News Column

VISION SCIENCES INC /DE/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

February 14, 2014

Executive Summary Business Overview Vision-Sciences, Inc. and its subsidiaries (the "Company," or "our", "us", or "we") designs, 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. We operate in two segments: medical and industrial. Medical Business Segment Our medical segment designs, manufactures, and sells our advanced line of endoscopy-based products, including our flexible fiber and video endoscopes and our EndoSheath technology, for a variety of specialties and markets. Our flexible endoscopes are unlike conventional endoscopes, and when utilized with our EndoSheath technology, offer a multitude of benefits and advantages to the healthcare practitioner and patient.



We target six market spaces for our endoscopes and our EndoSheath technology:

? Urology - we supply our cystoscopes, ureteroscopes, and EndoSheath technology

to the Endoscopy Division of Stryker Corporation ("Stryker") in North and

Latin America, South America, China and Japan. Although Stryker was to receive

the exclusive rights for the rest of the world in April 2012, we reached an

agreement with Stryker to delay this launch indefinitely. Until we agree with

Stryker on the date of such launch, we will continue to manufacture and sell

our cystoscopes and EndoSheath technology to our independent distributors for

the rest of the world. ? Pulmonology / Critical Care - we manufacture, market, and sell our



bronchoscope (an endoscope that allows detailed viewing of the lungs) and

EndoSheath technology to intensivists, pulmonologists, thoracic surgeons, and

other airway-related physicians.

? Surgery - we manufacture, market, and sell our TNE (trans-nasal esophagoscopy)

endoscope and EndoSheath technology to general surgeons, primarily bariatric

and gastroesophageal reflux disease ("GERD") surgeons.

? Gastroenterology - we manufacture, market, and sell our TNE endoscopes and

EndoSheath technology to gastroenterology ("GI") physicians, ear, nose, and

throat ("ENT") physicians and others with a GI focus as part of their practice. ? ENT (ear, nose, and throat) - we manufacture, market, and sell our ENT endoscopes to ENT physicians.



? Spine - we supply our flexible video surgical endoscope systems to SpineView

for use with SpineView's space creator product to provide direct visualization

for minimally invasive spine surgery procedures. 18

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The following table summarizes the products we sell in each market space and the distribution network we use to market and sell those products:

Market Products Distribution Network Urology URT-7000 Video Ureteroscope Stryker* CST-5000 Video Cystoscope Stryker*; international distributors CST-4000 Fiber Cystoscope Stryker*; international distributors DPU-5050 Digital Processing International distributors Unit DPU-7000 Digital Processing International distributors Unit EndoSheath technology Stryker*; international (cystoscopy only) distributors Peripherals and accessories Stryker*; international distributors ENT ENT-5000 Video Endoscope U.S. sales force; international distributors ENT-4500 Fiber Endoscope U.S. sales force; international distributors ENT-4000 Fiber Endoscope U.S. sales force; international distributors DPU-5050 Digital Processing U.S. sales force; Unit international distributors DPU-7000 Digital Processing U.S. sales force; Unit international distributors Peripherals and accessories U.S. sales force; international distributors TNE TNE-5000 Video Endoscope U.S. sales force; international distributors DPU-5050 Digital Processing U.S. sales force; Unit international distributors DPU-7000 Digital Processing U.S. sales force; Unit international distributors EndoSheath technology U.S. sales force; international distributors Peripherals and accessories U.S. sales force; international distributors Pulmonology BRS-5000 Video Bronchoscope U.S. sales force; international distributors BRS-4000 Fiber Bronchoscope U.S. sales force; international distributors DPU-5050 Digital Processing U.S. sales force; Unit international distributors DPU-7000 Digital Processing U.S. sales force; Unit international distributors EndoSheath technology U.S. sales force; international distributors Peripherals and accessories U.S. sales force; international distributors Spine SPV-7000 Video Endoscope SpineView DPU-7000 Digital Processing SpineView Unit Peripherals and accessories SpineView



* North America, South America, Latin America, China, and Japan

Our proprietary reusable flexible endoscope is combined with a single-use, sterile protective EndoSheath disposable, which is placed over the patient contact area of the scope. Our "always sterile" EndoSheath technology reduces the risks of cross-contamination associated with the reuse (or "reprocessing") of conventional endoscopes, which are difficult, costly, and time consuming to clean and disinfect or sterilize. The use of our EndoSheath technology allows healthcare providers to perform a rapid, simplified reprocessing routine after use, avoiding the elaborate high level disinfection/sterilization routines required by the U.S. Food and Drug Administration (the "FDA") for conventional endoscopes. The FDA requires that all conventional flexible endoscopes be reprocessed according to FDA-cleared manufacturers' regulations and organizational guidelines, whether they are used in hospitals, clinics or office settings. With our EndoSheath technology we are able to reduce the number of steps to reprocess flexible endoscopes from approximately 27 to three, thereby lowering costs and saving time. This design of "always ready" equipment, which allows for a rapid and less damaging cleaning process, provides a multitude of benefits to healthcare practitioners, such as lower capital equipment investment, less service and maintenance costs of capital equipment, less staff exposure to toxic chemicals, increased patient scheduling flexibility and throughput, improved staff productivity and a more practical implementation of endoscopy.



Our goal is to become a customer-centric organization with a focus on enhancing stockholder value. We are doing this by:

? Enhancing our sales force in the U.S. through continued sales training and

development; ? Targeting office-based clinics and acute care facilities that recognize patient safety and the patient experience as a primary value position;



? Capitalizing on our extensive and relevant library of published clinical

studies and peer reviewed papers on the efficacy and safety of our EndoSheath

technology; and ? Enhancing our professional educational programs to allow healthcare professionals to teach other healthcare professionals. 19

-------------------------------------------------------------------------------- As we look forward, we believe that our visualization platform and EndoSheath technology provide a strong platform to drive top-line sales growth, improve our operating efficiency, and increase our margins. At Vision-Sciences, we are guided by our mission to focus on innovative technologies that improve patient care and reduce costs to the healthcare system. We will continue to pursue this goal by working with physicians who strive to improve their patients' quality of life. We believe that our renewed focus on the areas where we have had historical success will help us to become a more financially secure company. New Product Releases 7000 Series Vision System® In April 2013, we introduced our next generation video processor platform, the 7000 Series Vision System®, at the annual Combined Otolaryngology Spring Meeting ("COSM") in Orlando, Florida. Designed to provide users with a powerful, efficient, and easy-to-use system, the 7000 Series Vision System is the first endoscopy platform to include video, audio, archiving, and workflow enhancements in a single standalone unit. The all-in-one, "plug-and-play" platform provides vibrant, high-resolution imaging that can be effortlessly recorded for future assessment or on-the-spot review with the patient post-procedure, enhancing both the practice workflow and the patient experience. The 7000 Series Vision System includes a new, simplified user interface, programmable user preference controls, expanded on-screen notifications, and easy-to-maintain patient lists, all of which allow end-users to improve productivity and workflow by customizing the operation of the system to the day-to-day needs of the practice. Additionally, the system incorporates a "one-touch" integrated keyboard to ensure quick activation of functions, including full control of video playback options, such as frame-by-frame review or historical image comparison, both of which are ideal for patient progress review. Flexible Ureteroscope In December 2012, Stryker began to ship a new flexible ureteroscope, the URT-7000 video ureteroscope, to its customers, and customer feedback has been strong. This flexible ureteroscope is primarily used in the operating room, which represents approximately 30% of the overall urology market. Stryker added dedicated sales specialists, augmenting its 250-person endoscopy sales force that currently promotes our urology products. Industrial Business Segment Our industrial segment, through our wholly-owned subsidiary Machida, designs, manufactures, and sells borescopes to a variety of users, primarily in the aircraft engine manufacturing and aircraft engine maintenance industries. A borescope is an instrument that uses optical fibers for the visual inspection of narrow cavities. Our borescopes are used to inspect aircraft engines, casting parts and ground turbines, among other items. Machida's quality line of borescopes includes a number of advanced standard features normally found only in custom designed instruments. Patents We hold 17 U.S. patents, and we have 10 U.S. patent applications pending. In addition, we have 16 foreign patents issued and have 6 foreign patent applications pending. These patents relate to disposable sheaths for endoscopes and reusable flexible endoscopes, as well as other various products, endoscopy and non-endoscopy related. The issued patents will expire on various dates in the years 2014 through 2029. Trademark Property We own the trademarks Vision SciencesTM and Slide-OnTM and the registered trademarks EndoSheath®, EndoWipe® and The Vision System®. Not all products referenced in this report are approved or cleared for sale, distribution, or use.



Debt Arrangements - Related Party

Convertible Promissory Notes On September 25, 2013 (the "Effective Date"), we entered into a $3.5 million revolving convertible promissory note (the "2013 Note") with Mr. Pell. The 2013 Note accrues annual interest, payable annually, at the rate of 1.66%. The 2013 Note must be repaid in full on or before the fifth anniversary of the Effective Date (the "Maturity Date"), but may be prepaid by us at any time without penalty. We will be required to repay all amounts outstanding under the 2013 Note upon an event of default, as defined in the 2013 Note. The outstanding principal amount of the 2013 Note is convertible at any time prior to the Maturity Date, at Mr. Pell's option, into shares of our common stock at a price of $0.89, the closing bid price of our common stock on the Effective Date. At December 31, 2013, we had outstanding principal borrowings of $2.0 million under the 2013 Note. 20

-------------------------------------------------------------------------------- On September 19, 2012 (the "Replacement Note Effective Date"), we entered into a $20.0 million revolving convertible promissory note (the "Replacement Note") with Mr. Pell. The Replacement Note (i) consolidated and restructured the $15.0 million in aggregate borrowings collectively outstanding under an Amended and Restated Loan Agreement, dated September 30, 2011, between us and Mr. Pell (the "Original Agreement") and a separate promissory note, dated July 25, 2012, between us and Mr. Pell, and (ii) provided for up to $5.0 million in additional borrowings. The Replacement Note accrues annual interest, payable annually, at the rate of 0.84%. The Replacement Note must be repaid in full on or before the fifth anniversary of the Replacement Note Effective Date (the "Replacement Note Maturity Date"), but may be prepaid by us at any time without penalty. We will be required to repay all amounts outstanding under the Replacement Note upon an event of default, as defined in the Replacement Note. The outstanding principal amount of the Replacement Note is convertible at any time prior to the Replacement Note Maturity Date, at Mr. Pell's option, into shares of our common stock at a conversion price of $1.20 per share, which was the closing bid price of our common stock on the Replacement Note Effective Date. At December 31, 2013, we had $20.0 million in outstanding principal borrowings under the Replacement Note, which is reflected as convertible debt - related party on our condensed consolidated balance sheet. The following table is a summary of our convertible debt-related party at December 31, 2013: Gross Principal Unamortized Net Amount Debt Amount Convertible Debt-Related Party Outstanding Discount Outstanding Replacement Note $ 20,000 $ - $ 20,000 2013 Note 2,000 (196 ) 1,804 $ 22,000$ (196 )$ 21,804 Pursuant to the Original Agreement, Mr. Pell received warrants to purchase an aggregate of 1,880,620 shares of our common stock at a weighted average exercise price of $1.86 per share. All of the warrants are vested and expire on the later of September 30, 2016 or one year after the termination of the Original Agreement and repayment of all amounts due and payable under the Original Agreement. In connection with the issuance of the Replacement Note and the termination of the Original Agreement, we determined that the transaction should be classified as an extinguishment of debt. Accordingly, we wrote-off the remaining deferred debt cost balance of $1.2 million at September 19, 2012. We estimated the fair value of all of the stock warrants issued on the date of vesting using a Black-Scholes valuation model that used the weighted average assumptions for the risk-free interest rate, expected life (in years), and expected volatility. We recorded the transaction as a deferred debt cost and amortized to expense over the term of the loan. Letter Agreement Pursuant to a letter agreement dated June 21, 2013, Mr. Pell has agreed to provide financial assistance to us in the amount of up to $5.0 million, if necessary to support our operations, for a period ending on the earlier of (i) July 1, 2014 or (ii) our raising debt or equity capital in the amount of $5.0 million or more. This financial assistance, if drawn by us, would be in the form of an additional loan, share purchase, or financing transaction, on such terms as we and Mr. Pell may determine. As of December 31, 2013, we had not utilized the financial assistance agreement.



Results of Operations (in thousands, except percentages)

Net Sales In our medical segment, we track sales of our endoscopes and EndoSheath technology by market. We also track sales of peripherals and accessories which can be sold to more than one market. Net sales by operating segment and by market/category for the three and nine months ended December 31, 2013 and 2012 were as follows: Three Months Ended Nine Months Ended December 31, December 31, Market/Category 2013 2012 Change 2013 2012 Change Urology $ 2,097$ 1,421 48 % $ 5,614$ 3,365 67 % ENT 386 398 -3 % 1,128 1,417 -20 % TNE 361 385 -6 % 944 895 5 % Pulmonology 276 238 16 % 757 525 44 % Spine - - n/a - 440 -100 % Repairs, peripherals, and accessories 466 528 -12 % 1,570 1,548 1 % Total medical sales 3,586 2,970 21 % 10,013 8,190 22 % Borescopes 723 743 -3 % 1,543 2,216 -30 % Repairs 198 239 -17 % 571 681 -16 % Total industrial sales 921 982 -6 % 2,114 2,897 -27 % Net sales $ 4,507$ 3,952 14 % $ 12,127$ 11,087 9 % Net sales increased $0.6 million (14%) in the third quarter of fiscal 2014 to $4.5 million compared to $4.0 million in the third quarter of fiscal 2013. During the third quarter of fiscal 2014, our medical segment's net sales of $3.6 million increased by $0.6 million (21%), primarily attributable to higher international sales of our endoscopes and EndoSheath technology in the urology market. Our industrial segment's net sales of $0.9 million decreased by $0.1 million (6%), primarily attributable to lower repair revenue. 21 -------------------------------------------------------------------------------- Net sales increased $1.0 million (9%) in the first nine months of fiscal 2014 to $12.1 million compared to $11.1 million in the first nine months of fiscal 2013. During the first nine months of fiscal 2014, our medical segment's net sales of $10.0 million increased by $1.8 million (22%), primarily attributable to higher sales of our endoscopes and EndoSheath technology in the urology market. Our industrial segment's net sales of $2.1 million decreased by $0.8 million (27%), primarily attributable to lower demand of our 2mm video-based borescopes and engine turning tools. The following table summarizes net sales by market/category and by product for our medical operating segment for the three and nine months ended December 31, 2013 and 2012: Three Months Ended Nine Months Ended December 31, December 31, Market/Category 2013 2012 Change 2013 2012 Change Urology Endoscopes $ 1,219$ 610 100 % $ 3,206$ 1,546 107 % EndoSheath technology 878 811 8 % 2,408 1,819 32 % Total urology market 2,097 1,421 48 % 5,614 3,365 67 % ENT Endoscopes 386 398 -3 % 1,128 1,417 -20 % TNE Endoscopes 309 348 -11 % 788 781 1 % EndoSheath technology 52 37 41 % 156 114 37 % Total TNE market 361 385 -6 % 944 895 5 % Pulmonology Endoscopes 245 211 16 % 633 417 52 % EndoSheath technology 31 27 15 % 124 108 15 % Total pulmonology market 276 238 16 % 757 525 44 % Spine Endoscopes - - n/a - 440 -100 % Repairs, peripherals, and accessories 466 528 -12 % 1,570 1,548 1 % Total medical sales $ 3,586$ 2,970 21 % $ 10,013$ 8,190 22 % Product Endoscopes $ 2,159$ 1,567 38 % $ 5,755$ 4,601 25 % EndoSheath technology 961 875 10 % 2,688 2,041 32 % Repairs, peripherals, and accessories 466 528 -12 % 1,570 1,548 1 % Total medical sales $ 3,586$ 2,970 21 % $ 10,013$ 8,190 22 % Net sales to the urology market during the third quarter and first nine months of fiscal 2014 increased by $0.7 million (48%) and $2.2 million (67%), respectively, compared to the same periods in fiscal 2013. The year-over-year increase was primarily attributable to the higher sales of our endoscopes and EndoSheath technology products to Stryker and our international distributors. Net sales to Stryker were up $0.3 million (34%) and $1.5 million (90%) in the third quarter and first nine months of fiscal 2014, respectively. We also achieved solid growth of 72% ($0.4 million) and 50% ($0.8 million) in our international markets during the third quarter and first nine months of fiscal 2014, respectively, compared to the same periods in fiscal 2013. The adoption of our EndoSheath technology in these markets continues to be strong and a growth driver for our business. Net sales to the ENT market during the third quarter and first nine months of fiscal 2014 decreased by $12 thousand (3%) and $289 thousand (20%), respectively, compared to the same periods in fiscal 2013. We recently renewed our sales effort in the ENT market after spending the second half of fiscal 2013 and most of the first quarter of fiscal 2014 focusing on the TNE and pulmonology market opportunities. We believe this change will enable us to grow this product line's sales over the next several quarters. Net sales to the TNE (surgical and GI) market during the third quarter and first nine months of fiscal 2014 decreased by $24 thousand (6%) and increased by $49 thousand (5%), respectively, compared to the same periods in fiscal 2013. We are encouraged by the utilization of our EndoSheath technology in this market as evidenced by the unit volume growth of 35% and 29% during third quarter and first nine months of fiscal 2014, respectively, compared to the same periods in fiscal 2013. 22

-------------------------------------------------------------------------------- Net sales to the pulmonology (critical care) market during the third quarter and first nine months of fiscal 2014 increased by $38 thousand (16%) and $232 thousand (44%), respectively, compared to the same periods in fiscal 2013. The increases were primarily attributable to higher demand of our critical care platform (BRS-5000 video bronchoscope and digital processing unit) in the U.S. and fiber bronchoscopes worldwide. We continue to focus our efforts on increasing our installed base to drive further adoption of our EndoSheath technology in this market. Net sales to SpineView during the first nine months of fiscal 2014 decreased by $440 thousand (100%) compared to the same period in fiscal 2013. There were no sales to SpineView in the third quarter of fiscal 2014 or 2013. In December 2012, SpineView received 510(k) clearance from the FDA to use our system for spine applications. With this clearance and the units supplied from the initial stocking order, the balance of which was fulfilled during fiscal 2013, SpineView continues to conduct clinical preference trials for minimally invasive spine surgeries. As a result, we do not anticipate any sales to SpineView during the remainder of fiscal 2014. Net sales of repairs, peripherals, and accessories during the third quarter and first nine months of fiscal 2014 decreased by $62 thousand (12%) and increased by $22 thousand (1%), respectively, compared to the same periods in fiscal 2013. The year-over-year decline in the third quarter of fiscal 2014 was primarily attributable to a decrease in sales of our peripherals and accessories ($47 thousand, or 15%).



Gross Profit (Net Sales Less Cost of Sales)

Gross profit by operating segment for the three and nine months ended December 31, 2013 and 2012 was as follows:

Three Months Ended Nine Months Ended December 31, December 31, Gross Profit 2013 2012 Change 2013 2012 Change Medical $ 996$ 728 37 % $ 2,770$ 2,068 34 % As percentage of net sales 27.8 % 24.5 % 3.3 % 27.7 % 25.3 % 2.4 % Industrial 382 404 -5 % 883 1,046 -16 % As percentage of net sales 41.5 % 41.1 % 0.4 % 41.8 % 36.1 % 5.7 % Gross profit $ 1,378$ 1,132 22 % $ 3,653$ 3,114 17 % Gross margin percentage 30.6 % 28.6 % 2.0 % 30.1 % 28.1 % 2.0 % The gross margin percentage was 30.6% in the third quarter of fiscal 2014 compared to 28.6% in the third quarter of fiscal 2013. The gross margin percentage was 30.1% in the first nine months of fiscal 2014 compared to 28.1% in the first nine months of fiscal 2013. The year-over-year improvement in our gross margin percentage was primarily attributable to favorable manufacturing absorption from higher production of our urology endoscopes and EndoSheath technology (gross margin percentage impact of 2.5% and 1.7% in the third quarter and first nine months of fiscal 2014, respectively). Operating Expenses



Operating expenses by operating segment for the three and nine months ended December 31, 2013 and 2012 were as follows:

Three Months Ended Nine Months Ended December 31, December 31, Operating Expenses 2013 2012 Change 2013 2012 Change SG&A expenses Medical $ 2,120$ 2,131 -1 % $ 6,779$ 7,490 -9 % Industrial 184 180 2 % 625 715 -13 % Total SG&A expenses 2,304 2,311 0 % 7,404 8,205 -10 % R&D expenses Medical 552 347 59 % 1,399 1,361 3 % Industrial - - - - - - Total R&D expenses 552 347 59 % 1,399 1,361 3 % Total operating expenses $ 2,856$ 2,658 7 % $ 8,803$ 9,566 -8 % 23

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Selling, General, & Administrative ("SG&A") Expenses

SG&A expenses were flat during the third quarter of fiscal 2014 compared to the third quarter of fiscal 2013. During the first nine months of fiscal 2014, SG&A expenses decreased by $0.8 million (10%) compared to the same period in fiscal 2013. The year-over-year decrease was primarily attributable to the following:



? Lower stock-based compensation expense of $0.7 million. The fiscal 2014 period

benefited from the reversal of stock-based compensation expense for our former

President and Chief Executive Officer, Cynthia F. Ansari ($0.3 million); and

? Lower corporate salaries and benefits expenses of $0.3 million. We recorded a

one-time severance pay of $0.3 million for our former our former VP, Corporate

Development and Chief Financial Officer, Katherine L. Wolf, in the second

quarter of fiscal 2013, which was not repeated in the current fiscal year.

Research & Development ("R&D") Expenses

R&D expenses during the third quarter and first nine months of fiscal 2014 increased by $205 thousand (59%) and $38 thousand (3%), respectively, compared to the same periods in fiscal 2013. The increases were primarily attributable to the following:



? Higher R&D materials used in the development of our next generation

bronchoscope ($46 thousand and $40 thousand in the third quarter and first

nine months of fiscal 2014, respectively);

? Higher engineering costs of $80 thousand in the third quarter of fiscal 2014.

We improved the stability and reliability of our next generation digital

processing unit, the DPU-7000, which we launched in March 2013 and introduced

at a trade show in April 2013; and

? The reversal of a relocation allowance of $31 thousand for a former management

employee, which was not repeated in the current fiscal year. Other (Expense) Income



Other (expense) income for the three and nine months ended December 31, 2013 and 2012 was as follows:

Three Months Ended Nine Months Ended December 31, December 31, Other (Expense) Income 2013 2012 Change

2013 2012 Change Interest income $ - $ 1 -100 % $ 1$ 4 -75 % Interest expense (58 ) (36 ) 61 % (143 ) (467 ) -69 % Other, net (18 ) (6 ) 200 % (16 ) (47 ) -66 % Debt cost expense - - n/a - (272 ) -100 % Loss on extinguishment of debt - - n/a - (1,244 ) -100 % Other expense $ (76 )$ (41 ) 85 % $ (158 )$ (2,026 ) -92 % Other expense during the third quarter and first nine months of fiscal 2014 increased by $35 thousand (85%) and decreased by $1.9 million (92%), respectively, compared to the same periods in fiscal 2013. In the same periods in fiscal 2013, we recognized a loss on the extinguishment of debt as a result of the $20.0 million convertible debt with Mr. Pell and the termination of the previous debt arrangements with him. This one-time charge was not repeated in the current fiscal year. Net Loss Net loss for the three and nine months ended December 31, 2013 and 2012 was as follows: Three Months Ended Nine Months Ended December 31, December 31, Net Loss 2013 2012 Change 2013 2012 Change

Loss before provision for income taxes $ (1,554 )$ (1,567 ) -1 % $ (5,308 )$ (8,478 ) -37 % Income tax (benefit) provision 8 10 -20 % 11 10 10 % Net loss $ (1,562 )$ (1,577 ) -1 % $ (5,319 )$ (8,488 ) -37 % Net loss improved during the third quarter and first nine months of fiscal 2014 by $15 thousand (1%) and $3.2 million (37%), respectively, compared to the same periods in fiscal 2013. Lower operating expenses of $0.8 million in the first nine months of fiscal 2014 and the loss on the extinguishment of debt of $1.2 million in the first nine months of fiscal 2013 that was not repeated in the current fiscal year were the primary drivers for the year-over-year net loss improvement for the first nine months of fiscal 2014. 24 --------------------------------------------------------------------------------



Liquidity, Capital Resources, and Outlook

The following table summarizes selected financial information and statistics as of December 31, 2013 and March 31, 2013:

December 31, March 31, 2013 2013 Cash and cash equivalents $ 1,122$ 788 Accounts receivable, net $ 3,410$ 3,624 Inventories, net $ 5,394$ 5,158 Working capital $ 7,392$ 6,957 At December 31, 2013, our principal source of liquidity was working capital of approximately $7.4 million, including $1.1 million in cash and cash equivalents. Our cash and cash equivalents increased $0.3 million during the first nine months of fiscal 2014. The increase was primarily attributable to the cash proceeds from the convertible debt arrangement with Mr. Pell, partially offset by the cash used to fund our operations and cover the net loss of $5.3 million sustained during the period. In the first nine months of fiscal 2014, we used $4.5 million of net cash in our operating activities compared to $7.2 million in the same period last fiscal year. The improvement in cash used in operations was primarily attributable to higher accounts receivable collections during the first nine months of fiscal 2014 (a favorable change of $0.9 million) and reduced spend on inventories (a favorable change of $0.6 million) compared to the same period in fiscal 2013. In addition, since the beginning of fiscal 2013, management has made a concerted effort to control costs and reduce operating expenses as evidenced by the 20% improvement in operating loss ($5.2 million in the nine-month period of fiscal 2014 compared to $6.5 million in the same period last fiscal year) and lower cash usage (as described above) during the first nine months of fiscal 2014. In the first nine months of fiscal 2014, we used $50 thousand of net cash in our investing activities compared to $88 thousand in the same period last fiscal year. Lower capital expenditures during the first nine months of fiscal 2014 were the primary driver for the decrease in cash used (a favorable change of $40 thousand) compared to the same period in fiscal 2013. In the first nine months of fiscal 2014, we provided $4.9 million of net cash from our financing activities compared to $5.9 million in the same period last fiscal year. The decrease was primarily attributable to the net proceeds received from the sale of common stock to Lincoln Park Capital ($0.9 million) during the same period of fiscal 2013, which was not repeated in fiscal 2014. We have incurred substantial operating losses since our inception and there can be no assurance that we will ever achieve or sustain a profitable level of operations in the future. We anticipate negative cash flows from operations during the remainder of fiscal 2014, driven by continued investment in a direct sales force for the U.S. market, spending for marketing, spending for research and development, and general business operations. As of December 31, 2013, we had cash and cash equivalents totaling approximately $1.1 million. We expect that our cash at December 31, 2013, together with the $1.5 million of capital available as of December 31, 2013 under the 2013 Note and up to $5.0 million of capital to be made available to us, subject to certain conditions and an expiration date of July 1, 2014, under a letter agreement dated June 21, 2013 with Lewis C. Pell, our Chairman (the "Letter Agreement") (see Debt Arrangements - Related Party for additional information), should be sufficient to fund our operations through at least December 31, 2014. However, if our performance expectations fall short (including our failure to generate expected levels of sales) or our expenses exceed expectations, or if the commitments under the 2013 Note or the Letter Agreement become unavailable, we will need to secure additional financing and/or reduce our expenses to continue our operations. Our failure to do so would have a material adverse impact on our prospects and financial condition. There can be no assurance that any contemplated additional financing will be available on terms acceptable to us, if at all. If required, we believe we would be able to reduce our expenses to a sufficient level to continue to operate as a going concern.



Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.


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