respective heirs, executors,
administrators, legal representatives, successors and assigns of the parties
hereto, and shall remain in full force and effect (and the Bank shall be
entitled to rely thereon) until terminated as to future transactions by written
notice from either party to the other party of the termination hereof; provided
that any such termination shall not release or affect any Collateral in which
the Bank already has a security interest or any Obligations incurred or rights
accrued hereunder prior to the effective date of such notice (as hereinafter
defined) of such termination. Notwithstanding any such termination, the Bank
shall have a security interest in all Collateral to secure the payment and
performance of Obligations arising after such termination as a result of
commitments or undertakings made or entered into by the Bank prior to such
termination. The Bank may transfer and assign this Agreement and deliver the
Collateral to the assignee, who shall thereupon have all of the Bank's Rights
and Remedies; and the Bank shall then be relieved and discharged of any any
responsibility or liability with respect to this Agreement and the Collateral.

          13.   NOTICES. Any notices under or pursuant to this Agreement shall
be deemed duly received by the Pledgor and effective if delivered in hand to the
Pledgor, or if mailed by registered or certified mail, return receipt requested,
addressed to the Pledgor at the Pledgor's address as shown in the preamble
hereto. Any notices to the Bank under or pursuant to this Agreement shall be
mailed to the Bank by registered, certified, or express mail, return receipt
requested, addressed to the Bank at the address shown at the beginning of this
Agreement.

          14.   REPRODUCTIONS. This Agreement and all documents which have been
or may be hereinafter furnished by Pledgor to the Bank may be reproduced by the
Bank by any photographic, photostatic, microfilm, xerographic, or similar
process, and any such reproduction shall be admissible in evidence as the
original itself in any judicial or administrative proceeding (whether or not the
original is in existence and whether or not such reproduction was made in the
regular course of business).

          15.   MASSACHUSETTS LAW. This Agreement is intended to take effect as
a sealed instrument and has been executed or completed and is to be performed in
Massachusetts, and it and all transactions thereunder or pursuant thereto shall
be governed as to interpretation, validity, effect, rights, duties and remedies
of the parties thereunder and in all other respects by the domestic laws of
Massachusetts.

          16.   JURISDICTION AND VENUE. Pledgor irrevocably submits to the
non-exclusive jurisdiction of any federal or state court sitting in Boston,
Massachusetts over any suit, action or proceeding arising out of or relating to
this Agreement. Pledgor irrevocably waives, to the fullest extent it may
effectively do so under applicable law, any objection it may have or hereafter
have to the laying of the venue of any such suit, action or proceeding brought
in any such court and any claim that the same has been brought in an
inconvenient forum. Pledgor irrevocably agrees that any and all legal process
which may be served in any such suit, action or proceeding, may be



served by mailing a copy thereof by registered or certified mail, postage
prepaid, return receipt requested, to Pledgor and agrees that such service shall
in every respect be deemed effective service upon Pledgor.

     17.  JURY WAIVER. THE PLEDGOR AND BANK EACH HEREBY KNOWINGLY, VOLUNTARILY
AND INTENTIONALLY, AND AFTER AN OPPORTUNITY TO CONSULT WITH LEGAL COUNSEL, WAIVE
ANY AND ALL RIGHTS TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING IN CONNECTION
WITH THIS AGREEMENT, THE OBLIGATIONS, IN ALL MATTERS CONTEMPLATED HEREBY AND
DOCUMENTS EXECUTED IN CONNECTION HEREWITH. THE PLEDGOR CERTIFIES THAT NEITHER
THE BANK NOR ANY OF ITS REPRESENTATIVES, AGENTS OR COUNSEL HAS REPRESENTED,
EXPRESSLY OR OTHERWISE, THAT THE BANK WOULD NOT IN THE EVENT OF ANY SUCH
PROCEEDING, SEEK TO ENFORCE THIS WAIVER OF RIGHT TO TRIAL BY JURY.

     Witness our hands and seals as of this 30 day of April, 2002.

WITNESS                                           PLEDGOR:
                                                  VISION SCIENCES, INC.

 /s/ Amy Pace                                     By:  /s/ James A. Tracy
- ------------------------------------                 ---------------------------
                                                        VP Finance, Treasurer



                         SCHEDULE A TO PLEDGE AGREEMENT
                          BETWEEN VISION SCIENCES, INC.
                       AND CITIZENS BANK OF MASSACHUSETTS

     All of Pledgor's right, title and interest in and to the certificate of
deposit with the Bank described below and all interest and dividends thereon and
all renewals, substitutions and replacements thereof and all proceeds thereof,
including without limitation any other deposit account or investment account
with Citizens Bank of Massachusetts or any affiliate thereof into which such
proceeds may hereafter be deposited.

Citizens Bank of Massachusetts certificate of deposit no.______________________.

EX-23.1

                              [ARTHUR ANDERSEN LETTERHEAD]


                                                                  EXHIBIT 23.1


CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of
our report, included in this Form 10-K, into Vision-Sciences, Inc.'s
previously filed Registration Statement File Nos. 33-57298, 33-80762,
33-80764, 333-72547 and 333-48654.

/s/ Arthur Andersen LLP

Boston, Massachusetts
May 15, 2002

EX-23.2

                                                                  EXHIBIT 23.2

KPMG LOGO

Somekh Chaikin

Mail address         Office address                 Telephone 972 3 684 8000
PO Box 609           KPMG Millennium Tower          Fax 972 3 684 8444
Tel Aviv 61006       17 Ha'arba's Street
Israel               Tel Aviv 61070
                     Israel




                      CONSENT OF INDEPENDENT ACCOUNTANTS


The Board of Directors
3DV Systems Ltd:

We consent to incorporation by reference in the registration statements (No.
33-57298, 33-80762, 33-80764, 333-72547 and 333-48654) on Form S-8 of
Vision-Sciences, Inc. of our report dated March 5, 2002, relating to the
consolidated balance sheets of 3DV Systems Ltd. as of December 31, 2001, 2000
and 1999, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2001 and for the period from June 16, 1996
(inception) to December 31, 2001, which report appears in the Form 10-K of
Vision-Sciences, Inc. for the year ended December 31, 2001.

/s/ Somekh Chaikin
Somekh Chaikin
Certified Public Accountant (Isr.)


Tel Aviv, Israel
May 15, 2002





















Somekh Chaikin a partnership registered under
the Israeli Partnership Ordinance is a member of
KPMG International a Swiss association

EX-99.1

                                                                    EXHIBIT 99.1

                              VISION-SCIENCES, INC.

                                9 Strathmore Road
                                Natick, MA 01760


                                   May 6, 2002


Securities and Exchange Commission
450 Fifth Street, N.W.
Judiciary Plaza
Washington, D.C.  20549-0408

         Re:  CONFIRMATION OF ARTHUR ANDERSEN REPRESENTATIONS

Ladies and Gentlemen:

     This letter confirms that Vision-Sciences, Inc. has received from Arthur
Andersen LLP, the independent public accountant engaged by the company to
examine the company's financial statements that are included in the Form 10-K to
which this letter is filed as an exhibit, a representation letter addressed to
the company and stating that:

     o   the audit conducted by Andersen was subject to Andersen's quality
         control system for the U.S. accounting and auditing practice to provide
         reasonable assurance that the engagement was conducted in compliance
         with professional standards; and

     o   there was appropriate continuity of Andersen personnel working on the
         audit and the availability of national office consultation.
         Availability of personnel at foreign affiliates of Andersen is not
         relevant to this audit.


                                  Very truly yours,

                                  Vision Sciences, Inc.

                                  /s/ James A. Tracy

                                  James A. Tracy
                                  Vice President of Finance and Administration