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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

For the Fiscal Year Ended March 31, 2004
OR

For the transition period from                               to                              

Commission File No. 0-20970

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

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 ý    No o

        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.     ý    

        Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o    No ý

        Aggregate market value of Common Stock held by non-affiliates of the Registrant as of September 30, 2003 based upon the last sale price of the Common Stock on the Nasdaq SmallCap Market as reported by Nasdaq:    $25,056,757

        Number of shares outstanding of the Registrant's Common Stock as of May 31, 2004:    30,873,213

        Documents incorporated by reference: Portions of the Proxy Statement for the 2004 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", "we", "our", "us"), the availability of supplies, the sufficiency of our capital resources to meet anticipated capital requirements, our intentions to manufacture product in Israel, our sales distribution channels and our 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 our 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 Our Future Operating Results."

        This Business section should be read in conjunction with our Consolidated Financial Statements attached hereto as Appendix A, including the notes thereto.

        We design, develop, manufacture and market products for endoscopy, the science of using an instrument, known as an endoscope, to provide minimally invasive access to areas not readily visible to the human eye. We operate in three reportable segments: medical, industrial and corporate.

        The medical segment designs, manufactures and sells our 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 use of an EndoSheath gives health-care providers economic advantages because it allows them to avoid the burdensome cleaning required of endoscopes, reduces repair costs to endoscopes caused by the harsh chemicals used in the cleaning process and allows health-care providers to avoid investing in multiple endoscopes. Our EndoSheaths that have channels help to improve the practice efficiency of health-care providers by allowing them to perform procedures in their offices that otherwise they would have to perform in hospitals using special endoscopes that have channels. Often, the reimbursement rates are higher for physicians when they perform procedures in their offices. In addition, the EndoSheath is a sterile device that provides patients with a contaminant-free insertion tube for each procedure. There is a risk to patients of cross-contamination from the reuse of conventional flexible endoscopes that health-care providers are unable to effectively sterilize.

        The industrial segment manufactures and repairs flexible endoscopes for the medical segment. These include our conventional nasopharyngolaryngo ("ENT") endoscopes, and our Video Enabled Endoscopes ("VEE") for the ENT market. In addition, the industrial segment manufactures and repairs our trans-nasal diagnostic esophagoscope ("TNE D scope"), sigmoidoscope, bronchoscope and will be manufacturing our cystoscope, our new TNE therapeutic scope and other endoscopes after they complete the product development cycle. In addition, the industrial segment designs, manufactures and markets flexible endoscopes, called borescopes, for industrial markets, primarily aircraft maintenance, jet engine manufacturing and defense.

        The corporate segment consists of certain administrative activities applicable to all segments.

        We were incorporated in Delaware in 1987 under the name Machida Incorporated. Since that time, we have 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). We

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changed our name to Vision-Sciences, Inc. in December 1990. Our principal executive offices are located at 9 Strathmore Road, Natick, Massachusetts 01760. Our 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, generally involving 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. In many instances, the use of endoscopes allow physicians to receive higher reimbursement for performing procedures in their offices, compared to performing them in hospitals, due to the insurance plan not having to reimburse for the hospital cost component.

        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, and perform a variety of procedures. The typical ENT endoscope does not contain channels whereas most conventional flexible endoscopes for gastroenterology ("GI"), pulmonary, urology procedures and special ENT endoscopes do contain a series of channels running the length of the endoscope for delivery of air, water, suction and accessory devices, such as biopsy forceps and cutting instruments.

        Rigid endoscopes generally utilize a stainless steel tube encasing a series of high resolution lenses to transmit the optical image. Most rigid endoscopes do not contain the channels that are characteristic of flexible endoscopes. Rigid endoscopes are currently utilized for diagnostic and surgical procedures such as arthroscopy, laparoscopy, 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. We do 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. Our flexible endoscopes are designed primarily for screening, diagnostic and therapeutic procedures in fields such as otolaryngology (ear-nose-throat medicine, or "ENT"), gastroenterology, urology, pulmonary medicine, primary care and surgery. We estimate, based on various industry sources, that approximately 20 million flexible endoscopic procedures in these fields are performed in the United States annually.

        ENT Endoscopes.    These endoscopes, typically without channels, are used for viewing the ears, nose, throat and larynx for diagnostic purposes, such as testing for throat cancer or sleep apnea. We estimate that based on industry sources, approximately 4 million such procedures are performed in the United States annually, generally by otolaryngologists and allergists in hospitals, clinics and physicians'

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offices. In addition, there are ENT endoscopes with a channel, which are typically used in hospitals to perform procedures such as biopsies, removal of polyps in sinus cavities, tests for swallowing disorders and other procedures. These endoscopes require a significantly larger investment to acquire than flexible endoscopes without a channel.

        Gastrointestinal Endoscopes.    Based on industry sources, we estimate that over 12 million flexible endoscopic procedures involving the screening, diagnosis or treatment of the colon, esophagus, stomach and duodenum are performed in the United States annually. 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 77 million Americans) receive a screening sigmoidoscopy every three to five years, or a colonoscopy every ten years. The most common flexible endoscopes used in GI endoscopy are sigmoidoscopes, colonoscopes, gastroscopes and duodenoscopes.

        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. We estimate that 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.

        Urology Endoscopes.    Cystoscopes allow the urologist to view the inside of the bladder and urethra and are commonly used to diagnose and take biopsies of bladder tumors, identify obstruction of the bladder and to install and remove stents as part of surgical procedures. We estimate that based upon industry sources, over 250,000 flexible cystoscopies are performed annually in the United States, of 79% are done in an outpatient setting. Sterile equipment is highly desired for cystoscopy, but today, most cystoscopes are disinfected, not sterilized.

Problems with Conventional Flexible Endoscopes

        While endoscopy represents a significant advance in the field of clinical medicine, flexible endoscopes without EndoSheaths present a number of health risks and problems to both patients and medical personnel. 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, urine or stool. Therefore, flexible endoscopes without EndoSheaths must be meticulously manually cleaned and disinfected after each procedure. However, the design of 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 flexible endoscopes without EndoSheaths and the difficulty of thoroughly cleaning and disinfecting them after each use create the following problems:

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Patients, and to a lesser degree the physicians using the flexible endoscopes without EndoSheaths and the nurse assistants cleaning them, are exposed to the risk of infection from contaminated endoscopes that results from their repeated use.



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The nurses or other medical personnel who clean endoscopes used without EndoSheaths face health risks from exposure to toxic disinfecting agents used in the cleaning process.



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The proper cleaning of a flexible endoscope used without an EndoSheath is relatively expensive, time-consuming and arduous.

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•

The repeated cleaning of a flexible endoscope used without an EndoSheath 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 used without an EndoSheath 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 flexible endoscopes used without EndoSheaths can be better understood by examining the cleaning procedures they require. The cleaning of these 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:

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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.



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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.



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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.



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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.



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



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

        Proper cleaning of flexible endoscopes used without EndoSheaths, even when done in compliance with the SGNA Guidelines, is difficult to achieve for a number of reasons. Firstly, the design of these 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, we believe 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 federal Food & Drug Administration ("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

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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 used without EndoSheaths 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 currently recommended by the Centers for Disease Control ("CDC") for cleaning flexible endoscopes. However, studies indicate that high-level disinfection is often not attained and that cross-contamination remains a risk to patients and medical personnel.

        Numerous infectious agents, including pseudomonas, 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 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. We estimate, based upon our own experience, that the cleaning and disinfection procedure required following each use of a flexible endoscope without an EndoSheath, if done in compliance with the FDA recommendations, would take approximately 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

        Our business strategy is to design, develop, manufacture and market flexible endoscopes with Slide-On EndoSheath Systems as devices that provide physicians with tools to increase their practice efficiency and also protect patients by providing a sterile insertion tube for each procedure. To implement this strategy, we developed a variety of flexible endoscopes with Slide-On EndoSheath Systems described below. We market our ENT products domestically primarily through an exclusive distribution agreement with Medtronic Xomed, Inc., and our other products through our own network of independent sales representatives. We market all our products internationally through our network of independent international distributors. We manufacture EndoSheaths in our Natick, MA facility, and endoscopes in our Orangeburg, NY facility. In addition, to reduce our manufacturing costs, we have entered into an agreement with a subcontractor in Israel to manufacture certain of our EndoSheaths.

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Products and Product Development Programs

        In the medical segment, our primary products include a family of flexible endoscopes with Slide-On EndoSheath Systems for applications in the ENT, GI, pulmonary and urology markets. In addition, through our industrial segment we currently manufacture and sell borescopes, which are endoscope devices for industrial applications, and related products.

Medical Segment

ENT EndoSheaths and Endoscopes

        We have developed a family of Slide-On ENT EndoSheaths for use with our own conventional ENT-2000 endoscope and our slim ENT-1000 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, Slide-On EndoSheaths are made with materials using our own proprietary process that makes the EndoSheath slippery, allowing the health-care provider to easily slide the EndoSheath onto the insertion tube of an ENT endoscope. The user stretches the Slide-On EndoSheaths slightly until the proximal connector attaches 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, unlike endoscopes designed for use in gastroenterology, pulmonology or urology. Therefore, our standard Slide-On ENT EndoSheaths, designed to be the only component that comes into contact with the patient, do not contain channels. Other of our ENT EndoSheaths and our EndoSheaths for gastroenterology, pulmonology and urology do contain channels. We have also developed our own ENT endoscopes, with state-of-the-art fiberoptic bundles, designed so that any necessary repairs are inexpensive and with other features that we believe make them competitive with ENT endoscopes of other major manufacturers.

        As part of the Slide-On family of ENT EndoSheaths, we manufacture and sell a Slide-On ENT with Channel EndoSheath and a Slide-On ENT Sensory EndoSheath, both for our own flexible ENT-2000 endoscope and for ENT endoscopes manufactured by other companies. These EndoSheaths allow physicians to perform procedures in their offices using their conventional ENT endoscopes that otherwise they would have to perform using special ENT endoscopes that contain a channel. These special ENT endoscopes are expensive, and typically are found at hospitals.

        The Slide-On ENT Channeled EndoSheath contains a 2.1mm channel within the Slide-On EndoSheath that the physician can use to perform biopsies or other therapeutic procedures. The Slide-On ENT Sensory EndoSheath is designed to provide ENT physicians the opportunity to perform Flexible Endoscopic Evaluation of Swallowing with Sensory Testing ("FEESST") using their conventional endoscopes. FEESST, an alternative emerging procedure to modified barium swallow studies, is performed by the ENT physician using the Slide-On ENT Sensory EndoSheath that contains a channel through which air is pulsed to the larynx to elicit an airway protective reflex. The ENT physician, by observing the reaction to the air pulse, is able to diagnose, treat and manage patients with swallowing disorders with an emphasis on decreasing the risk of choking, coughing and aspirating food and liquids that can lead to aspiration pneumonia. Both of these EndoSheaths enhance the practice efficiency of physicians, as they enable the physicians to use their conventional ENT endoscope to perform tests in their offices, compared to traveling to a hospital to perform them with a special ENT endoscope. Often, by performing the tests in their offices, the ENT physician receives a higher reimbursement, compared to the reimbursement received when the test is performed in a hospital.

        Another member of our ENT family is our flexible ENT-2000VE endoscope, our first VEE, for the ENT market. The VEE architecture is a hybrid between video and fiberoptic endoscopes. The insertion tube contains a glass fiber bundle, but the optical eye piece is eliminated, replaced with a CCD camera

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that is integrated in the handle. The CCD camera's output cable connects to a compact camera control unit that sends standard video signals to a flat screen or video monitor. This integrated configuration eliminates the need for the physician to close one eye and view the patient's internal organs with the other via the small eyepiece, or the alternative of attaching a relatively expensive and heavy add-on camera to the eyepiece. The ENT-2000VE utilizes our standard optics, and our EndoSheath for the ENT-2000 endoscope.

        We manufacture and sell a TNE D scope with Slide-On EndoSheath System that is designed to allow ENT and GI physicians to view the esophagus transnasally, i.e. through the nose, compared to viewing it transorally, i.e. through the mouth, as with a conventional gastroscope. Conventional gastroscopes require patients to be consciously sedated to counteract the gag reflex encountered when a gastroscope is inserted transorally. Our TNE D scope with Slide-On EndoSheath System, with its narrow diameter allowing transnasal passage, enables physicians to perform examinations in their office of a patient's throat and esophagus for manifestations of gastroesophageal reflux disease ("GERD"). We estimate that approximately 40 million people in the United States suffer from some form of GERD affecting their vocal chords, esophagus or stomach.

        The TNE D scope can also be used to evaluate patients with dysphagia, a condition broadly defined as a subjective or objective patient complaint of difficulty swallowing, or of coughing or choking while swallowing or eating. A physician performs this test if an oropharyngeal exam did not fully reveal the cause of the patient's swallowing problem. Currently this procedure is performed in a hospital setting with conscious sedation and a special endoscope that contains a biopsy channel that doubles as an air-administration channel. The TNE D scope with Slide-On EndoSheath System is designed to allow these tests to be done by ENT and GI physicians in their offices, thus improving practice efficiency and lowering overall costs to the health care system. Both the diagnostic and therapeutic procedures have reimbursement codes, allowing physicians to receive payment for the service, and allowing us to measure the practice efficiencies presented by our products. We completed the development of the TNE D scope with Slide-On EndoSheath System in our fiscal year ended March 31, 2004 ("FY 04").

Gastrointestinal and Pulmonary EndoSheath/Endoscope Systems

        We have developed a family of proprietary flexible endoscope systems for GI and pulmonary applications consisting of two main components—a proprietary, sterile, disposable EndoSheath and a reusable, flexible endoscope incorporating our proprietary design. The EndoSheaths and endoscopes included in these systems are functional only when used together.

Industrial Segment

        Under the Machida name, we design, manufacture and market 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, we were 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. We also offer a variety of ancillary products for use with flexible endoscopes and borescopes, such as light sources, cameras, adapters, accessories and imaging systems.

Sales and Marketing

Medical Segment

        The end users of our disposable EndoSheaths, flexible endoscopes and related products are otolaryngologists (ENT doctors), gastroenterologists, urologists, colon and rectal surgeons,

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pulmonologists and primary care physicians in hospitals, medical clinics and physicians' offices. As of May 1, 2004, we had four sales and marketing employees. Since September 19, 2003 we have been distributing all of our products for the ENT markets in the U.S.A. and Canada through Medtronic Xomed, Inc. ("Medtronic Xomed") as part of our exclusive distribution agreement (the "Medtronic Agreement") with them. We have retained our domestic network of independent sales representatives for the GI, urology and pulmonary product lines. We distribute all our products internationally through 23 independent international distributors in Europe, Australia, South America, the Middle East and the Far East. We periodically evaluate the effectiveness of our sales channels, and may change them if we believe a different method will increase our revenues.

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

Industrial Segment

        Our borescopes are sold both directly by our Machida subsidiary and through independent sales representatives.

International Sales and Sales to Major Customers

        Sales to unaffiliated customers outside of the United States were approximately $1,830,000, $2,090,000 and $2,981,000 for FY 02, FY 03 and FY 04, respectively. In FY 04, sales to foreign customers accounted for approximately 34% of the annual net sales of our medical segment and 21% of net annual sales of our industrial segment. We expect to sell our medical segment products outside of the United States in the fiscal year ending FY 05 in approximately the same proportion as in FY 04. We currently sell certain models of our borescopes and repair services outside of the United States.

        During FY 02, Pratt Whitney accounted for 13% of net sales. During FY 03, no customer accounted for over 10% of net sales. During FY 04, Medtronic Xomed and Gyrus International Ltd. accounted for 30% and 10% of net sales, respectively.

Backlog

        We had an order backlog of approximately $1,797,000 at March 31, 2004, compared to a backlog of approximately $544,000 at March 31, 2003. The backlog in 2004 was comprised of approximately $1,585,000 and $212,000 for the medical and industrial segments, respectively. The backlog in 2003 was comprised of approximately $419,000 and $125,000 for the medical and industrial segments, respectively. The increase in the medical segment backlog is primarily due to an increase in ENT endoscopes and ENT EndoSheaths for delivery to Medtronic Xomed through the first year of the Medtronic Agreement. The increase in the backlog of the industrial segment was due primarily to an increase in the amount of orders from that segment's existing customer base. We expect to fill over 75% of our order backlog in the fiscal year ending March 31, 2005 ("FY 05").

Manufacturing and Suppliers

        We produce EndoSheaths at our Natick, Massachusetts facility using raw materials, molded parts and components purchased from independent vendors, some of which are manufactured to our specifications. We manufacture our ENT EndoSheaths using proprietary processes that utilize the forming and bonding machines that were manufactured to our specifications. In addition, we use molded purchased parts and a worldwide, royalty-free exclusive license, negotiated with a third party, to manufacture optically clear windows. This license is for windows used in our EndoSheaths for ENT and intubation endoscopes. We have also negotiated a non-exclusive license to include the same technology

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in our EndoSheaths for use in other markets. Currently, we are using this technology in the ENT EndoSheaths, ENT Channeled EndoSheaths, ENT Sensory EndoSheaths, TNE D EndoSheaths and in EndoSheaths for our bronchoscopes.

        We assemble the GI and pulmonary EndoSheaths using molded and extruded components purchased from independent vendors, some of which are manufactured to our specifications. Most purchased components are available from multiple sources. With the exception of our supply agreement with Pentax Corporation ("Pentax"), discussed below, we have no long-term agreements with any of our vendors or suppliers, and we purchase our required components and supplies on a purchase-order basis. We contract with third parties for the sterilization of all of our EndoSheaths.

        In June 2003, we entered into a Contract Manufacturing Agreement, a Loan Agreement and a Pledge Agreement (collectively, the "3BY Agreements") with Three BY Ltd., an Israeli company ("3BY"). The purpose of the 3BY Agreements was to lower the manufacturing cost of our EndoSheath products, and to provide for increased manufacturing capacity of our ENT EndoSheaths. The 3BY Agreements provide for, among other things, the manufacture of certain of our products by 3BY, and a loan of up to $267,500 from us to 3BY for the purchase and installation of certain manufacturing equipment by 3BY, at 3BY's facility, to be used to manufacture certain of our products. As of December 31, 2003, we had advanced $267,500 to 3BY. After production has begun, we and 3BY plan to establish a repayment schedule, according to the 3BY Agreements. We expect 3BY will begin to deliver GI, pulmonary and ENT EndoSheaths by the end of our second fiscal quarter of FY 05.

        We assemble our flexible endoscopes for the medical and industrial segments at our Orangeburg, New York facility using purchased components and subassemblies, as well as certain proprietary components produced by us. 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 segment and operator control bodies for sigmoidoscopes, are currently being purchased solely from Pentax, who competes with our medical segment in the endoscope market. These components are being purchased pursuant to a supply agreement, which expires in March 2005, subject to earlier termination by mutual consent or upon breach or bankruptcy, and which may be extended with the consent of both parties. We believe 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 our endoscope and additional regulatory clearances. Moreover, such substitute components may not be immediately available in quantities needed by us. Our inability to obtain a sufficient quantity of such critical components on favorable terms could materially adversely affect our business. To date, we have encountered no significant difficulties or delays in obtaining a sufficient quantity of such critical components or subassemblies for our ENT endoscopes, our TNE D scopes, our sigmoidoscope or our bronchoscope. However, there can be no assurance that no difficulties or delays will be experienced in the future as we increase our manufacturing operations. The industrial segment purchased approximately $1,477,000 and $833,000 worth of products, for the manufacture of both medical and industrial products, from Pentax in FY 04 and FY 03, respectively.

        Our 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 us to obtain a sufficient quantity of such components on favorable terms could materially adversely affect our business.

        We purchase light sources, cameras, adapters, accessories and imaging systems for industrial applications from a variety of vendors.

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Competition

        We believe 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 our industrial markets, we believe that product effectiveness, ease of product use, product reliability and price are the principal competitive factors. Our ability to compete in our markets is affected by our product development and innovation capabilities, our ability to obtain required regulatory clearances, our ability to protect the proprietary technology included in its products, our manufacturing and marketing skills and our ability to attract and retain skilled employees.

        The flexible endoscopes and related products currently sold and under development by us face competition primarily from medical products companies such as Olympus and Pentax. In addition, any company that is able to significantly redesign flexible endoscopes used without an EndoSheath to simplify the disinfection process, or significantly improve the current methods of disinfecting flexible endoscopes, would provide competition for our products. The principal competitors for our industrial products are Olympus and Welch Allyn, Inc.

        Our competitors and some potential competitors have greater financial resources, research and development personnel and manufacturing and marketing capabilities than we do. In addition, it is possible that other large health care companies may enter the flexible endoscope market in the future.

Patents and Proprietary Rights

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

        We, along with our subsidiaries, currently hold 28 U.S. patents and have 7 U.S. patent applications pending. In addition, we have 17 foreign patents and have 21 foreign patent applications pending. All of these patents relate to our disposable EndoSheaths and reusable flexible endoscopes. The issued patents will expire on various dates in the years 2004 through 2019. In addition to those listed above, we have 1 U.S. patent issued and 6 U.S. patents pending in the U.S. and 12 corresponding foreign applications for Complementary Metal Oxide Semiconductor ("CMOS") image sensor design patents. There can be no assurance that our pending patent applications will result in patents being issued or that our competitors will not circumvent, or challenge the validity of, any patents issued to us. In addition, in the event that another party infringes our patent rights, the enforcement of such rights is at our option 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, our products is not covered by any patent or patent application. We seek to maintain the confidentiality of our proprietary technology by requiring all employees who work with proprietary information to sign confidentiality agreements and by limiting access by outside parties 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 our patent rights, the enforcement of our trade secret rights can be lengthy and costly, with no guarantee of success.

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

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Government Regulation

        The medical products that we currently market and that are under development 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 our 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 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 market introduction of our products and could have a material adverse effect on us.

        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. We have received FDA clearance of our 510(k) Pre-market Notifications for all of our products that require clearance. We expect that we will be required to obtain 510(k) clearance for each additional disposable EndoSheath/reusable flexible endoscope system that we develop in the future.

        Effective July 1998, our Natick, Massachusetts facility was certified as having established, and we continue to maintain, 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, 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 July 2001, our Natick facility was re-certified, through July 2004, as maintaining a quality system that meets the requirements of ISO 9001, EN 46001 and ISO 13485. In addition to the three-year certification audits, we undergo

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annual surveillance audits to confirm that we are maintaining our quality system. The most recent surveillance audit was completed in August 2003. 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. We are 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. Our compliance with these various regulatory requirements will be monitored through periodic inspections by the FDA and audits by independent authorities to maintain our ISO 9001 and ISO 13485 status. 3BY is certified as meeting the standards of ISO 9001 and EN 46001.

        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 us 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 our operations.

Third-Party Reimbursement

        Hospitals, medical clinics and physicians' offices that purchase medical devices such as our 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. We believe, based upon our knowledge of third-party reimbursement practices, advice from consultants in this area and our own selling experience, that third-party reimbursement is available for most procedures that utilize our products. However, not all third-party payors will reimburse health-care providers separately for the cost of our EndoSheath.

        Third-party payors use a variety of mechanisms to determine reimbursement amounts for procedures such as endoscopies. In most cases, payment is based upon amounts determined by the Centers for Medicare & Medicaid Services ("CMS"), 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.

        CMS has developed practice expense RVUs specific to facility and non-facility settings. Generally, 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 2004 RVUs for procedures that utilize our ENT EndoSheath, ENT Channeled EndoSheath, ENT Sensory EndoSheath, our TNE D EndoSheath and our products in development for TNE therapeutic and cystoscopy, we believe health care providers will receive payments ranging from 40% to 137% more per procedure for performing them in non-facility settings in 2004 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.

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        We believe that, based upon the resource-based practice expense RVU, the number of procedures performed in non-facility settings will increase. This increase will be due primarily to the increased differential in payments that physicians will receive for performing these procedures. As these procedures move to non-facility settings, physicians will have to contend with the cost and effort required to reprocess endoscopes. We believe our disposable EndoSheaths, which eliminate the time and cost of cleaning endoscopes, will provide an economically beneficial alternative to the use of endoscopes without EndoSheaths. This economic benefit is based upon the provider not having to purchase multiple endoscopes, expensive special endoscopes with channels and expensive sterilizing equipment and supplies as well as not having to spend valuable time cleaning endoscopes. In addition, we believe that with approximately 77 million people in the United States over the age of 50, there will be an increase in the potential number of procedures that physicians will be performing. We believe our disposable EndoSheaths combined with the resource-based system for setting values for physician services together represent a sound economic solution for performing diagnostic and therapeutic procedures for a variety of illnesses.

        There can be no assurance that third-party reimbursement will continue to be available for procedures performed with our products or that the cost of our EndoSheaths would be covered by such reimbursement in the future. In addition, reimbursement standards and rates may change. We believe that the inability of users of our GI and pulmonary EndoSheaths to obtain adequate reimbursement from third-party payors has had a materially adverse effect on us.

Product Liability and Insurance

        The nature of our products exposes the Company to significant product liability risks. We maintain product liability insurance with coverage limits of $2,000,000 per year. We believe that this level of coverage is adequate, given our past sales levels and our anticipated sales levels for FY 05. We evaluate the adequacy of this coverage annually to determine if we need to increase it. No product liability claims have been brought against us to date. However, there can be no assurance that product liability insurance will continue to be available to us on acceptable terms, or that product liability claims in excess of our insurance coverage, if any, will not be successfully asserted against us in the future.

Research and Development

        We believe that our future success depends in part upon our ability to develop new products and enhance our existing products. In the past, we have devoted significant resources to research and development.

        Our research and development expenses, excluding stock-based compensation charges, in FY 02, FY 03 and FY 04 were approximately $320,000, $426,000 and $689,000, respectively.

        In FY 02 our research and development efforts focused on developing a Slide-On ENT Channeled EndoSheath to allow biopsy sampling, and on developing a Slide-On bronchoscope EndoSheath. In FY 03 our research and development efforts focused on finishing the Slide-On bronchoscope EndoSheath and the ENT Channeled EndoSheath, and beginning the development efforts for FEESST and TNE. In FY 04 our research and development efforts focused on completing products for FEESST and TNE. In addition, we completed the development of our ENT-1000 endoscope with Slide-On EndoSheath System, and continued efforts to develop a flexible cardio-thoracic endoscope with EndoSheath System. Also, we began efforts to develop a flexible cystoscope with Slide-On EndoSheath System, and our VEE line. We also have begun development of a line of peripheral products for ENT physicians, including a product for capturing images of patient conditions and archiving them for future reference.

        The cardio-thoracic ("CT") endoscope and EndoSheath System that we are developing for Endoscopic Technologies, Inc. ("Estech") is being designed to provide minimally invasive access to the

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pericardium in order to enhance visualization during epicardial atrial fibrillation procedures. Estech will have exclusive rights to distribute these products within the field of minimally invasive coronary atrial fibrillation surgery, assuming it meets certain minimum purchases. We expect to complete the development of the CT endoscope and EndoSheath in FY 05.

        Cystoscopy is a procedure that is normally performed to evaluate changes in urinary performance, blood in the urine and to visualize anatomy. These procedures are done in both the office and hospitals settings. We have developed, and will begin, in the first fiscal quarter of FY 05, the manufacture and marketing of a flexible cystoscope with Slide-On EndoSheath System for use by urologists. We believe these products will be useful to urologists to diagnose and take biopsies of bladder tumors, identify obstructions of the bladder and the installation and removal of stents. Cystoscopy and cystoscopy with biopsy have reimbursement codes.

        We plan to develop a TNE therapeutic ("TNE-T") endoscope with Slide-On EndoSheath System in FY 05. This configuration would include a trans-nasal esophagoscope designed to accept our TNE-T EndoSheath that has a channel allowing the physician to perform biopsies in the office. We believe this product will prove useful to increase the practice efficiency of both ENT and GI physicians, by allowing them to do biopsies in their offices.

Employees

        As of April 30, 2004, the Company had 69 employees, including temporary 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.

Executive Officers of the Company

        Ron Hadani, age 47, has been our President and Chief Executive Officer since February 2003. From 2001 to February 1, 2003, Mr. Hadani was a self-employed consultant, working in various capacities with early-stage companies in the U.S and Israel. From 1999-2001, he served as President of Kontran Medical, LLC. From 1997-1999 he served as Divisional Vice President of U.S. Surgical, a division of Tyco International, Ltd.

        Katsumi Oneda, age 66, a co-founder of the Company, was President and Chief Executive Officer from October 1993 to February 2003, and has served as Chairman of the Board of Directors 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 since 1987, and is a member of the Executive Committee.

        Lewis C. Pell, age 61, a co-founder of the Company, has been Vice-Chairman of the Board of Directors 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.

        James A. Tracy, age 55, 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. He received a CPA certificate in 1975.

        Isao Fujimoto, age 56, has served as Vice President Manufacturing and Engineering of the industrial segment since January 1995. Mr. Fujimoto joined the Company in 1987, and served in a variety of roles in the manufacturing and engineering departments from that date to January 1995.

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        Mark S. Landman, age 50, 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 51, 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 that segment.

        Thomas Olmstead, age 50, has served as Vice President Sales and Marketing for the medical segment since October 1, 2001. 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.

Item 2.    Properties

        The operations of our medical segment currently occupy approximately 20,000 square feet of space in Natick, Massachusetts under a lease that expires in October 2006. 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.

        Our 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. We believe that the physical characteristics and layouts of these facilities are adequate to manufacture our products in compliance with applicable FDA regulations. In addition, our Natick facility is registered as meeting the requirements of ISO 9001, EN 46001 and ISO 13485, allowing us to sell our medical products in Europe and Canada.

Item 3.    Legal Proceedings

        As of March 31, 2004, there were no material legal proceedings to which we or any of our subsidiaries are a party, or to which any of our properties are subject.

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

        No matters were submitted to a vote of our security holders during the last quarter of FY 04.

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PART II

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

        Since October 30, 1997, the Company's Common Stock has been quoted 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.

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

        As of May 31, 2004, there were 30,873,213 outstanding shares of Common Stock held by 218 stockholders of record, in addition to which there were approximately 1700 beneficial stockholders.

        We have never paid cash dividends on our Common Stock, and we do not expect to pay any cash dividends on our Common Stock in the foreseeable future. In accordance with a line-of-credit agreement that we have with a bank, we are prevented from paying cash dividends on our Common Stock.

        In March 2003, we completed a private equity placement with two of our employee/directors in an offering exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. We sold an aggregate of 2,385,568 shares of common stock at a price of $.67 per share, which represented 67% of the average closing price of the common stock on the Nasdaq SmallCap Market during the five trading days ended March 21, 2003. We received an aggregate consideration of approximately $1,600,000 for the newly issued shares of Common Stock.

        In April, 2003, we completed a private equity placement with accredited private investors in an offering exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. We sold an aggregate of 524,098 shares of common stock at a price of $0.67 per share, which represented 67% of the average closing price of the common stock on the Nasdaq SmallCap Market during the five trading days ended March 21, 2003. We received an aggregate consideration of approximately $351,000 for the newly issued shares of Common Stock.

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Securities Authorized for Issuance Under Equity Compensation Plans

        The following table provides information about the securities authorized for issuance under our equity compensation plans as of March 31, 2004:

Equity Compensation Plan Information

(1)

In addition to being available for future issuance upon exercise of options that may be granted after March 31, 2004, shares issuable under the 2000 Stock Incentive Plan may instead be issued in the form of restricted stock, unrestricted stock, stock appreciation rights, performance shares or other equity-based awards.

(2)

Includes any shares of Common Stock that would be issuable pursuant to the 2003 Director Option Plan, approved by the stockholders in July 2003.

(3)

All of our equity compensation plans have been approved by our stockholders.

        There were no repurchases of registered equity securities during the last quarter of FY 04.

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 contained in Appendix A to this report.

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

Executive Summary

        This Annual Report on Form 10-K contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include statements about expectations about future financial results, future products and future sales of new and existing products, future expenditures, and capital resources to meet anticipated requirements. 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 our actual results may differ significantly from those 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, the availability of supplies, competition, technological difficulties, general economic conditions and other risks. See "Certain Factors That May Affect Our Future Operating Results." We do not undertake an obligation to update our forward-looking statements to reflect future events or circumstances.

        We develop, manufacture and sell flexible endoscope products for the medical device and industrial device markets. We operate in three reporting segments: medical, industrial and corporate.

Medical Segment

        The medical segment supplies flexible endoscopes and disposable EndoSheaths to the ENT, GI and pulmonary markets. We expect to provide a flexible endoscope with disposable EndoSheath System to the urology market in the year ending March 31, 2005 ("FY 05"). Health-care providers use EndoSheaths to cover the insertion tube of flexible endoscopes, such as ENT endoscopes, TNE scopes, cystoscopes, sigmoidoscopes and bronchoscopes. The EndoSheaths allow the health-care providers to process patients economically by avoiding the reprocessing of endoscopes after each use. In addition, the EndoSheaths ensure a sterile insertion tube for each patient procedure.

        Our strategy in the medical segment in FY 04 was comprised of three components: a) improve sales distribution, b) lower manufacturing costs and c) increase the number of new product offerings.

Sales Distribution

        Since September 19, 2003 we have been distributing all of our products for the ENT markets in the U.S.A. and Canada through Medtronic Xomed as part of the Medtronic Agreement. The initial term of the Medtronic Agreement is three years. Thereafter, the Medtronic Agreement will be automatically renewed for successive one-year periods, unless terminated by either party upon advance written notice. Under the Medtronic Agreement, we have granted Medtronic Xomed exclusive distribution rights in the United States and Canada to market and sell our ENT EndoSheaths and ENT endoscopes to ENT practitioners. Medtronic Xomed has agreed to certain minimum purchase requirements for the initial twelve-month period of the term. The Medtronic Agreement has resulted in an increase in sales of our ENT EndoSheaths and ENT endoscopes due to the quantities of endoscopes and EndoSheaths purchased by Medtronic Xomed. In addition, due to the marketing and sales capabilities of Medtronic Xomed, the Medtronic Agreement has facilitated the introduction of new products to the ENT market, such as the TNE scope with Slide-On EndoSheath System, by allowing quicker market acceptance of these products. As a result of the Medtronic Agreement, the success of our ENT product lines is substantially dependent upon the success of the marketing and sales activities of Medtronic Xomed over which we have limited control. We have retained our domestic network of independent sales representatives for the GI and pulmonary product lines. Also, we have retained our own international network of distributors for all our medical product lines.

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Cost Reduction

        In the fourth fiscal quarter of FY 03, we completed the installation of machinery used to manufacture ENT EndoSheaths in our Natick, MA facility. We designed this machinery to lower the cost to manufacture these items by increasing the automation of the assembly process. For FY 04, the operation of the machinery has resulted in a reduction of the standard unit cost of ENT EndoSheaths of approximately 43%. In FY 04 we decided we could reduce manufacturing costs further by sub-contracting the manufacture of our EndoSheaths for the GI, Pulmonary and ENT markets to a company in Israel. That program continues, and we expect to begin to receive product in the second fiscal quarter of FY 05.

New Products

        In calendar 2003 we have received clearance from the FDA to market our ENT Channeled EndoSheath, our ENT Sensory EndoSheath and our TNE D scope with Slide-On EndoSheath System. In March 2004 we introduced our new small diameter ENT-1000 endoscope with Slide-On EndoSheath System, and we announced that we have CE Marked our TNE D scope with Slide-On EndoSheath System for marketing in Europe. We designed the first two products to allow ENT physicians to perform various procedures in their offices, as opposed to the current practice of performing the procedures in a hospital setting. Using our ENT Channeled EndoSheath or the ENT Sensory EndoSheath, along with the physician's conventional ENT endoscope, gives the ENT physician the ability to perform procedures in the office, instead of traveling to a hospital to utilize a special channeled ENT endoscope. In addition, under reimbursement procedures of the CMS, the ENT physician will receive a higher reimbursement by performing the procedures in their offices than they receive when they perform them in a hospital. We designed the TNE D scope with Slide-On EndoSheath System to give ENT physicians the ability to perform a new procedure, the diagnosis of GERD in their offices, using a local anesthetic. Currently gastroenterologists perform these procedures orally in endoscopy suites or hospitals using conscious sedation. We intend to also market this product to GI physicians, allowing them to perform a diagnostic procedure in their offices, where they will also receive the higher reimbursement rate.

        Our plans for new product introductions in FY 05 include the VEE line of endoscopes, the TNE T endoscope with Slide-On EndoSheath System, a cystoscope with Slide-On EndoSheath System, a line of peripheral products for ENT physician offices and an image-capturing and archiving system for ENT offices.

Industrial Segment

        The industrial segment designs, manufactures and sells flexible endoscopes, termed borescopes, for industrial users, and manufactures and repairs flexible endoscopes for the medical segment. The industrial segment users consist primarily of companies in the aircraft engine manufacturing and maintenance markets and the defense market.

Corporate Segment

        The corporate segment consists of certain administrative and business development activities applicable to the company as a whole.

Critical Accounting Policies and Estimates

        This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. See the Notes to the Consolidated Financial Statements included elsewhere herein. Certain of our accounting policies require the application of judgment in

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selecting the appropriate assumptions for calculating financial estimates. By their nature these judgments are subject to an inherent degree of uncertainty. We periodically evaluate the judgments and estimates used for our critical accounting policies to ensure that such judgments and estimates are reasonable for our interim and year-end reporting requirements. These judgments and estimates are based upon our historical experience, current trends and information available from other sources, as appropriate. If different conditions result from those assumptions used in our judgment, the results could be materially different from our estimates. Our critical accounting policies include the following:

Revenue Recognition

        We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104) and EITF 00-21 Revenue Arrangements with Multiple Deliverables. These pronouncements requires that five basic criteria must be met before revenue can be recognized: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; (4) collectibility is reasonably assured and (5) the fair value of undelivered elements, if any, exists. 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 criteria is not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.

Non-qualified Options Issued to Non-employees

        For FY 02—04 we accounted for certain non-qualified options granted to non-employees to purchase our common stock in accordance the EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, and carried 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. The Company uses the Black-Scholes option pricing model to determine the fair market value of non-qualified options.

        Effective March 31, 2004, we amended the non-qualified option agreements previously granted to non-employees. This amendment provides that we may settle our obligation to the holder by delivering unregistered shares to the holder. As a result of this amendment, we now account for these non-qualified options as equity instruments, and the fair market value of these options was transferred to the equity section of our balance sheet. We will account for these options in accordance with the provisions of EITF 96-18.

Income Taxes

        Under our income tax policy, we record 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 evaluation of the recoverability of any tax assets recorded on the balance sheet is subject to significant judgement. We have provided valuation allowances for all our deferred tax assets to date.

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Results of Operations

Fiscal Years Ended March 31, 2004 and 2003

Sales

        Net sales in FY 04 were $9,927,126, an increase of $3,497,484, or 54%, compared to net sales in FY 03. Sales in the medical segment increased by $2,925,540, or 77%, to $6,700,606, while sales of the industrial segment increased by $571,944, or 22% to $3,226,520. In the medical segment, sales by market in FY 04 and FY 03 were as follows ($000's):

Medical Segment—ENT Market

        Sales to the ENT market include products for the domestic and international markets as follows: