Applied Visual Sciences, Inc. - FORM 10-Q

Attached files

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EX-31 - CEO CERT EX 31.1 - Applied Visual Sciences, Inc.	f20111stqtr10qceocertex311.htm
EX-32 - CFO CERT EX 32.2 - Applied Visual Sciences, Inc.	f20111stqtr10qcfocertex322.htm
EX-31 - CFO CERT EX 31.2 - Applied Visual Sciences, Inc.	f20111stqtr10qcfocertex312.htm
EX-32 - CEO CERT EX 32.1 - Applied Visual Sciences, Inc.	f20111stqtr10qceocertex321.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

_______________________________

FORM 10-Q

(Mark One)

X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ____ to ____

Commission file number: 000-28238

APPLIED VISUAL SCIENCES, INC.

(Exact name of registrant as specified in its charter)


Delaware		54-1521616
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

250 Exchange Place, Suite H, Herndon, Virginia 20170

(Address of principal executive offices and zip code)

(703) 464-5495

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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 ü No __

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes __ No __

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ü]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes __ No ü

At May 10, 2011, 84,992,979 shares of the registrant’s Common Stock, $0.001 par value, were outstanding.

NOTE REGARDING FORWARD-LOOKING STATEMENTS

Our disclosure and analysis in this Report contains forward-looking statements which provide our current expectations or forecasts of future events. Forward-looking statements in this Report include, without limitation:

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those related to earnings, earnings growth, revenue and revenue growth;

statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;

statements about expected future sales trends for our products;

statements about our future capital requirements and the sufficiency of our cash, cash equivalents, and available bank borrowings to meet these requirements;

information about the anticipated release dates of new products;

other statements about our plans, objectives, expectations and intentions;

and other statements that are not historical fact.

Forward-looking statements generally can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “intends, “plans,” “should,” “seeks,” “pro forma,” “anticipates,” “estimates,” “continues,” or other variations thereof (including their use in the negative), or by discussions of strategies, plans or intentions. Such statements include but are not limited to statements under Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2010, Part I, Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Report, and elsewhere in this Report. A number of factors could cause results to differ materially from those anticipated by such forward-looking statements, including those discussed under Part II, Item 1A - Risk Factors of this Report. The absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including factors described in Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2010 and Part II, Item 1A – Risk Factors of this Report. You should carefully consider the factors described in Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2010, and Part II, Item 1A – Risk Factors of this Report in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Report. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we file from time to time with the Securities and Exchange Commission (“SEC”).

APPLIED VISUAL SCIENCES, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

Condensed Consolidated Statements of Cash Flows

Notes to Condensed Consolidated Financial Statements

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 22

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

ITEM 4. CONTROLS AND PROCEDURES

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 1A. RISK FACTORS

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

ITEM 5. OTHER INFORMATION

ITEM 6. EXHIBITS

SIGNATURES

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

		March 31	December 31
		2011	2010
		(Unaudited)
ASSETS
Current Assets
	Cash and cash equivalents	$ 87,764	$ 4,874
	Accounts receivable	69,527	69,527
	Prepaid expenses	19,595	19,281
	Total current assets	176,886	93,682

Equipment, net		273,254	286,772

Other Assets
	Other noncurrent assets	11,122	11,122
	Intangible assets, net	359,411	365,173
	Total assets	$ 820,673	$ 756,749

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
	Accounts payable	$ 1,597,669	$ 1,766,870
	Other accrued liabilities	5,263,619	5,021,712
	Note payable and advances, related parties	96,400	117,100
	Convertible debentures	1,688,205	1,688,205
	Derivative liabilities - embedded conversion feature of debentures	1,215,508	2,228,431
	Total current liabilities	9,861,401	10,822,318

Common shares subject to repurchase, stated at estimated redemption value; 282,704 shares outstanding at December 31, 2010
		-	98,946

Stockholders' Equity (Deficit)
	Convertible preferred stock, $0.20 par value; authorized 1,000,000 shares
	Shares issued and outstanding at March 31, 2011 - none
	Shares issued and outstanding at December 31, 2010 - none	-	-
	Common stock, $0.001 par value; authorized 200,000,000 shares
	Shares issued and outstanding at March 31, 2011 - 84,763,958
	Shares issued and outstanding at December 31, 2010 - 82,212,233	84,764	82,212
	Additional paid-in capital	81,216,292	80,242,987
	Accumulated comprehensive income	63,354	63,354
	Deficit accumulated	(90,405,138)	(90,553,068)
	Total stockholders' equity (deficit)	(9,040,728)	(10,164,515)
	Total liabilities and stockholders' equity (deficit)	$ 820,673	$ 756,749

See notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)


	Three Months Ended
	March 31
	2011	2010

Net revenues	$ -	$ 13,665

Cost of sales	-	13,777

Gross profit (loss)	-	(112)

Selling, general and administrative expense	864,993	1,424,946

Operating loss	(864,993)	(1,425,058)

Other income	1,012,923	575,265

Net income (loss)	$ 147,930	$ (849,793)



Net income (loss) per common share
Basic	$ 0.00	$ (0.01)
Diluted	0.00	(0.01)

Weighted average common shares outstanding
Basic	83,578,915	62,292,373
Diluted	137,765,021	105,724,234


Other comprehensive income
Comprehensive income - beginning of period	$ 63,354	$ 62,481
Cumulative translation adjustments	-	1,190

Comprehensive income - end of period	$ 63,354	$ 63,671

See notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Cash Flows


APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Three Months Ended March 31
	2011	2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$ 147,930	$ (849,793)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	24,151	28,135
Stock-based compensation expense	259,621	558,315
Amortization of debentures discounts	-	16,500
Revaluation of derivative instrument expense (income)	(1,012,923)	(487,947)
Gain on settlement of debt	-	(241,600)
Other noncash (stock issued in lieu of interest paid)	-	3,892
Changes in operating assets and liabilities:
(Increase) in accounts receivable	-	(4,593)
(Increase) in prepaid expenses	(314)	(1,934)
Increase in accounts payable	73,448	298,790
Increase in accrued expenses	283,547	467,543
Increase in deferred revenue	-	2,800
Net cash flows used in operating activities	(224,540)	(209,892)

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment	(4,870)	-
Investment in patents	-	(635)
Net cash flows used in investing activities	(4,870)	(635)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock, net	333,000	217,400
Proceeds from short-term convertible notes payable	-	27,138
Reduction of short-term note payable, related party	(20,700)	-
Net cash flows provided by financing activities	312,300	244,538

Effect of exchange rate changes on cash and cash equivalents	-	(139)

Net increase in cash and cash equivalents	82,890	33,872
Cash and cash equivalents at beginning of the period	4,874	8,707

Cash and cash equivalents at end of the period	$ 87,764	$ 42,579

Supplemental disclosure of cash flow information:
Remeasurement of common stock subject to repurchase	$ -	$ 2,827
Reclassification of common stock previously subject to repurchase	98,946	2,733
Conversion of short-term convertible notes to common stock	-	50,000
Conversion of convertible debenture to common stock	-	377,500
Conversion of accounts payable and other accrued liabilities to common stock	242,650	-
Conversion of accrued wages to common stock	11,340	-
Conversion of accrued wages for exercise of employee stock options	30,300	-

See notes to condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

Description of Business

Applied Visual Sciences, Inc. was incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010. Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the “Company,” “Applied Visual Sciences, Inc.,” “Applied Visual,” “us,” “we,” or “our.”

Applied Visual Sciences is a technology company that designs and develops imaging informatics solutions for delivery to its target markets through its two operating subsidiaries: Guardian Technologies International, Inc. for aviation/homeland security and Signature Mapping Medical Sciences, Inc., for healthcare. The Company utilizes imaging technologies and analytics to create integrated information management technology products and services that address critical problems in healthcare and homeland security for corporations and governmental agencies. Each product and service can improve the quality and response time of decision-making, organizational productivity, and efficiency within the enterprise. Our product suite integrates, streamlines, and distributes business and clinical information and images across the enterprise.

Our core technology is an “intelligent imaging informatics” (“3i™”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists’ diagnostic imaging tools. Product development in these areas is ongoing, and while there can be no assurance, we believe that the technology should produce results equal to or greater than those currently achieved in baggage scanning.

On July 19, 2010 we announced that we had expanded ours organizational structure to better reflect our business operations and to provide an enhanced operational structure to capitalize on domestic and international business and joint product development opportunities. We changed our name to Applied Visual Sciences, Inc. (“APVS”) and our common stock began to be quoted on the OTC Bulletin Board under symbol “APVS.” APVS serves as the holding company and IT development organization for the group. The Company has achieved certain significant corporate life cycle milestones that necessitated a more diverse corporate structure. The purpose of the structure is to segregate distinct business operations into separate corporate entities, all under a single umbrella organization. Our two wholly-owned operating subsidiaries are: Guardian Technologies International, Inc. - the homeland security/defense technology entity, and Signature Mapping Medical Sciences, Inc. - the healthcare technology entity. APVS will maintain ownership of all existing and in-process patents, as well as any future patentable technology developed by its research and development staffs, or developed as a tangential application of its core patented technologies. Our subsidiaries will be the business operations focused on new product development, marketing, and sales for their respective markets.

By structuring in this manner, as a means to conduct business, we expect to realize the following benefits:

Creation of autonomous business units with defined measurable goals and objects;

Alignment of risk characteristics to the specific product, line of business or foreign market;

Provide a level of legal risk insulation to the core assets, the patents & intellectual property;

Flexibility to maximize tax benefits, both domestic & foreign activities;

Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships;

Facilitate the potential “spin-off” of one of the subsidiary entities;

Facilitate the potential sale of part of the company; and,

Attract investment from investors that focus on specific industries.

Currently, we are focused on providing technology solutions and services in two primary markets, healthcare and aviation/homeland security. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry. We may also engage in one or more acquisitions of businesses that are complementary to our business. Further, we may form wholly-owned subsidiaries to operate within defined vertical markets.

(2)

Basis of Presentation

The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying unaudited condensed consolidated financial statements do not include complete footnotes and financial statement presentations. As a result, these unaudited condensed consolidated financial statements should be read along with the audited consolidated financial statements and notes thereto for the year ended December 31, 2010, included in our 2010 Annual Report on Form 10-K. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments, including normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows for those periods presented. The preparation of financial statements in conformity with United States (U.S.) generally accepted accounting principles requires management to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ from those estimates and assumptions. Moreover, the results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the entire year. The Company maintains a web site at www.appliedvs.com, which makes available free of charge our recent annual report and other filings with the SEC.

These unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern and, accordingly, do not include any adjustments that might result from the outcome of this uncertainty. Our independent registered public accounting firm’s reports on the consolidated financial statements included in our annual report on Form 10-K for the years ended December 31, 2010 and 2009, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.

Effective July 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 105-10, Generally Accepted Accounting Principles – Overall (“ASC 105-10”). ASC 105-10 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Positions or Emerging Issue Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASUs”).

The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. References made to FASB guidance throughout this document have been updated for the Codification.

Summary of Significant Accounting Policies

As disclosed in our most recent Annual Report on Form 10-K for the fiscal year ended December 31, 2010, the discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in conformity with United States (U.S.) generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. These judgments can be subjective and complex and, consequently, actual results could differ from those estimates and assumptions. Since December 31, 2010, there have been no significant changes to the assumptions and estimates related to those critical accounting policies.

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, RJL Marketing Services, Guardian Technologies International, Inc., Signature Mapping Medical Sciences, Inc., Guardian Healthcare Systems UK, Ltd., and Wise Systems Ltd., in which it has the controlling interest. Subsidiaries acquired are consolidated from the date of acquisition. All significant intercompany balances and transactions have been eliminated.

The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and embedded conversion features and detachable warrants approximates fair value based on the liquidity of these financial instruments and their short-term nature.

The Company reviews the terms of convertible debt and equity securities for indications requiring bifurcation, and separate accounting, for the embedded conversion feature. Under guidelines of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” public companies that are required, or that could be required, to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value (or allocate on a fair value basis if issued as part of a debt financing), and report the value in permanent equity. However, in certain circumstances (e.g. the company could not ascertain whether sufficient authorized shares exist to settle the contract), permanent equity classification should be reassessed. The classification of the contract as permanent equity should be reassessed at each balance sheet date and, if necessary, reclassified as a liability on the date of the event causing the reclassification. If a reclassification occurs from permanent equity to a liability, the fair value of the financial instrument

should be removed from permanent equity as an adjustment to stockholders’ equity. Any portion of the contract that could be net-share settled as of the balance sheet date would remain classified in permanent equity. Subsequent to the initial reclassification event, changes in fair value of the instrument are charged to expense until the conditions giving rise to the reclassification are resolved. When a company has more than one contract subject to reclassification, it must determine a method of reclassification that is systematic, rational, and consistently applied. The Company adopted a reclassification policy that reclassifies contracts with the latest inception date first. To the extent that changes in fair value of equity instruments relates to financings since November 8, 2006 (the date of first closing under the debenture financing with reset provisions that made the number of potentially issuable shares indeterminable), the increase or decrease in the fair value of the warrants is charged or credited to interest expense. To the extent the equity instruments relate to other transactions (e.g. consulting expense), the increases or decreases are charged or credited based on the nature of the transaction. The number of additional shares potentially issuable under the November 8, 2006, outstanding convertible debentures and related outstanding warrants and other subsequent warrants issued was determinable as of the debentures’ final milestone reset date on May 20, 2008, and, therefore, the outstanding fair value of the warrants issued to the debenture holders, other subsequent warrants issued through May 20, 2008, and the warrants’ related beneficial conversion feature were reclassified as stockholders’ equity in accordance with currently effective generally accepted accounting principles.

Reclassifications

Certain reclassifications of previously reported amounts have been made to conform to the current period presentation. These classifications had no effect on the previously reported net loss.

Geographic and Segment Information

ASC 280-10, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the manner in which public companies report information about operating segments in annual and interim financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The method for determining what information to report is based on the way management organizes the operating segments within the Company for making operating decisions and assessing financial performance. The Company’s chief operating decision-maker is considered to be the Company’s chief executive officer (“CEO”). The CEO reviews financial information presented on an entity level basis accompanied by disaggregated information about revenues by product type and certain information about geographic regions for purposes of making operating decisions and assessing financial performance. The entity level financial information is identical to the information presented in the accompanying consolidated statements of operations.

The Company has two groups of products and services - Security (PinPoint™) and Healthcare (Signature Mapping™ Medical Computer Aided Detection (“Medical CAD”)), and operates in three geographic markets. The Company has determined that as of the balance sheet date, it operates as a single operating unit since the two products make up a slight revenue stream to the Company.

The Company operates in North America, Africa, and Asia. In general, revenues are attributed to the country in which the contract originates. There were no revenue for the first three months ended March 31, 2011, and the same period ended March 31, 2010 was $13,665 from research activities of our security product/services.


Segment and Geographic Information	Three Months Ending March 31
	2011	2010
Net revenues:
The Americas:
Software licenses	$ -	$ -
Research funding	-	13,665
Maintenance and support	-	-
The Americas	-	13,665

United Kingdom:
Software licenses	-	-
Research funding	-	-
Maintenance and support	-	-
United Kingdom	-	-
Total net revenues	$ -	$ 13,665

Cost of sales:
The Americas:
Software licenses	$ -	$ -
Research funding	-	13,777
Maintenance and support	-	-
The Americas	-	13,777



United Kingdom:
Software licenses	-	-
Research funding	-	-
Maintenance and support	-	-
United Kingdom	-	-
Total cost of sales	$ -	$ 13,777

Operating (loss):
The Americas:
Software licenses	$ (864,993)	$ (1,420,723)
Research funding	-	(4,011)
Maintenance and support	-	-
The Americas	(864,993)	(1,424,734)

United Kingdom:
Software licenses	-	-
Research funding	-	-
Maintenance and support	-	(324)
United Kingdom	-	(324)
Total operating (loss)	$ (864,993)	$ (1,425,058)

Depreciation and amortization:
The Americas:
Software licenses	$ 24,151	$ 27,811
Research funding	-	-
Maintenance and support	-	-
The Americas	24,151	27,811

United Kingdom:
Software licenses	-	-
Research funding	-	-
Maintenance and support	-	324
United Kingdom	-	324
Total depreciation and amortization	$ 24,151	$ 28,135

Total assets:
The Americas	$ 820,673	750,908
United Kingdom	-	8,425
Total	$ 820,673	$ 759,333

Long-lived assets, net:
The Americas	$ 632,665	648,452
United Kingdom	-	5,938
Total	$ 632,665	$ 654,390

Long-lived assets, net: Consists of software, goodwill, patents, property and equipment, and other noncurrent assets.

Stock-Based Compensation

The Company has two active equity compensation plans which include the Amended and Restated 2003 Stock Incentive Plan and the 2009 Stock Compensation Plan (collectively, the “Plans”). A total of 50,000,000 shares have been reserved for issuance under these Plans in the form of stock-based awards to employees, non-employee directors and outside consultants of the Company, of which 28,078,023 shares remain available for issuance thereunder as of March 31, 2011. The grant of awards under the Plans require approval by the Compensation Committee of the Board of Directors of the Company (or the Board of Directors, in the absence of such a committee) (the “Committee”), and the Committee is authorized under the Plans to take all actions that it determines to be necessary or appropriate in connection with the administration of the Plans.

The Company adopted the provisions of ASC 718-10, “Share-Based Payment” to account for its share-based payments. ASC 718-10 requires all share-based payments to employees or to non-employee directors as compensation for service on the Board of Directors to be recognized as compensation expense in the consolidated financial statements based on the estimated fair values of such payments, and the related expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures. The Company’s estimated forfeiture rates are based on its historical experience within separate groups of employees. The fair value of each option granted was estimated on the date of grant using the Black-Scholes Merton option pricing

model (Black-Scholes model). In accordance with ASC 718-10, the Company recognized total stock-based compensation expense for employees and non-employee members of the Board of Directors for the three months ended March 31, 2011 of $129,969, and $438,335 for the same period during 2010. All options granted during the three months ended March 31, 2011 were at fair value, and the related compensation expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures.

The Company accounts for stock options granted to non-employees in accordance with ASC 718-10 and ASC 505-50, “Accounting For Equity Instruments That Are Issued To Other Than Employees For Acquiring, Or In Conjunction With Selling, Goods Or Services.” ASC 505-50 establishes the measurement principles for transactions in which equity instruments are issued in exchange for the receipt of goods or services. The Company has relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied, and recognizes as an expense the estimated fair value of such options as calculated using the Black-Scholes model. The fair value is remeasured during the service period at each balance sheet date, and is amortized over the service period to vesting for each option or the term of the recipient’s contractual arrangement, whichever is shorter. The Company recognizes compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. The Company considers voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate. Total stock-based compensation expense for consultants during the three months ended March 31, 2011 and 2010 were $129,652 and $117,480, respectively. All options granted during the three months ended March 31, 2011 were at fair value, and the related compensation expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are not transferable. The fair value of each option granted was estimated on the date of grant using the Black-Scholes Merton option pricing model (Black-Scholes model) with the following weighted-average assumptions:


Black-Scholes Model Assumptions		2011	2010

Risk-free interest rate (1)		2.27%	3.01%
Expected volatility (2)		136.7%	134.3%
Dividend yield (3)		0.0%	0.0%
Expected life (4)		6.5 years	6.5 years

(1)	The risk-free interest rate is based on US Treasury debt securities with maturities similar to the expected term of the option.
(2)	Expected volatility is based on historical volatility of the Company*s stock factoring in daily share price observations.
(3)	No cash dividends have been declared on the Companys common stock since the Companys inception, and the Company currently does not anticipate paying cash dividends over the expected term of the option.

(4)	The expected term of stock option awards granted is derived from historical exercise experience under the Company*s stock option plan and represents the period of time that stock option awards granted are expected to be outstanding. The expected term assumption incorporates the contractual term of an option grant, which is usually ten years, as well as the vesting period of an award, which is generally pro rata vesting over two years.

The Amended and Restated 2003 Stock Incentive Plan

The Board of Directors adopted the 2003 Stock Incentive Plan on August 29, 2003. The plan may be modified or terminated at any time, and any such amendment or termination will not affect outstanding options without the consent of the optionee. The Board of Directors amended and restated the plan on December 2, 2003. The Amended and Restated 2003 Stock Incentive Plan (“2003 Plan”) was approved by the shareholders on February 13, 2004, pursuant to which it grants stock-based compensation in the form of options, which will result in the issuance of up to an aggregate of 30,000,000 shares of the Company’s common stock. The 2003 Stock Incentive Plan terminates on August 29, 2013. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The Plan provides for options which qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986, as well as the issuance of Non-Qualified Options, which do not so qualify. Pursuant to the terms of the 2003 Plan, the Company, as determined by the Board of Directors or a committee appointed by the Board, may grant Non-Qualified Stock Options (“NQSOs”) to its executive officers, non-employee directors, or consultants of the Company and its subsidiaries at any time, and from time to time. The 2003 Plan also provides for Incentive Stock Options (“ISOs”) to be granted to any officer or other employee of the Company or its subsidiaries at any time, and from time to time, as determined by the Board or selected by the committee appointed by the Board. Such stock options granted allow a grantee to purchase a fixed number of shares of the Company’s common stock at a fixed exercise price not be less than the quoted market price (or 110% thereof for Incentive Stock Options issued to a holder of 10% or greater beneficial ownership) of the shares on the date granted. The options may vest on a single date or over a period of time, but normally they do not vest unless the grantee is still employed by, or a director of, the Company on the vesting date. Generally for all employees, the options vest 50% after the first year from the date of grant and the remaining 50% after the second year from the date of grant. Stock options granted to independent board of directors vest 100% after the service period, which generally is one year from the date of grant.

Factors considered in granting stock options included: (i) the general policy during the past five, and in the foreseeable future, of not increasing base salaries of all employees, (ii) the performance of employees, (iii) the employees’ increasing responsibilities in a dynamic, and shrinking organization, and (iv) the accomplishments achieved by the Company during the prior year. The 2003 Plan has been the principal method for our employees and executive officers to acquire equity interests in the Company. We believe that the annual aggregate value of these awards should be set near competitive median levels for comparable companies. We may provide a greater portion of total compensation to our executives and employees through stock options given the general policy of not increasing base salaries in the foreseeable future. Our Compensation Committee administers the 2003 Plan based on the above factors, and the Committee approved the grant of stock options to all current employees, including its named executives, during 2007 through 2009 as an incentive for continued contributions in moving our product development efforts forward. Stock options were not granted to employees, including its named executives, during 2010 and the first three months of 2011 as the Company did not achieve the desired results during 2009 and 2010. Also, the Compensation Committee, based on management’s recommendation and discussions with the Committee, may grant stock options to new employees. There were no stock options granted to new employees during the first three months of 2011, since there were no new employees hired during this period.

Options granted under the Plan must be evidenced by a stock option agreement in a form consistent with the provisions of the 2003 Plan. Each option shall expire on the earliest of (a) ten (10) years from the date it is granted, (b) sixty (60) days after the optionee dies or becomes disabled, (c) immediately upon the optionee's termination of employment or service or cessation of Board service, whichever is applicable, or (d) such date as the Committee shall determine, as set forth in the relevant option agreement; provided, however, that no ISO which is granted to an optionee who, at the time such option is granted, owns stock possessing more than ten (10) percent of the total combined voting power of all classes of stock of the Company or any of its subsidiaries, shall be exercisable after the expiration of five (5) years from the date such option is granted.

To exercise an option, the 2003 Plan participant, in accordance with the relevant option agreement, must provide the Company a written notice setting forth the number of options being exercised and their underlying shares, and tender an amount equal to the total exercise value of the options being exercised. The right to purchase shares is cumulative so that once the right to purchase any shares has vested; those shares or any portion of those shares may be purchased at any time thereafter until the expiration or termination of the option. ISOs and NQSOs that are not exercised in accordance with the terms and provisions of the stock option agreement will expire as to any then unexercised portion. Stock options that expire, are cancelled, or forfeited will again become available for issuance under the 2003 Plan as described below. The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction. The shares issued by the Company under the 2003 Plan may be either treasury shares or authorized but unissued shares as the Company’s board of directors or the Compensation Committee may determine from time to time. Except as specifically provided in an option agreement, options granted under the 2003 Plan may not be sold, pledged, transferred or assigned in any way, except by will or by the laws of descent and distribution, and during the lifetime of a participant to whom the ISOs is granted, and the ISOs may only be exercised by the participant.

The Compensation Committee did not grant any stock options under the 2003 Plan during the three months ended March 31, 2011. As of March 31, 2011, the Company has reserved under the 2003 Plan, 15,850,531 shares to be issued upon exercise of outstanding options, and 12,255,969 shares were available for future awards. Compensation expense for stock options granted is recognized over the requisite service period, which is typically the period over which the stock-based compensation awards vest. In anticipation of implementation of SFAS 123R, we accelerated the vesting of the outstanding options in December 2005, prior to adopting SFAS 123R. We applied the guidance of SAB 107 in conjunction with the adoption of SFAS 123R. This acceleration was for all employees, including the named executive officers.

On April 24, 2010, the Company’s Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options to purchase an aggregate of 10,552,921 shares of common stock, $.001 par value per share (“Common Stock”), of the Company previously granted to officers, directors, employees and consultants of the Company (the “Outstanding Options”) pursuant to the Company’s Amended and Restated 2003 Stock Incentive Plan. The Compensation Committee re-priced the Outstanding Options to a price equal to the mean between the closing bid and asked quotations for the Company’s Common Stock on April 26, 2010, as reported on the OTC Bulletin Board, the quotation service for the Company’s shares of Common Stock, namely, $0.30 per share. The Outstanding Options had been issued with exercise prices ranging from $0.43 to $5.27 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant. The Compensation Committee re-priced the Outstanding Options as compensation for the hardship of each optionee not regularly receiving his or her salary, wages, or other compensation due during the period April 6, 2006, through and including the present and ongoing, and the continued or continuing non-payment of such amounts by the Company. The Compensation Committee determined that such action was in the best interest of the Company and its stockholders.

Stock Options Exercised under the 2003 Plan

During 2011, an employee exercised an aggregate of 101,000 stock options that resulted in the aggregate issuance of 101,000 shares of common stock for cash proceeds to the Company of $30,300. Common stock was increased by $101 for the par value of the shares and paid-in capital increased by $30,199.

Summary of stock option activity under the 2003 Plan for the three months ended March 31, 2011 issued to employees, non-employee members of the Board of Directors and consultants is as follows:


Fiscal Year and Activity	Weighted- Average Exercise Price	Number of Options



Outstanding December 31, 2010	$ 0.32	16,394,681

Fiscal 2011 activity
Granted	-	-
Exercised ($0.30)	0.30	(101,000)
Cancelled ($0.30)	0.30	(443,150)
Outstanding March 31, 2011	$ 0.32	15,850,531

Stock options available for grant		12,255,969

The following table summarizes additional information about the 2003 Plan stock options outstanding at March 31, 2011:


Issued and Outstanding				Exercisable
Type of Option and Range of Exercise Prices	Number of Options	Weighted-Average Remaining Contractual Life (Yrs)	Weighted-Average Exercise Price	Number of Options	Weighted-Average Price
Nonqualified Stock Options $0.30 (1) (5)	1,542,000	2.7	$ 0.30	1,542,000	$ 0.30
Nonqualified Stock Options $0.30 (2) (5)	44,000	3.8	0.30	44,000	0.30
Incentive Stock Options $0.15 - $4.05 (3)	802,042	4.3	0.85	719,592	0.92
Incentive Stock Options $0.15 - $0.30 (4) (5)	13,462,489	6.7	0.29	11,279,929	0.29
Total	15,850,531	6.2	$ 0.82	13,585,521	$ 0.32

(1) Issued to employees below fair value and during the period of May 2003 through February 2004.
(2) Issued to directors below fair value and during the period of February 2004 through September 2005.
(3) Issued to consultants at fair value.
(4) Issued to directors and employees at fair value, or above fair value for those individuals with greater than 10% beneficial ownership.
(5) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010.

The 2009 Stock Compensation Plan

On June 4, 2009, the Board of Directors adopted the 2009 Stock Compensation Plan (“2009 Plan) which provides for the grant or issuance of up to an aggregate of 20,000,000 shares of the Company’s common stock pursuant to non-qualified stock options (“NQSOs”), restricted stock awards (“RSAs”), restricted stock rights (“RSRs”), or common stock awards (“Common Stock Awards”) (a NQSO, RSA, RSR or Common Stock Award, individually, an “Award;” collectively, “Awards”). The exercise price of NQSOs may not be less than 100% of the fair market value of the stock on the date of the option grant, and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement, but may not be exercised after ten years from the date on which it was granted. RSAs and RSRs consist of a specified number of shares of the Company’s Common Stock that are, or may be, subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Committee. Generally, unless the Committee determines otherwise, once the restricted stock vests, the shares of Common Stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions, under a RSA (but not a RSR), a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock Awards. Compensation expense for these Awards is recognized over the period they vest, although generally Common Stock Awards vest immediately, while the RSAs, RSRs and NQSOs will have a vesting period.

The purpose of the 2009 Plan is to foster our success and the success of our subsidiaries and affiliates by providing incentives to employees, directors, officers and consultants to promote our long-term financial success. The Plan complements our 2003 Amended and Restated Stock Incentive Plan (the “2003 Plan”) and provides greater flexibility to us in that it permits us to compensate and award employees, directors, officers and consultants through the issuance of certain options, RSAs, RSRs, and stock awards in addition, or as an alternative, to the incentive and non-qualified stock options that may be awarded under the 2003 Plan. The 2009 Plan terminates on June 4, 2019, and no award may be made after that date, however, awards made before that date may extend beyond that date. If an award under the 2009 Plan is cancelled, expires, forfeited, settled in cash or otherwise terminates without being exercised in full, the shares of common stock not acquired pursuant to the award will again become available for issuance under the 2009 Plan.

Our Board of Directors has delegated its authority to administer the 2009 Plan to the Compensation Committee. Subject to the provisions of the 2009 Plan, the committee has the power to:

Prescribe, amend, and rescind rules and regulations relating to the 2009 Plan and to define terms not otherwise defined therein;

Determine which persons are eligible to participate, to which of such participants, if any, awards shall be granted, and the timing of any such awards;

Grant awards to participants and determine the terms and conditions thereof, including the number of shares subject to awards and the exercise or purchase price of such shares and the circumstances under which awards become exercisable or vested or are forfeited or expire;

Establish any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any award;

Prescribe and amend the terms of the agreements or other communications evidencing awards made under the 2009 Plan (which need not be identical) and the terms or form of any document or notice required to be delivered to us by participants under the 2009 Plan;

Determine the appropriate adjustment, if any, required as a result of any reorganization, reclassification, combination of shares, stock split, reverse stock split, spin-off or dividend (other than regular, quarterly cash dividends), or other changes in the number or kind of outstanding shares or any stock or other securities into which such shares shall have been exchanged;

Interpret and construe the 2009 Plan, any rules and regulations under the 2009 Plan and the terms and conditions of any award granted thereunder, and to make exceptions to any such provisions in good faith and for the benefit of the Company; and

Make all other determinations deemed necessary or advisable for the administration of the 2009 Plan.

Unless the Board expressly provides otherwise prior to a change of control or in an award agreement, in the event of a change of control of the Company, all outstanding options under the 2009 Plan vest and become exercisable on the date immediately before the change of control and all restrictions under RSAs and RSRs shall lapse or be deemed satisfied on the date immediately prior to the change of control. A change of control is deemed to have occurred upon the occurrence of one of the following events: (i) any person or group of persons becomes the beneficial owner of shares of the Company to which 50% or more of the total number of votes for the election of directors may be cast; (ii) as a result of a cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, persons who were directors immediately prior to the event cease to constitute a majority of the board; (iii) stockholders approve an agreement providing either that the Company will cease to be an independent publicly owned corporation or for sale or other disposition of all or substantially all the assets of the Company; or (iv) a tender offer or exchange offer is made for shares of our common stock (other than one made by us) and shares of common stock are acquired.

The Compensation Committee determines all awards to non-employee directors and such awards are not subject to management’s discretion. From time to time, the committee will set the amount and the type of award that will be granted to non-employee directors on a periodic, nondiscriminatory basis, including pursuant to any plan adopted by the Compensation Committee or Board for the compensation of non-employee directors. The committee may set additional awards to be granted to non-employee directors also on a periodic, nondiscriminatory basis based on one or more of the following criteria: (i) service as the chair of a Board committee; (ii) service as chairman of the Board; (iii) the number or type of Board committees on which a director serves; or (iv) the first selection or appointment of an individual to the Board.

Non-qualified stock options may be granted pursuant to non-qualified stock option award agreements and certificates adopted by the Board, as amended by the Compensation Committee. The Compensation Committee determines the terms of each stock option granted under the 2009 Plan, including the number of shares covered by an option, exercise price and means of payment, the vesting and exercisability of the option, and restrictions on transfer and the term. The exercise price of an option granted under the Plan may not be less than the fair market value on the date of grant. The options expire on the earliest of ten years after the date of grant, 90 days after the death or disability of the recipient, immediately upon termination of employment or service other than by death or disability, or such date as the Compensation Committee determines. The Compensation Committee, in its sole discretion, may change by agreement the post-termination rights of a recipient, including accelerating the date or dates on which the option becomes vested and is exercisable following termination of employment or service, or extend the period. Options granted under the plan may be

exercised by delivering cash, a cashless exercise, or by delivering to us the proceeds of shares of our common stock issuable under an option.

An award of restricted stock awards consists of a specified number of shares of our common stock that are subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Compensation Committee. Prior to the termination of the restrictions, a participant may vote and receive dividends on the restricted stock unless the committee determines otherwise, but may not sell or otherwise transfer the shares.

An award of restricted stock rights entitles a participant to receive a specified number of shares of our common stock upon the expiration of a stated vesting period. It may also include the right to dividend equivalents if and as so determined by the committee. Unless the committee determines otherwise, once a RSR vests, the shares of common stock specified in the award will be issued to the participant. A participant who has been awarded RSRs may not vote the shares of common stock subject to the rights until the shares are issued. Until the vesting period applicable to a RSRs award expires and the shares are issued, the participant also may not transfer or encumber any interest in the RSRs or in any related dividend equivalents.

The Compensation Committee may also make stock awards of common stock without restrictions, except that if the award is in lieu of salary, service fee, cash bonus or other cash compensation, the number of shares covered by an award shall be based on the fair market value of such shares on the date of grant. The Compensation Committee has discretion to determine the terms of any award of restricted stock or RSRs, including the number of shares subject to the award, and the minimum period over which the award may vest, and the acceleration of any vesting in the event of death, disability or change of control, as discussed above with regard to options. Awards are not transferable or assignable unless provided otherwise by the Compensation Committee with respect to certain specified family-related transfers.

The Board may amend, terminate, or modify the 2009 Plan at any time, without shareholder approval, unless required by the Internal Revenue Code of 1986, pursuant to Section 16 under the Securities Exchange Act of 1934, as amended, or by any national securities exchange or system on which our common stock is then listed or reported, or by any regulatory body.

The following is a summary of the number and type of awards granted to, or exercised or forfeited by, employees, non-employee members of the Board of Directors and consultant pursuant to the Company’s 2009 Stock Compensation Plan for the three months ended March 31, 2011.


	Weighted-Average Grant or Exercise Price Per Share


Fiscal Year and Activity		Number of Shares
Reserved for future issuance as of December 31, 2010		15,929,563

Fiscal 2011 activity:
Common stock awards	$ 0.29	107,509
Restricted stock awards	-	-
Restricted stock rights	-	-
Non-qualified stock options	-	-
Issued during 2011	0.19	107,509

Reserved for future issuance as of March 31, 2011		15,822,054

Stock options or restricted stock rights outstanding		-

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation. For financial statement purposes, depreciation is provided on the straight-line method over the estimated useful life of the asset ranging from 3 to 10 years.


	(Unaudited)
Asset (Useful Life)	March 31, 2011	December 31, 2010

Software (3 years)	$ 84,224	$ 84,224
Computer equipment (3 to 5 years)	329,861	324,991
Furniture and fixtures (7 to 10 years)	488,239	488,239
Equipment (7 to 10 years)	79,627	79,627
	981,951	977,081
Less accumulated depreciation	708,697	690,309
Equipment, net	$ 273,254	$ 286,772

Depreciation expense for property and equipment was $18,389 and $22,804 in the three months ended March 31, 2011 and 2010, respectively, and is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.

Goodwill and Other Intangible Assets

Intangible Assets – Intangible assets consist of acquired software and patents. Under ASC 350, “Goodwill and Other Intangible Assets,” such assets acquired including software technology is considered to have a finite life. Management has estimated the useful life to be 5 years and amortized such costs on a straight-line basis over this period. In addition, ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” requires the Company to consider whether or not the software technology is impaired using a net realizable value analysis based on projected discounted cash flows. The Company prepared this analysis as of March 31, 2011, and concluded that the intangible assets are not impaired. Patent acquisition costs pertaining to the Company’s 3i technology that covers its PinPoint™ and Signature Mapping™ intellectual property (technology not acquired through acquisition), have been capitalized and are being amortized over the 20-year legal life of the patents. The Company has been granted by the United States Patent & Trademark Office (“USPTO”) five patents related to its 3i technology. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. The Company’s intangible acquired software technology was fully amortized as of December 31, 2009. Therefore, there was no amortization costs associated with acquired software during the three months ended March 31, 2011 and 2010, respectively. Amortization expense for patent acquisition costs was $5,762 and $5,331 during the three months ended March 31, 2011 and 2010, respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations. The Company anticipates incurring additional patent acquisition costs during 2011.

Excess of Purchase Price over Net Assets Acquired (Goodwill) – The Company follows the provisions of ASC 805-10, “Business Combinations” and ASC 350-10, “Goodwill and Other Intangible Assets.” These statements establish financial accounting and reporting standards for acquired goodwill. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. Effective January 1, 2002, with the adoption of ASC 350-10, goodwill must be evaluated for impairment and is no longer amortized. Excess of purchase price over net assets acquired (“goodwill”) represents the excess of acquisition purchase price over the fair value of the net assets acquired. To the extent possible, a portion of the excess purchase price is assigned to identifiable intangible assets. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2010 and the three months ended March 31, 2011, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years. Therefore, there was no amortization expense of goodwill during the three months ending March 31, 2011 or during the same period in 2010.

Impairment of Excess Purchase Price over Net Assets Acquired – The Company follows the provisions of ASC 350-10 “Goodwill and Other Intangible Assets” for the impairment of goodwill. The Company determines impairment by comparing the fair value of the goodwill, using the undiscounted cash flow method, with the carrying amount of that goodwill. Impairment is tested annually or whenever indicators of impairment arise. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2010 and the three months ended March 31, 2011, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years.

Impairment of Long-Lived Assets – The Company evaluates the carrying value of long-lived assets for impairment, whenever events or changes in circumstances indicate that the carrying value of an asset within the scope of ASC 360-10, “Accounting of the Impairment or Disposal of Long-Lived Assets” may not be recoverable. The Company’s assessment for impairment of assets involves estimating the undiscounted cash flows expected to result from use of the asset and its eventual disposition. An impairment loss recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset, and considers year-end the date for its annual impairment testing.


	Three Months Ended March 31, 2011
	Beginning Period Cost	Additions	Reductions	Net Book Value
Intangibles with finite lives:
Software technology	$ -	$ -	$ -	$ -
Patent acquisition costs	365,173	-	5,762	359,411
	$ 365,173	$ -	$ 5,762	$ 359,411

Recently Issued Accounting Pronouncement

In December 2010, the Financial Accounting Standards Board (“FASB”) amended its authoritative guidance related to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more-likely-than-not that goodwill impairment exists. In determining whether it is more-likely-than-not that goodwill impairment exists, consideration should be made as to whether there are any adverse qualitative factors indicating that an impairment may exist. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB amended its authoritative guidance related to business combinations entered into by an entity that are material on an individual or aggregate basis. These amendments clarify existing guidance that if an entity presents comparative financial statements that include a material business combination, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance becomes effective prospectively for business combinations for which the acquisition date is on or after the first day of the Company’s fiscal 2012. This disclosure-only guidance will not have a material impact on the Company’s results of operations, financial position or cash flows.

In May 2010, the Financial Accounting Standards Board (“FASB”) amended its authoritative guidance related to foreign currency issues that were discussed at the FASB’s Emerging Issues Task Force (“EITF”) meeting in March 2010 where the staff of the U.S. Securities and Exchange Commission (“SEC”) announced temporary guidance on certain exchange rate issues. Prompted by the use of multiple currency exchange rates in Venezuela, the use of different rates for remeasurement and translation purposes has caused reported balances for financial reporting purposes and the actual U.S. dollar denominated balances to be different. The SEC staff indicated that any differences between the amounts reported for financial reporting purposes and actual U.S. dollar denominated balances that may have existed prior to the application of highly inflationary accounting requirements on January 1, 2010 should be recognized in the income statement upon adoption, unless the issuer can document that the difference was previously recognized as a cumulative translation adjustment (“CTA”), in which case the difference should be recognized as an adjustment to CTA. The adoption of this guidance, effective March 31, 2010, did not have a material impact on the Company’s consolidated financial statements.

In February 2010, the Financial Accounting Standards Board (“FASB”), issued ASU No. 2010-09, “Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements”, whereby it amended its authoritative guidance related to subsequent events to alleviate potential conflicts with current United States Securities and Exchange Commission (“SEC”) guidance. Effective immediately, these amendments remove the requirement that an SEC filer disclose the date through which it has evaluated subsequent events. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the Company adopted FASB ASU No. 2010-06, “Fair Value Measurement and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”). These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require new disclosures of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. These new disclosures are effective beginning with the first interim filing in 2010. The disclosures about the rollforward of information in Level 3 are required for the Company with its first interim filing in 2011. The Company does not believe this standard will impact their financial statements.

Other ASU’s that have been issued or proposed by the FASB ASC that do not require adoption until a future date and are not expected to have a material impact on the financial statements upon adoption.

(3)

Financial Condition, Going Concern Uncertainties and Events of Default

certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in our annual report on Form 10-K for the year ended December 31, 2010, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.

Our outstanding Series A 10% Senior Convertible Debentures originally became due on November 7, 2008. On October 15, 2010, we entered into an agreement with our two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the amendment agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in lieu of and in exchange for the payment in cash of amounts of accrued but unpaid regular interest, additional interest and late fees, liquidated damages and certain other amounts due under the debentures (“Interest and Default Amounts”), the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (“Defaults”) under the debentures and debenture transaction documents would be waived and the Company was released from any claims with respect thereto, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures if our common stock equals or exceeds certain price and volume conditions. There were no such conversions of our debentures during the three months ended March 31, 2011.

As of March 31, 2011, we have outstanding trade and accrued payables of $1,165,400, other accrued liabilities of $485,063, and accrued salaries due to our employees and management of $5,210,825. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $96,400.

During February 2010, the Company sold securities for gross proceeds of $200,000 (or $197,000, net of commission and expenses of $3,000) to certain accredited investors at a series of closings, and issued an aggregate of 800,000 shares of common stock, and 800,000 Class Q Warrants. The Class Q Warrants are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance. Also, on February 23, 2011, the Company executed a Securities Purchase Agreement, (the “SPA”), with an institutional accredited investor for an investment up to $1,000,000. Subsequently on February 24, 2011, the Company sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance; contain piggyback registration rights, a cashless exercise provision, and certain anti-dilution and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor. The institutional investor has agreed to purchase additional shares if pre-established stock price and volume conditions are met during the eight months following the closing. The stock price and volume conditions for the second and third closings were not met, and there can be no assurance our shares will satisfy such conditions in connection with any subsequent closing.

As of March 31, 2011, we had a cash balance of $87,764. Management believes these funds to be insufficient to fund our operations for the next twelve months absent any cash flow from operations or funds from the sale of our equity or debt securities. Currently, we are spending or incurring (and accruing) expenses of approximately $325,000 per month on operations and the continued research and development of our 3i technologies and products, including with regard to salaries and consulting fees. Management believes that we will require aggregate of approximately $3,900,000 to fund our operations for the next 12 months and to repay certain outstanding trade payables and accrued expenses. This assumes that holders of our outstanding debentures convert such debt into shares of our common stock or that we are able to extend the term of the debentures, of which there can be no assurance. In the event we are unable to extend the term of the debentures beyond their new maturity date, the debenture holders do not convert such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.

our stock, we may have limited or no access to the capital markets. Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

During Fiscal 2011, our total stockholders’ deficit decreased by $1,123,787 to $9,040,728 and our consolidated net income was $147,930 for the three months ended March 31, 2011, mainly due to the change in the fair value of the derivative liability that increased net income by $1,012,923. Notwithstanding the foregoing discussion of management’s expectations regarding future cash flows, Applied Visual Sciences’ insolvency continues to increase the uncertainties related to its continued existence. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.

(4)

Acquisitions

Acquisition of Certain Assets of Difference Engines

On October 23, 2003, the Company entered into an agreement with Difference Engines Corporation (Difference Engines), a Maryland corporation, pursuant to which Applied Visual Sciences agreed to purchase certain intellectual property (IP) owned by Difference Engines, including but not limited to certain compression software technology, described as Difference Engine’s Visual Internet Applications or DEVision, as well as title and interest in the use of the name and the copyright of Difference Engines.

Under the terms of an Asset Purchase Agreement, Applied Visual Sciences issued 587,000 shares of its common stock as consideration for the purchase of the IP from Difference Engines Corporation. The 587,000 shares of common stock were subject to a two (2) year lock up. Upon expiration of the two (2) year lock up period, in the event that the shares are not eligible for resale under “Rule 144” and have not been registered under the Securities Act, the holder of the shares may demand redemption of the shares. The redemption price is to be calculated on the basis of the average of the closing bid and asked prices of Applied Visual Sciences’ common stock for the twenty (20) consecutive business days ending on the day prior to the date of the exercise of the holder’s right of redemption. Under SEC Accounting Series Release (“ASR”) 268, “Presentation in Financial Statements of ‘Preferred Redeemable Stock’,” such freestanding financial instruments are to be classified as temporary equity and measured at the value of the redemption right. The initial redemption value of the common stock issued in the Difference Engines asset purchase was calculated at $2,044,228 and reclassified from permanent equity to temporary equity. As shares of common stock are sold by the holders and/or the Company registers its outstanding shares of common stock, the then current fair value of those shares, based on the redemption value, shall be reclassified from temporary equity to permanent equity.

Since the acquisition of the intellectual property, the cumulative effect on the temporary equity account for the change in the estimated redemption value of the outstanding shares held by the shareholders of Difference Engines Corporation was reduced by $1,309,496, and further reduced by $635,786 due to the sale of the Company’s stock previously held by the shareholders of Difference Engines Corporation. On March 31, 2011, prior to remeasurement, the balance of the temporary equity account for the purchase of the intellectual property owned by Difference Engines was $98,946. The lock up period expired and the shares are eligible for resale under Rule 144. The Company therefore considered ASU 2009-04 “Accounting for Redeemable Equity Instruments” and on March 31, 2011, reclassified the carrying value of the redemption, or $98,946, from temporary equity to permanent equity.

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Stockholders’ Equity

Issuance of Common Stock and Related Common Stock Warrants

During February 2011, the Company sold to accredited investors an aggregate of 800,000 shares of common stock and 800,000 Class Q Warrants for gross proceeds of $200,000 ($197,000, net of commissions and expenses in the amount of $3,000). The Class Q Warrants are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance. Common stock was increased by $800 for the par value of the shares and $196,200 to paid-in capital.

On February 23, 2011, the Company executed a Securities Purchase Agreement, (the “SPA”), with an institutional accredited investor for an investment up to $1,000,000. Subsequently on February 24, 2011, the Company sold to an institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 Class CSF common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance; contain piggyback registration rights, a cashless exercise provision, and certain anti-dilution and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor. The institutional investor has agreed to purchase additional shares if pre-established stock price and volume conditions are met during the eight months following the closing. The stock price and volume conditions for the second and

third closings were not met, and there can be no assurance our shares will satisfy such conditions in connection with any subsequent closing. Common stock was increased by $600 for the par value of the shares and $135,400 to paid-in capital.

Other Common Stock Issued Including Exercises of Warrants and Options

On February 24, 2011, an employee converted $11,340 of accrued and unpaid wages for 42,000 shares of common stock. Common stock was increased by $42 for the par value of the shares, paid-in capital was increased by $11,298, and accrued wages was reduced by the fair value of the stock of $11,340.

From January 31 – February 7, 2011, the Company issued to a vendor 89,355 shares of common stock as final payment towards an outstanding accounts payable, with the fair value of the common stock of $29,487, and another vendor accepted 678,861 shares of common stock as full payment towards an outstanding accounts payable, with the fair value of the common stock of $213,163. Common stock was increased in the aggregate of $768 for the par value of the shares, paid-in capital was increased in the aggregate of $241,882, and accounts payable trade was reduced in the aggregate by the fair value of the stock of $242,650.

During January through March 2011, the Company issued to two (2) consultants an aggregate of 65,509 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $66 for the par value of the shares and paid-in capital was increased by approximately $19,656. Stock compensation expense of $19,722 was also recorded.

On January 4, 2011, the Company issued to consultant 175,000 shares of common stock as compensation for services rendered. Common stock was increased by $175 for the par value of the shares, paid-in capital was increased by $66,325, and stock compensation expense of $66,500 was recorded.

Other Common Stock Warrants Issued or Forfeited

The Company has issued warrants as compensation to its bridge note holders, placement agents and other consultants, as well as to incentivize investors in each of the Company’s private placement financings. The table below shows by category, the warrants issued and outstanding at March 31, 2011.


Common Stock Purchase Warrants	Number of Warrants Outstanding and Exercisable	Date Warrants are Exercisable	Exercise Price	Date Warrants Expire
Note and debenture holders	142,652	December 2003	$ 0.75	June 2011
	53,334	April 2004	0.75	June 2011
	600,000	August 2006	1.60	August 2011
	1,312,056	November 2006	0.25	November 2011
	1,362,057	April 2007	0.25	April 2012
	243,666	April 2007	1.60	April 2011
	10,000	December 2007	0.70	December 2012
	18,293	February 2009	0.41	February 2014
	1,140,555	June 2009	0.25	November 2011
	1,140,554	June 2009	0.25	April 2012
	150,000	January 2010	0.25	January 2015
	78,750	September 2010	0.25	September 2015
	6,251,917

Private placement investors	8,000	May 2007	0.75	June 2011
	864,798	July 2007	1.17	July 2012
	312,500	August 2007	0.80	December 2011
	937,500	August 2007	1.75	August 2012
	1,500,000	February 2008	0.70	February 2013
	214,285	March 2008	0.75	March 2013
	2,142,850	April 2008	0.70	April 2013
	2,682,553	Sept to Dec 2008	0.41	Sept to Dec 2013
	4,358,981	Jan to April 2009	0.41	Jan to April 2014
	1,050,000	June to July 2009	0.25	June to July 2014
	3,631,973	August 2009	0.25	July to Dec 2013
	214,285	September 2009	0.41	December 2012
	2,499,007	Oct to Dec 2009	0.25	Oct to Dec 2014
	3,299,568	March to June 2010	0.25	March to June 2015


	3,881,907	July to Sept 2010	0.25	July to September 2015
	5,301,345	Oct to Dec 2010	0.25	Oct to December 2015
	400,000	Nov to Dec 2010	0.50	Nov to December 2013
	800,000	February 2011	0.25	February 2014
	600,000	February 2011	0.25	February 2016
	34,699,552

Placement agents	311,760	November 2006	0.25	November 2011
	311,760	April 2007	0.25	April 2012
	47,564	July 2007	1.17	July 2012
	198,154	June 2009	0.25	November 2011
	198,154	June 2009	0.25	April 2012
	272,827	June 2009	0.45	June 2014
	108,000	July 2009	0.25	July 2014
	205,000	December 2009	0.28	December 2014
	72,000	February 2011	0.25	February 2016
	1,725,219

Consultants	60,000	February 2008	0.54	February 2013
	200,000	December 2009	0.25	December 2014
	63,000	June to August 2009	0.25	June to August 2014
	14,000	August 2010	0.25	August 2015
	14,000	September 2010	0.28	September 2015
	128,000	December 2010	0.50	December 2013
	479,000

Total Warrants Issued/Outstanding	43,155,688

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Subsequent Events

Subsequent events are reported by the Company to disclose events that have occurred after the balance sheet date, but before the financial statements are issued. Such events may be to provide additional information about conditions that existed at the date of the balance sheet, or conditions that did not exist at the balance sheet date. The Company has evaluated subsequent events through the date of this report.

On April 19, 2011, the Company completed the processing and analysis of 985 tuberculosis sputum cases (slides) using the fully automated Signature Mapping TBDx™ for the South African National Laboratory Services (“NHLS”) clinical trial, and submitted our performance results to the London School of Medicine for tabulation, analysis, and reporting against the performance of culture and two human readers.

On April 20, 2011, the Company issued to a consultant an aggregate of 123,139 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $123 for the par value of the shares and paid-in capital was increased by approximately $20,667. Stock compensation expense of $20,790 was also recorded.

On April 25, 2011, an employee exercised 105,882 stock options that resulted in the issuance of 105,882 shares of common stock for cash proceeds to the Company of $31,765. Common stock was increased by $106 for the par value of the shares and paid-in capital increased by $31,659.

(7)

Fair Value Measurement

The Company determines the fair value of its derivatives that are classified as liabilities, on a recurring basis using significant unobservable inputs. The fair value measurement of these liabilities is consistent with ASC 820, "Fair Value Measurements" ASC 820 did not have an impact on the consolidated financial position or results of operations; however, the required disclosure for the year ended March 31, 2011 is as follows:


Liabilities Measured at Fair Value	Convertible Notes and Debentures, Net of Discount (1)	Embedded Conversion Feature of Debentures (2)	Total




Beginning balance as of December 31, 2010	$ 1,688,205	$ 2,228,431	$ 3,916,636
Revaluation (gain) loss of event of default provision	-	(1,012,923)	(1,012,923)
Ending balance as of March 31, 2011	$ 1,688,205	$ 1,215,508	$ 2,903,713

Total (gain) loss from revaluation of derivatives and event of default waived by holders included in earnings for the period and reported as an adjustment to interest

	$ -	$ (1,012,923)	$ (1,012,923)

(1) The balance as of March 31, 2011represents the outstanding convertible debentures issued November 8, 2006 and April 12, 2007.
(2) Represents the conversion feature of outstanding concertible debentures issued November 8, 2006 and April 12, 2007. The fair value of the conversion feature since May 20, 2009, the final milestone reset date of the debentures, was determined using market quotation.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

You should read the following summary together with the more detailed information and consolidated financial statements and notes thereto and schedules appearing elsewhere in this report. Throughout this report when we refer to the “Company,” “Applied Visual Sciences,” “we,” “our” or “us,” we mean Applied Visual Sciences, Inc., and its subsidiaries.

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. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, intangible assets, and contingencies. We base our estimates on historical experience, where available, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

Except for historical information, the material contained in this Management’s Discussion and Analysis is forward-looking. Our actual results could differ materially from the results discussed in the forward-looking statements, which include certain risks and uncertainties. These risks and uncertainties include the rate of market development and acceptance of our “intelligent imaging informatics” (“3i™”) technology (particularly for our PinPoint™ and Signature Mapping™ products), the unpredictability of our sales cycle, the limited revenues and significant operating losses generated to date, and the possibility of significant ongoing capital requirements.

Our independent registered public accounting firm’s report on the consolidated financial statements included herein for the years ended December 31, 2010 contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.

Overview

We were incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010. Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the “Company,” “Applied Visual,” “us,” “we,” or “our.”

By structuring in this manner, as a means to conduct business, we expect to realize the following benefits:

Creation of autonomous business units with defined measurable goals and objects;

Alignment of risk characteristics to the specific product, line of business or foreign market;

Provide a level of legal risk insulation to the core assets, the patents & intellectual property;

Flexibility to maximize tax benefits, both domestic & foreign activities;

Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships;

Facilitate the potential “spin-off” of one of the subsidiary entities;

Facilitate the potential sale of part of the company; and,

Attract investment from investors that focus on specific industries.

As of the date of this report, we were granted by the United States Patent & Trademark Office (“USPTO”) five patents related to our underlying 3i technology. We also have 11 pending patents applications (U.S. and foreign) and one U.S. provisional patent application further covering the implementation of our core 3i technology. We cannot provide assurance that any or all of the remaining patent applications will issue to patents or that they will not be challenged, or that rights granted to us would actually provide us with an advantage over our competitors. Prior art searches have been conducted and, based on the results of these searches; we believe that we do not infringe any third party patents identified in the searches.


Date Granted	Patent No.	Patent Description
February 17, 2009	7,492,937	System and Method for Identifying Objects of Interest in Image Data – for Signature Mapping™
February 24, 2009	7,496,218	System and Method for Identifying Objects of Interest in Image Data – for PinPoint™
October 19, 2010	7,817,833	System and Method for Identifying Feature of Interest in Hyperspectral Data
November 23, 2010	7,840,048	System and Method for Determining Whether There is an Anomaly in Data
March 15, 2011	7,907,762	Method of Creating a Divergence Transform for Identifying a Feature of Interest in Hyperspectral Data

or condition (“Defaults”) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. There were no such conversions of our debentures during the three months ended March 31, 2011. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures.

Please refer to and carefully consider the factors described in Part I, Item 1A - Risk Factors of our Form 10-K for the year ended December 31, 2010, and Part II, Item 1A – Risk Factors of this Report.

We offer two principal “intelligent imaging informatics” (“3i™”) products. They are as follows:

Aviation/Homeland Security Technology Solution - PinPoint™

Our PinPoint™ product is an “intelligent imaging informatics” (3i™) technology for the detection of guns, explosives, and other threat items contained in baggage in the airport environment or for building security applications. PinPoint™ can identify threat items, notify screeners of the existence of threat items, and speed the security process by eliminating unnecessary baggage checks, provide the screener with an instantaneous second opinion, and reduce processing time spent on false positives (baggage selected for security review that contains no threat items). We market and seek to license the PinPoint™ product primarily to the United States Transportation Services Administration (TSA) for use in airports, the Federal Protection Services for use in federal buildings and to foreign governments and airport authorities. We compete with manufacturers of baggage screening, luggage and large parcel screening, people screening for weapons and explosive detection, container and vehicle screening, and cargo screening equipment and certain software companies and academic institutions that are developing solutions to detect threat items. It is also our intent to distribute the product through various distribution methods.

The market for contraband detection systems is anticipated to become intensely competitive and many of our competitors are better capitalized and have greater marketing and other resources than Applied Visual Sciences, Inc. PinPoint™ continues to be developed to address the market for contraband detection. The extended alpha version working model of PinPoint™ has been tested successfully at live carry-on baggage checkpoints in three international airports. Integration within currently deployed manufacturers’ scanning equipment is a requisite to anticipated sales, and is considered a significant development risk. PinPoint™ is available for sale to customers; however no sales are anticipated until we are able to seamlessly integrate with the manufacturers’ scanning equipment.

Currently, there are limited standards within the aviation security marketplace for the testing and validation of software technology solutions. To date the marketplace has placed a premium on the newest innovations in hardware technology and has failed to grasp how a threat detection software solution can succeed.

A major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) is expected to open a path to both increase the interoperability of security equipment as well as provide a mechanism to use third party threat detection software as part of the screening solution. This enabling initiative is the Digital Imaging and Communications in Security (DICOS) standard, similar to the Digital Imaging and Communications in Medicine (DICOM) standard. With a defined standard for the output of each screening device, complimentary automated threat detection software can be appended to any x-ray equipment. Applied Visual Sciences, Inc co-chaired one of the three NEMA working groups drafting the DICOS standard, and the DICOS standard was published in October 2010.

As highlighted below in the NEMA article, “DICOS - Homeland Security Spending Keeps on Growing” - Published by HYPE, expenditures for security solutions are increasing. Management believes Applied Visual Sciences, Inc. is well positioned to be a third party solution provider leveraging the standard output of all future security equipment procured by the US Government. “Global homeland security spending has received a major boost in light of recent international terrorist events, as countries look at new ways to thwart terrorists and secure borders. Spending in the industry is expected to triple to $178 billion by 2015. Security-related spending will include more sophisticated information technology and the protection of other vulnerable terrorist targets. With the initial focus on airport security, NEMA has stepped up its outreach to DHS and TSA. Currently developing DICOS, the new NEMA standard will capture scans of checked baggage so that scans can be read by threat detection software. The new standard will facilitate interoperability of security-imaging equipment. With DHS/TSA expected to purchase new equipment for over 400 U.S. airports, NEMA members have joined with DHS to develop the standard. With Phase 1 of DICOS expected to be completed this year, NEMA has begun looking at other modalities. The security industry is looking at border, rail, seaport, industrial and nuclear plant security.”

Management believes that international market acceptance of PinPoint™ as a viable threat detection solution will not only enhance our ability to sell worldwide, but it will open additional opportunities for the development of PinPoint™ as the “intelligent image” analysis solution for areas such as military target acquisition, satellite remote sensing, and additional opportunities within aviation security such as whole-body scanners and cargo scanning. Additionally, we will seek support of the U.S. Congress and the

equipment manufacturers through lobbying and other efforts. We remain focused on the ongoing development of PinPoint™, particularly with respect to field test results as well as the promotion of DICOS as the medium for deployment. This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country. Market acceptance is a key to our future success.

We completed a funded research and development contract with the U.S. Department of Homeland Security (“DHS”). As part of the project, we have also entered into a Mutual Non-Disclosure Agreement with DHS. The scope of work is focused on the expansion of PinPoint’s™ capabilities to include the detection of certain TSA specified explosives for future deployment on both existing and future deployed scanners. We submitted proposals for locations within the U.S. that are designated ‘high threat targets” to provide PinPoint™ for private facility security. These opportunities would permit Applied Visual Sciences, Inc. to have deployed sites in a public facility as well as other advantages. We will continue to pursue opportunities for the deployment of our PinPoint™ product.

Healthcare Signature Mapping™ Solution

In an effort to expand upon the use of our core technology 3i™ “intelligent imaging informatics,” we are migrating and adopting our threat detection algorithms and quantitative imaging capabilities for use in the imaging field of diagnostic radiology and pathology. The technology is called Signature Mapping™. Our Signature Mapping™ platform technology represents the technological basis upon which we expect all diagnostic radiology and pathology applications will be developed. Any Signature Mapping™ product introduced in the United States may be subject to Food and Drug Administration (“FDA”) review and approval, including with regard to its safety and effectiveness before we may begin marketing and selling any such product in the U.S. Such approval may require us to obtain extensive data from clinical studies to demonstrate such safety or effectiveness. Within the international markets the regulatory requirements differ, specifically in South Africa, where we are testing our TBDx™ application for the detection of tuberculosis by analyzing digital images of auramine stained sputum slides captured through a photo microscopy system. There may be similar regulatory requirements in foreign countries in which we seek to market and sell our healthcare CAD products.

Similar to a person’s fingerprint, each tissue has a unique structure. Each structure creates a unique pattern or “signature” that can be extracted from an image to differentiate, locate, identify, and classify by using our Signature Mapping™ technology. Signature Mapping™ is expected to further help radiologists by visualizing the various structures within a particular tissue so they can be examined and quantified. This capability is expected to provide a next-generation image analysis, clarification, visualization and Signature Mapped ™ “tissue characterization” and detection. Management believes that it will add significant clinical value to a wide range of difficult to detect diseases in diagnostic radiology by distinguishing and characterizing different tissue types in images regardless of the modality that generated the image.

Based on its unique properties, Signature Mapping™ is expected to be capable of being used to analyze images generated across all imaging modalities without the need for new image capture hardware costs. It will serve as a software-based, multi-modality approach to image analysis when combined with Signature Mapping’s™ unique” tissue characterization” and detection. As a result, Signature Mapping™ is expected to differentiate the contrast resolution between different tissue types, even when the material or tissue in the image is very diffuse or obscured by other objects, such as is the case where diseased lung tissue is located behind a rib in an x-ray chest examination. It is capable of displaying these ‘signatures’ in a way that empowers radiologists to make a more informed and confident diagnosis, even for hard to distinguish structures such as masses in dense breast tissue.

Signature Mapping™ appears to provide advantages for providing the knowledge for automatic detection. The development of a “tissue characterization” and detection model employs the use of supervised machine learning and contextual image analysis to analyze and classify the features associated with the newly created “signatures.” The fusion of these three technologies is known as Applied Visual Sciences, Inc.’s Intelligent Imaging Informatics 3i™. Unlike other pattern recognition methodologies, the 3i™ solution can reveal and differentiate inherent structures for all materials in an image regardless of: The imaging modality used to create the image, Location within the image, Shape or texture, and Object orientation even if obscured by its relationship to other materials.

Clinical Experience and Medical Accomplishments

While Signature Mapping™ is expected to be capable of use in a wide range of medical image analysis applications, our initial application product development efforts are focused in four areas:

detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system;

breast cancer detection using x-ray mammography, MRI and ultrasound;

neurological imaging analysis through the detection and quantification of acute intracranial hemorrhage using non-contrast CT, normal pressure hydrocephalus,

multiple sclerosis using MRI; and

chest radiography targeted at tuberculosis and silicosis detection using digital x-ray.

Our research to-date includes five programs and studies conducted under the direction of the Image Processing and Informatics Laboratory at the University of Southern California (USC) using clinical data and images provided by: the Image Processing and Informatics Laboratory at USC, Howard University, and the South Florida Clinical Mammography Data Base. In addition a program and study for the detection of TB in stained sputum slides through a photo microscopy system at the National Health Laboratories of South Africa.

Competition is expected to be with existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health. We may also partner with one or more of these existing CAD manufacturers, or an emerging company with new technology for the CAD arena. Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (“OEM”), or system integrators.

Although there is no current computer-aided-detection for TB sputum microscopy analysis, which can be identified as competition to Signature Mapping™, there are substitute technologies, which in the long run could compete for sputum specimen analysis. The dipstick or biomarker approach could be considered a future competitor to Signature Mapping™. Ultimately, competition to our approach will be driven by its cost per procedure, ease-of-use, sensitivity and specificity, and ability to be used by non-trained or lightly trained personnel in the point of care environment. These emerging tests are Polymerase Chain Reaction, TB Breathalyzer, Q-Beta Replicase Assay, Transcription-Medicated Amplification, Ligase Chain Reaction, Strand Displacement Amplification, Nucleic Acid Sequence-Based Amplification and Branched DNA and Cepheid Systems GeneXpert^® System.

Recent Developments - Signature Mapping™

In March 2011, the Company developed an entry-level automated tuberculosis visualization product for the Indian market. The product, Signature Mapping TBDx™ Visualization (“TBDxV™”) has a 200-slide capacity auto-loader that delivers individual slides to a microscope and collects 100 fields of view from each Ziehl-Neelsen stained tuberculosis sputum slide. Fields of view will be presented to the microscopist on a workstation monitor thereby alleviating the tedious, boring, and error prone diagnosis using a microscope. TBDxV™ will provide the microscopist with enhanced visualization capabilities to improve overall detection capabilities.

On March 15, 2011, the United States Patent & Trademark Office (“USPTO”) issued to the Company a fifth patent, Patent No. US 7,907,762, titled “Method of Creating a Divergence Transform for Identifying a Feature of Interest in Hyperspectral Data,” which is related to our underlying “intelligent imaging informatics” (3i™) technology for our healthcare product.

On December 28, 2010, submitted with our partner LRSI Institute of Tuberculosis & Research Development - Government of India, a preliminary application to the Wellcome Trust for the migration, development, and clinical evaluation of Signature Mapping TBDx™ system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope. This is in response to the Wellcome Trust’s invitation after the review of our concept application.

On December 6, 2010, delivered our first fully automated Signature Mapping TBDx™ system to the South African National Health Laboratory Services (the "NHLS"), resulting in net revenue of $90,225.

On December 1, 2010, the Company and our South African partner, The Aurum Institute for Health Research, presented the TBDx™ fully automated system and the initial clinical findings from the first 496 of the 2500 cases analyzed to the senior management and physicians from the South African National Laboratory Services (“NHLS”). The initial results persuasively emphasizes the use of TBDx™ as a front end screening diagnostic system with the use of its decision support capabilities aiding the laboratory technologist in a decision support capacity. As a result, a decision was taken to revise the clinical protocol and add to the clinical study the combined performance of the TBDx™ system and the laboratory technologist. It was determined that this is a ‘real-world’ performance evaluation in which to conduct the study. As an additional outcome of the meeting, based on the strength of clinical findings and TBDx™ demonstration, the CEO of the National Health Laboratory Services together with their TB Program Director, agreed to conduct the next phase of the TBDx™ evaluation, the Demonstration Project. This is to be conducted at the Braamfontein Hospital in Johannesburg, South Africa under laboratory production conditions and acceptable clinical protocol. To perform the evaluation and testing, the NHLS was provided a quotation for three TBDx™ fully automated systems.

On November 29, 2010, the company installed its fully automated slide management and detection system in the NHLS National TB Reference Laboratory. The TBDx system is comprised of an auto-slide loader, bar code reader and 4 magazines with 200 slide capacity, upgraded BX41 fluorescence microscope, and Signature Mapping computer aided detection software and high resolution workstation with image processing and TB decision support capabilities.

Principal Offices

The Company entered into a lease on April 13, 2010 for approximately 3,269 square feet of office space, for a monthly lease payment of $5,585, and expires on April 30, 2011. Although the lease did not contain a renewal option, the landlord has agreed to an extension of the lease for an additional six months at the same monthly lease payment of $5,585. Therefore, the extension expires on October 31, 2011 and does not contain a renewal option. The Company’s principal offices are located at 250 Exchange Place, Suite H, Herndon, Virginia 20170. Our telephone number at such address is (703) 464-5495.

Results of Operations

Three Months Ended March 31, 2011 Compared to the Three Months Ended March 31, 2010

The following analysis reflects the condensed consolidated results of operations of the Company and its subsidiaries.

Net Revenues. There were no revenues for the three month period ended March 31, 2011, compared to $13,665 for the comparable period in 2010, or a decrease of $13,665 (100.0%). The Company did not receive funding from the various outstanding research and development proposals, or other revenue activities. Revenue during the first three months of 2010 was from a funded research and consulting services contract with the National Electrical Manufacturers Association (“NEMA”), which is a funded project by the Department of Homeland Security (DHS) for the establishment of the Digital Imaging and Communications in Security (DICOS).

Cost of Sales. There was no cost of sales for the three months ended March 31, 2011, compared to $13,777 during the same period in 2010, or a decrease of 13,777 (100.0%). Cost of sales for the three months ended March 31, 2010 was 101.8% of net revenue for the period, and represents labor and related costs for the funded research and development services.

Selling, General and Administrative Expenses. Selling, general and administrative expenses for the three months ended March 31, 2011, decreased $559,953 (39.3%) to $864,993 for 2011, as compared to $1,424,946 for the same period in 2010. The table below details the components of selling, general and administrative expense, as well as the dollar and percentage changes for the three-month period ended March 31.


	Three Months Ended March 31
	2011	2010	$ Change	% Change

Payroll and related costs	$ 349,987	$ 535,906	$ (185,919)	(34.7)
Professional fees	131,306	117,238	14,068	12.0
Research and development costs	34,151	65,431	(31,280)	(47.8)
Insurance costs	23,318	22,030	1,288	5.8
Rent - building and equipment	18,052	76,007	(57,955)	(76.2)
Travel and related	8,816	4,535	4,281	94.4
Miscellaneous expenses	15,591	19,849	(4,258)	(21.5)
Depreciation and amortization	24,151	28,135	(3,984)	(14.2)
Stock-based compensation	259,621	555,815	(296,194)	(53.3)
Total	$ 864,993	$ 1,424,946	$ (559,953)	(39.3)

Payroll and related costs, which includes salaries, commissions, taxes and benefits, decreased $185,919 (34.7%), due to five employees being on temporary leave of absence, although they continue to support the Company on a part-time basis as needed.

Professional fees include legal, accounting, stock transfer agent, SEC filing, and general consulting fees. Professional fees increased for the three months ended March 31, 2011 versus the same period last year by $14,068 (12.0%) due to: (i) an increase in legal fees of $19,039 for review of the securities purchase agreement executed on February 23, 2011, and additional compliance reporting, (ii) increase in general consultants and investor relations services of $1,360, (iii) a decrease in accounting services by $8,000, and (iv) a net increase of $1,669 for various miscellaneous services and fees.

Research and development (“R&D”) costs decreased for the three months ended March 31, 2011, compared to the same period last year by $31,280 (47.8%), due to: (i) no activities during the period for our PinPoint™ product, or a reduction of $1,977 (100.0%), (ii) reduced R&D activities for Signature Mapping TBDx™ project of $29,303 (46.2%) since the focus for TBDx™ during the period was one of refinement than development. Costs for the three months ended March 31, 2010 were previously $95,534, and was reduced by $30,103 for reclassification of stock-based compensation to consultants, in order to conform to the 2011 classification. The reclassification had no impact on the net loss for 2010.

Insurance costs in the three months ended March 31, 2011, were $23,318 compared to $22,030 for the same period in 2010, an increase of $1,288 (5.8%).

Rent decreased by $57,955 (76.2%) to $18,052 in the three months ended March 31, 2011, as compared to $76,007 for the same period in 2010, due to the Company relocating its office, effective May 1, 2010, to a smaller facility of approximately 3,269

square feet of space, whereas our previous office lease was for approximately 15,253 square feet. The fixed monthly rent of $5,585 reduced monthly operating costs by approximately $22,648.

Travel and entertainment expense for the three months ended March 31, 2011 of $8,816 compared to the same period for 2010 of $4,535, or an increase of $4,281 (94.4%). During the first quarter of 2011, the Company increased its travel costs associated with our Signature Mapping TBDx™ activities in South Africa.

Miscellaneous expense decreased by $4,258 (21.5%) to $15,591 for the three months ended March 31, 2011, as compared to $19,849 for the same period in 2010. The decrease for the three month period is related to: (i) a reduction of $3,007 for telephone usage as a result of a renegotiated contract with our service provider, ii) reduced penalties and late fees of $3,496, (iii) an increase of $2,245 in various miscellaneous expenses.

Depreciation and amortization expense in selling, general, and administrative for the three months ended March 31, 2011, of $24,151 compared to the same period for 2010 of $28,135, or a decrease of $3,984 (14.2%). The decrease in depreciation expense is due to acquired assets that became fully depreciated during the 2010.

Stock-based compensation, which represents a noncash expense category, is the amortization of the estimated fair value of stock-based compensation to employees, non-employee members of our Board of Directors, and consultants in lieu of cash compensation. During the three months ended March 31, 2011, the Company recognized an expense associated with employee stock-based and director’s compensation of $129,969, and $129,652 of consulting expense. During the same period of 2010, the Company recognized stock-based compensation expense for employees and directors of $438,335 and consultants of $117,480 (includes $30,103 that was previously expensed to research and development costs as mentioned above, in order to conform to the 2011 classification). The decrease in stock-based compensation for employees and non-employee directors of $308,366 (70.3%) is due: (i) the issuance of stock awards in January 2010 in the amount of $266,250 under the 2009 Stock Compensation Plan for employees as compensation for not receiving salaries on a regular basis during the period of June 2008 through December 2009, and their continued or continuing forbearance of wages, and (ii) no issuance of incentive stock options to employees in 2010, whereas stock options were issued to employees during prior years. The increase in stock-based compensation expense for consultants of $12,172 reflects the continued use of stock-based compensation versus cash compensation for consultants.

Employee stock option expense in 2011 and 2010 represents the amortization of the Black-Scholes fair value as outlined above in accordance with ASC 718-10. ASC 718-10 requires the recognition of all share-based payments to employees or to non-employee directors, as compensation for service on the Board of Directors, as compensation expense in the consolidated financial statements. The amount of compensation is measured based on the estimated fair values of such stock-based payments on their grant dates, and is amortized over the estimated service period to vesting. Consulting expense for stock-based payments to consultants is based on the fair value of the stock-based compensation at inception and amortized over the estimated service period but, in accordance with ASC 505-50, is remeasured on each reporting date until the performance commitment is complete.

Other Income (Expense). Other income (expense) includes interest income, interest expense and other non-operating income. Other income for the three months ended March 31, 2011 was $1,012,923 compared to $575,265 for the same period last year, for a net increase of $437,658 (76.1%).

There was no interest income from interest bearing accounts for the three months ended March 31, 2011 or for the same period in 2010, due to low average daily cash balances in interest bearing accounts during the periods.

For the three months ended March 31, 2011, the Company had other non-operating income of $1,012,923, compared to $575,265 for the same period in 2010, or an increase in other non-operating income of $437,658 (76.1%). The components of the first quarter of 2011 and the variances to the same period in 2010 include: (i) income of $1,012,923 from the revaluation of beneficial conversion feature of the outstanding debentures, compared to income in 2010 of $278,113, or an increase in income of $734,810 (264.2%), (ii) no interest expense for 2011as a result of the October 15, 2010 Amendment Agreement, whereby the $1,688,205 of outstanding principal amount of will not bear interest from July 1, 2010 through their maturity on June 30, 2011, or a decreased from the same period in 2010 of $137,782 (100.0%), (iii) no expense in 2011 for the fair value of warrants as inducement of short-term note, or a decrease of $16,500 (100.0%), (iv) no income from the revaluation of the default provision for the outstanding debentures, or a decrease in income of $209,834 (100.0%), and (v) no gain on settlement of debt for the beneficial conversion feature of debentures since there were no conversion during 2011, compared to income for the same period last year of $241,600 (100.0%). Non-cash non-operating income included above for the three months ended March 31, 2011 and 2010 were $1,012,923 and $713,047, respectively.

Net Income (Loss) and Net Income (Loss) per Common Share. Net income for the three months ended March 31, 2011 was $147,930, compared to a net loss for the same period in 2010 of $849,793, for an increase in net income of $997,723 (117.4%). Net income (loss) for the Company per common share (“basic EPS”) is computed by dividing net income (loss) by the weighted average number of shares outstanding. Net income (loss) per common share assuming dilution (“diluted EPS”) is computed by reflecting potential dilution from contingently issuable shares (i.e. common stock purchase warrants and stock options issued and outstanding).

Reconciliation between the numerators and denominators of the basic and diluted EPS computations is as follows:


	Three Months Ended
	March 31
	2011	2010
Numerator:
Net income (loss)	$ 147,930	$ (849,793)

Denominator:
Weighted average common shares outstanding - Basic	83,578,915	62,292,373
Weighted average common shares outstanding - Diluted	137,765,021	105,724,234

Net income (loss) per common share:
Basic	$ -	$ (0.01)
Diluted	-	(0.01)

LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of our net cash provided by (used in) operating, investing and financing activities:


	Three Months Ended March 31
Category	2011	2010

Net cash provided (used) in operating activities	$ (224,540)	$ (209,892)
Net cash provided (used) in investing activities	(4,870)	(635)
Net cash provided by financing activities	312,300	244,538
Effect of exchange rates on cash and cash equivalents	-	(139)

Net increase (decrease) in cash	$ 82,890	$ 33,872

Net Cash Used in Operations

Net cash used in operating activities for the three months ended March 31, 2011, was $224,540, compared with net cash used in operating activities of $209,892 during the same period for 2010, or an increase in the use of cash for operating activities of $14,648 (7.0%). The increase in the use of cash is due to: (i) lower operating costs of $397,669 (40.9%), including but not limited to a decrease in revenue of $13,665 (100.0%), a decrease in cost of sales of $13,777 (100.0%), decreases in selling, general and administrative costs (other than depreciation and amortization, and stock based compensation) of $259,775 (30.9%), and a decrease in net non-operating income and expense (other than noncash items) of $137,782 (100.0%); and (ii) offset by a net decrease in components of operating assets and liabilities of $412,317 (54.1%).

Net Cash Used in Investing Activities

Net cash used in investing activities of $4,870 was for the net purchase of equipment and costs for patent applications for the three months ended March 31, 2011. This compares with net cash used for the same activities of $635 for same period for 2010, or an increase of $4,235, or 666.9%. The net increase is comprised of higher equipment costs for the TBDx™ project of $4,870, and a decreased in patent costs of $635 (100.0%). The Company anticipates it will continue to incur equipment costs during the current fiscal year ending December 31, 2011, as we design add-on features that extend our current products into other areas, and ongoing patent costs related to further protection of our PinPoint™ and Signature Mapping™ products.

Net Cash Provided by Financing Activities

Net proceeds from financing activities were $312,300 for the three months ended March 31, 2011, compared with $244,538 for the same period in 2010, or an increase of $67,772 (54.1%). Of the 2011 net proceeds from financing activities, $333,000 (106.6%) was from the issuance of a new equity financing, and a reduction of cash provided by financing activities of $20,700 (6.6%) for the reduction of short-term note payable from an executive of the Company. The increase in the net cash provided by financing activities is due to (i), an increase of $115,600 (53.2%) from the issuance of new equity financings, (ii) a reduction of $27,138 (100.0%) from short-term convertible notes and (iii) an increase in use of funds of $20,700 to reduce short-term note payable from an executive of the Company. Management is seeking, and expects to continue to seek to raise additional capital through equity or debt financings or bank borrowings, including through one or more equity or debt financings or bank borrowings to fund its operations,

repay or repurchase its debentures, and pay amounts due to its creditors and employees. However, there can be no assurance that the Company will be able to raise such additional equity or debt financing or obtain such bank borrowings on terms satisfactory to the Company or at all.

Cash and Cash Equivalents

Our cash and cash equivalents increased during the three months ended March 31, 2011 by $82,890, compared to an increase in cash and cash equivalents during the same period in 2010 of $33,872. As outlined above, the increase in cash and cash equivalents for the current period was the result of; (i) cash used in operating activities of $224,540, (ii) cash used for the purchase of equipment costs of $4,870, and (iii) an increase in cash by $312,300 from financing activities. The net change in cash and cash equivalents for the three months ending March 31, 2011, as compared to the same period in 2010, was $49,018 (144.7%), and is the result of (i) an increase in cash used in operating activities of $14,648 (7.0%), (ii) an increase from the net purchase of equipment and patent costs of $4,235 (666.9%), (iii) a decrease of 139 (100.0%) from the negative effect of currency exchange rates, and (iv) offset by an increase in of $67,762 (27.7%) from financing activities.

Working Capital Information - The following table presents a summary of our working capital at the end of each period:


	(Unaudited)
Category	March 31, 2011	December 31, 2010

Cash and cash equivalents	$ 87,764	$ 4,874

Current assets	176,886	93,682
Current liabilities	9,861,401	10,822,318
Working capital (deficit)	$ (9,684,515)	$ (10,728,636)

At March 31, 2011, we had a working capital deficit of $9,684,515, compared with a working capital deficit at December 31, 2010 of $10,728,636, or a decrease in working capital deficit of $1,044,121 (9.7%). As of March 31, 2011, the Company had cash and cash equivalents of $87,764, as compared to $4,874 on December 31, 2010. For 2011, overall current assets increased $83,204 (88.8%), including (i) an increase in cash and cash equivalents of $82,890, and (ii) an increase in prepaid expenses of $314 (1.6%). Current liabilities decreased $960,917 (8.9%), with specific decreases in liabilities of $1,317,913, including: i) $20,700 in note payable, related party, ii) $41,640 for conversion of accrued wages, iii) $242,650 for conversion of accounts payable for stock, iv) $1,012,923 for the reduction of derivative liabilities due to the revaluation of the beneficial conversion feature of the outstanding debentures, vii) and specific increases in current liabilities of $356,996, including: (i) $73,449 in other trade payables, ii) $283,547 for the continued accrual of unpaid wages and related expenses for all employees.

In view of the above matters, realization of certain of the assets in the accompanying balance sheets is dependent upon our continued operation, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing, and the success of its future operations.

Other Liabilities

2006 and 2007 Series A Debentures and Series D Common Stock Purchase Warrants

that there were insufficient shares to share settle the contracts. The Series D Warrants that became exercisable at the first closing will expire on November 8, 2011, and those related to the second closing will expire in April 12, 2012. On April 1, 2007, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agent’s Warrants issued as compensation to Midtown Partners & Co., LLC, were reset to a price $0.7453 per share, to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. As a result of a June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,281,109 Series D warrants. Our outstanding Series A 10% Convertible Debentures originally became due on November 7, 2008. As of March 31, 2011, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of March 31, 2011, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted, and 4,995,222 Series D Warrants remain unexercised. Proceeds of the two offerings were used for the purpose of hiring new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO.

As of the date of the filing of this report, approximately 13,566,734 warrants (excluding the warrants exercisable by the debenture holders) may be exercised pursuant to the cashless exercise provisions of such warrants, which may be subsequently resold as “restricted securities” under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Company’s common stock could cause the market price of the Company’s common stock to drop.

Our outstanding Series A 10% Senior Convertible Debentures originally became due on November 7, 2008. On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (“Interest and Default Amounts”) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (“Defaults”) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures. The Company has and may in the future seek to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although the Company has not reached any agreement with our debenture holders with regard to any such repayment, repurchase or extension. The Company’s ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures.

Also under the Debenture amendment agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures. Although, there were no such conversions of our debentures during the three months ended March 31, 2011. Such a forced conversion may only be effected once every 90 days and the ability of the Company to force any such conversion is subject to certain equity conditions, which conditions were amended under the terms of the Debenture Amendment Agreement in accordance with the following:

if the variable weighted average price for the Company’s common stock (“VWAP”) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for the Company’s common stock during such period equals or exceeds $50,000, the Company may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;

if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, the Company may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture;

if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, the Company may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.

The Company did not make timely payment of the interest due under our Series A 10% Senior Convertible Debentures on July 1, 2008, through October 1, 2010, which may be deemed to be events of default under the debentures. The debentures provide

that any default in the payment of interest, which default is not cured within five trading days of the receipt of notice of such default or ten trading days after we become aware of such default, will be deemed an event of default. The Company has not maintained the registration of the shares underlying the debentures and Series D Warrants to permit the reoffer and resale of such shares as required under the terms of our agreements with the holders of the debentures which also may have been deemed an event of default under the Debentures.

Failure to pay the principal, unpaid interest and certain late fees under the Debentures when due may have constituted an event of default under the debentures and failure to remit payment of the debentures and all late fees may have resulted in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law, although the holders did not seek to enforce their rights under the debentures. We did not maintain the registration of the shares underlying the debentures and Series D Warrants in order to permit the reoffer and resale of such shares as required under the terms of our agreements, which also may be deemed an event of default under the debentures. If an event of default occurs under the debentures, the debenture holders could elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, plus accrued but unpaid interest, or (b) the outstanding principal amount plus accrued but unpaid interest divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. Also, interest under the debentures accrued at a rate of 18% per annum or the maximum amount allowed under the law and we may be subject to a late fee equal to the lesser of 18% per annum or the maximum rate permitted by law. In the event the debenture holders had made such a demand, the Company had insufficient funds to meet such demand. In anticipation of such election by the debenture holders, due to the late payment of the January 1, 2008 interest payment made on April 8, 2008, we measured the default on December 31, 2007 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense. We remeasured the default amount as of December 31, 2009 at approximately $2,587,216, and on September 30, 2010 at approximately $2,541,739. This default amount was recognized as interest expense in Fiscal 2007 of approximately $645,641, an additional $76,658 during Fiscal 2008, $1,864,917 during Fiscal 2009, and a net reduction of interest expense during Fiscal 2010 of $45,477. On October 15, 2010, the two remaining Series A Debenture holders waived all defaults and default amount of $2,541,739, which the Company reversed to interest expense.

Prior to the Debenture amendment agreement and absent a default, the Debentures bore interest at the rate of 10% per annum due on the first day of each calendar quarter, upon conversion or redemption of the Debentures as to the principal amount converted or redeemed, or on the maturity date of the Debentures. We could elect to pay interest due under the Debentures in cash or registered shares of our common stock. If we elected to pay the interest due in shares of our common stock, the number of shares to be issued in payment of interest is determined on the basis of 85% of the lesser of the daily volume weighted average price of our common stock as reported by Bloomberg LP (“VWAP”) for the five trading days ending on the date that is immediately prior to (a) date the interest is due or (b) the date such shares are issued and delivered to the holder. We could pay interest in shares of our common stock only if the equity conditions, described below, have been met during the 20 consecutive trading days prior to the date the interest is due and through the date the shares are issued.

As discussed above, the payment of interest in shares of our stock, the redemption of the Debentures and the occurrence of certain other events, was subject to a requirement that certain equity conditions (“equity conditions”) were met, as follows: (i) we have honored all conversions and redemptions of a Debenture by the holder, (ii) we have paid all liquidated damages and other amounts due to the holder, (iii) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a holder to utilize the registration statement to resell its shares, (iv) our stock is traded on the OTC Bulletin Board or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of our common stock to cover the issuance of the shares upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holder’s 4.99% or 9.99% ownership restriction cap, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control of the Company may occur and the transaction has not been consummated, (ix) the holder is not in possession of material public information regarding us, and (x) the daily trading volume of our shares for 20 consecutive trading days prior to the applicable date exceeds 100,000 shares. Under the terms of the Debenture Amendment Agreement, (A) the equity condition in (iii) above was amended to provide that such condition is met if, in the alternative, the shares issuable upon conversion of the Debentures may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered to a holder an opinion of the Company’s counsel that such resale may legally be made and provided the holder has furnished a representation letter reasonable acceptable to the Company’s counsel that the holder is not an “affiliate” for purposes of Rule 144; (B) the equity condition in (vi) above was amended to except an event of default that has previously been waived; and (C) the equity condition in (x) above was amended to except circumstances where another volume condition is applicable.

The Debentures contain a limitation on the amount of Debenture that may be converted at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted

portion of the Debenture. This limitation may be waived upon 61 days’ notice to us by the holder of the Debenture permitting the holder to change such limitation to 9.99%.

We have agreed to compensate a holder of a Debenture in the event our transfer agent fails to deliver shares upon conversion of the Debentures within three trading days of the date of conversion, and the holder’s broker is required to purchase shares of our common stock in satisfaction of a sale by a holder. If certain events of default occur under the Debentures, holders could accelerate the due date of the interest and principal due under the Debentures, and we may become obligated to pay all costs, expenses and liquidated damages due under the Debenture plus an amount equal to the greater of (i) 120% of the principal and interest due under the Debenture and (ii) the outstanding principal amount of the Debenture and accrued interest divided by the conversion price on the date the amount is due or paid, whichever is higher, multiplied by the VWAP for our shares on the date of demand or payment, whichever is higher.

An event of default may occur under the Debentures if (a) the Company defaults in the payment of interest, liquidated damages or principal, (b) the Company fails to materially observe or perform a covenant or agreement in the Debentures, (c) a default or event of default occurs under any other transaction document related to the financing or in any other material agreement to which the Company is a party that results in a material adverse effect on the Company, (d) any representation or warrant the Company made to investors in the transaction documents related to the financing is materially untrue or incorrect, (e) a bankruptcy event occurs with regard to the Company, (f) the Company defaults on any other loan, mortgage, or credit arrangement that involves an amount greater than $150,000 and results in the obligation becoming declared due prior to the due date, (g) the Company’s common stock is not eligible for quotation on the OTC Bulletin Board or other exchange on which the Company’s shares are traded, (h) a transaction occurs in which the control of the Company changes, the Company effects a merger or consolidation, the Company sells substantially all of the assets, a tender offer is made for the Company’s shares, the Company reclassify their shares or a compulsory share exchange, or the Company agrees to sell more than 33% of the assets, unless the Company receives the consent of holders of 67% of then outstanding principal of the Company’s Debentures, (i) the registration statement has not been declared effective within 240 days of the first closing, (j) the registration statement lapses for more than 20 consecutive trading days or more than 40 trading days in a 12 month period, or 60 consecutive trading days and 90 non-consecutive trading days in the event of a material merger or acquisition, (k) the Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (l) the Company has a judgment against them for more than $150,000.

The Series D Warrants are exercisable at the same price as the conversion price of the debentures outlined above. If certain milestones are not met, the conversion price of the Debentures and exercise price of the Series D Warrants may be and were re-set. Also, the exercise price may be adjusted under anti-dilution and other price re-set provisions contained in the Series D Warrants. One-half of the Series D Warrants became exercisable on the date of the first closing on November 8, 2006, and the remaining one-half of the Series D Warrants became exercisable on the date of the second closing on April 12, 2007. The original conversion price was $1.1563 per share, but has been reset to $0.4089 effective May 20, 2008 (the final milestone reset provision). As a result of the June 2009 financing, in which the Company issued shares of common stock and warrants, the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) would be increased to an aggregate of 6,889,848 shares.

The Series D Warrants contain a cashless exercise provision in the event (i) at any time after one year following the date the Series D Warrants are first exercisable there is no registration statement effective covering the resale of the shares underlying the Series D Warrants or (ii) at any time after four years following the date the Series D Warrants were issued.

The Series D Warrants contain a limitation on the amount of Series D Warrants that may be exercised at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the warrants. This limitation may be waived upon 61 days’ notice to us by the holder of the Series D Warrants permitting the holder to change such limitation to 9.99%.

The conversion price of the Debentures and the exercise price of the Series D Warrants or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants are subject to adjustment in the event of a stock dividend, stock split, subdivision or combination of our shares of common stock, reclassification, sales of our securities below their then conversion or exercise price, a subsequent rights offering, or a reclassification of our shares. Also, if we effect a merger or consolidation with another company, we sell all or substantially all of our assets, a tender offer or exchange offer is made for our shares, or we effect a reclassification of our shares or a compulsory share exchange, a holder that subsequently converts its Debenture will be entitled to receive the same kind and amount of securities, cash or property as if the shares it is entitled to receive on the conversion had been issued and outstanding on the date immediately prior to the date any such transaction occurred. Except as discussed above, no such events have occurred through the date of this report.

We are not required to make an adjustment to the conversion or exercise price or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants under the anti-dilution provisions related to an “exempt issuance,” which is defined as: (A) any stock or options that are issued under our stock option plans or are approved by a majority of non-

employee directors and issued (i) to employees, officers or directors or (ii) to consultants, but only if the amount issued to consultants does not exceed 400,000 shares in a 12 month period, (B) securities issued under the Debentures or Series D Warrants, (C) shares of common stock issued upon conversion or exercise of, or in exchange for, securities outstanding on the date we entered into the securities purchase agreement, (D) the issuance of the Midtown placement agent’s warrants or the shares underlying the placement agent’s warrants, or (E) the issuance of securities in an acquisition or strategic transaction approved by our disinterested directors. Under the Debenture Amendment Agreement, commencing October 15, 2010, Debenture holders agreed that an “exempt issuance” shall also include the issuance of stock or common stock equivalents authorized and approved in advance by the Company’s disinterested directors at a price per share or at a conversion or exercise price per share equal to or greater than $0.25.

Under the terms of a Registration Rights Agreement we entered into with each purchaser at the closing of the sale of our Debentures and Series D Warrants (“purchasers”), we agreed we would use our best efforts to file a registration statement under the Securities Act within 45 days of the first closing to permit the public resale by purchasers of the shares that may be issued upon conversion of the Debentures and upon exercise of the Series D Warrants, including the shares of our common stock underlying the Debentures to be issued at the second closing. We are required to keep the registration statement effective until the earlier of either the date all shares underlying the Debentures and Series D Warrants have been sold or such shares are eligible for resale under Rule 144(k), but no later than four years after the effective date of the registration statement. The initial registration became effective on April 9, 2007. We were required to register a number of shares of our common stock equal to 130% of the shares underlying the Debentures and the Series D Warrants. At any time after the effective date of the registration statement covering the resale of the shares to be issued upon conversion or exercise of the Debentures and Series D Warrants, we may call for cancellation up to 75% of the Series D Warrants if: (i) the closing bid or closing sale price of the common stock for 20 consecutive trading days (the “measurement period”) exceeds $2.89, (ii) the daily trading volume during the measurement period exceeds 100,000 shares per trading day, and (iii) the holder is not in possession of material nonpublic information regarding us. We are required to give notice of cancellation to the holders within one trading day of the end of the measurement period. The Series D Warrants covered by the call notice will be cancelled effective 30 trading days after the date of the call notice, subject to certain conditions, including that the holder shall have the right to exercise the Series D Warrant during the measurement period. As not all of these conditions are met, the Debentures and Series D warrants are not yet cancelable.

On April 28, 2008, the Company filed a new Form S-1 Registration Statement with the Securities and Exchange Commission (“SEC”), to register additional shares for resale by certain holders (“Registered Shares”) of the Series A Convertible Debentures and Series D Warrants upon conversion or exercise thereof at a lower conversion price due to the reset provisions of the agreements, and to carry forward in such registration statement certain unsold shares from our Form S-1 Registration Statement that became effective April 9, 2007 (Registration Statement), in a combined prospectus under applicable SEC Rules. On June 5, 2008, Applied Visual Sciences filed a Post-Effective Amendment No. 1 to the Registration Statement (“Post-Effective Amendment No. 1”) to de-register 1,157,971 shares of Common Stock issuable in lieu of interest accrued through December 22, 2006, which became effective on June 6, 2008. On July 25, 2008, the Company filed a Post-Effective Amendment No. 2 to the Registration Statement (“Post-Effective Amendment No. 2”) to de-register an aggregate of an additional 4,208,495 of the Registered Shares. This amount includes: (i) an aggregate of 2,465,460 Registered Shares previously registered under the Registration Statement for resale by certain of the holders of the Company’s Series A 10% Senior Convertible Debentures (the “Debentures”) upon conversion thereof; and (ii) an aggregate of 1,743,035 Registered Shares previously registered under the Registration Statement that represent additional shares registered under the Registration Statement for resale by certain of the holders of the Debentures and Series D Common Stock Purchase Warrants upon conversion or exercise thereof, which was approved by the SEC on August 6, 2008. On August 11, 2008, the Company filed a Post-Effective Amendment No. 3 to the Registration Statement to de-register the remaining unsold shares under the Registration Statement, which became effective August 13, 2008. On August 11, 2008, and in view of the Company’s current financing requirements, the Company filed a request with the SEC to withdraw the April 28, 2008 Form S-1 Registration which withdrawal request was approved by the SEC.

Under the terms of the Debenture amendment agreement, the remaining Debenture holders agreed to terminate the Registration Rights Agreement with each such holder; however, the Company continues to be obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture but continues to hold Series D Warrants.

We also granted to each purchaser of the Debentures and Series D Warrants the right to participate in any offering by us of common stock or common stock equivalents until the later of (i) 12 months after the effective date of the registration statement and (ii) the date a purchaser holds less than 20% of the principal amount of the Debenture the purchaser originally agreed to purchase, except for an exempt issuance or an underwritten public offering of our common stock. Purchasers may participate in such an offering up to the lesser of 100% of the future offering or the aggregate amount subscribed for under the securities purchase agreement by all purchasers. Although such common stock offerings have occurred, the original purchasers have not yet elected to participate in any such offerings through the date of the filing of this report, and have notified the Company that they do not want to participate in any future financings.

The securities purchase agreement also contained representations and warranties of both us and purchasers, conditions to closing, certain indemnification provisions, and other customary provisions. Also the Debenture Amendment Agreement amended

certain provisions covering events of default under the Debentures, contained certain representations and warranties of the Company, a reaffirmation of certain of the representations and warranties in the securities purchase agreement, contained certain conditions to closing, and certain other customary provisions.

We were prohibited from effecting a reverse or forward stock split or reclassification of our common stock except as may be required to comply with the listing standards of any national securities exchange.

Midtown Partners & Co., LLC acted as placement agent for the financing pursuant to the terms of a Placement Agent Agreement, dated July 14, 2006, between us and Midtown. At the first closing, we paid or issued the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees of $30,000 of which $10,000 was paid prior to closing, (iii) placement agent’s warrants to purchase an aggregate of 623,520 shares (one half of the Midtown placement agent’s warrants are exercisable commencing on November 6, 2006 and the remaining one-half become exercisable on the second closing). The second closing took place on April 12, 2007, at which time we paid the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees equal to 1% of the second closing or $25,750, (iii) the placement agent’s warrants to purchase an aggregate of 311,760 shares (the remaining one-half of the placement agent’s warrants). The Midtown placement agent’s warrants are exercisable at a price of $1.15634 per share for a period of five years from the date they become exercisable, the exercise price was re-set as disclosed above for the convertible debentures, contain a piggyback registration right, a cashless exercise provision and are substantially identical to the warrants issued to purchasers in the Debenture and Warrant offering. As a result of the June 2009 financing, the exercise price of the placement agent’s warrants were adjusted under the anti-dilution provisions of such warrants to a price of $0.25 per share and the number of shares underlying the placement agent’s warrants would be increased to an aggregate of 1,019,828 shares.

The securities, including certain securities issued to Midtown, were not registered under the Securities Act of 1933 or any state laws and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

2006 through 2010 Short-Term Promissory Notes, Related Party

On April 21, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, our Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $200,000. The Company issued a non-negotiable promissory note, dated effective April 21, 2006, to Mr. Trudnak in the principal amount of $200,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition. In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full. The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys’ fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On October 21, 2006, Mr. Trudnak extended the due date of the loan to December 31, 2006. Subsequently, on October 3 and October 18, 2006, Mr. Trudnak loaned the Company $102,000 and $100,000, respectively, on substantially the same terms as the April 21, 2006 loan, except that each loan is due six months after the date thereof. Accordingly, following such additional loans, the Company owed an aggregate of approximately $402,000 to Mr. Trudnak. On November 10, 2006, Mr. Trudnak extended the due dates of such loans to May 31, 2007, except that $100,000 of the April 21, 2006, loan becomes due upon the Company raising $2,500,000 in financing after November 6, 2006, and the remaining amount of $202,000 of such loans become due upon the Company raising an aggregate of $5,000,000 in financing after November 6, 2006, and prior to May 31, 2007. Following the first closing of our Debenture and Series D Warrant financing on November 8, 2006, the Company repaid $100,000 on November 20, 2006, in principal amount of the April 1, 2006 loan, and paid an additional $100,000 to Mr. Trudnak on April 17, 2007 upon the second closing of our Debenture and Series D Warrant financing. On May 31, 2007, Mr. Trudnak extended the due dates of the remaining loans to May 31, 2008. Although, the anticipated payment of $202,000 had not been made, and Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, for total outstanding notes of $226,000. Subsequently, the maturity date of the outstanding loans was extended to May 31, 2009, and subsequently to May 31, 2010. On June 1, 2010, the outstanding loans were extended to June 30, 2011. The Company repaid an

aggregate of $108,900 of the notes during 2010, and repaid an aggregate $20,700 during the three months ended March 31, 2011, resulting in an outstanding balance at March 31, 2011 of $96,400. The terms of the above transaction were reviewed and approved by the Company’s audit committee and by our Board of Directors.

Financing Arrangements

2011 Securities Purchase Agreement

On February 23, 2011, the Company executed a Securities Purchase Agreement, (the “SPA”), with an institutional accredited investor for an investment up to $1,000,000, subject to certain stock price and volume conditions. Subsequently, on February 24, 2011, we sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor.

In addition, under the SPA, the investor has agreed to provide additional financing to us by purchasing shares of our common stock at seven subsequent closings and in the following amounts; i) at a second closing to be held one month following the first closing, an amount of shares equal to forty percent (40%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a third closing to be held one month following the second closing, an amount of shares equal to thirty percent (30%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a fourth closing to be held one month following the third closing, an amount of shares equal to twenty percent (20%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, and iv) at each of four additional subsequent closings to be held one month following the immediately preceding closing, an amount of shares equal to ten percent (10%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding the subsequent closing. The investor agreed to purchase our shares at each subsequent closing for a price per share equal to the lower of an amount equal to: (a) 60% of the volume weighted average of actual trading prices of the shares for the ten (10) consecutive trading days immediately prior to a date of the applicable closing and (b) 64% of the volume weighted average of actual trading prices of the shares for the trading day immediately prior to the applicable closing date. If, under this calculation, the price of a share at a subsequent closing does not exceed a floor price of $0.25, the investor will not be obligated to purchase our shares at that closing. The failure to hold a closing will not impact the holding of the subsequent closings. Also, the investor will not be obligated to purchase shares at a closing if such purchase would cause them to beneficially own in excess of 9.99% of our shares. The stock price and volume conditions for the second and third closings were not met, and there can be no assurance our shares will satisfy such conditions in connection with any subsequent closing.

We have granted to the investor piggy back registration right with regard to the shares issued in the financing, including the shares underlying the Warrants. The SPA contains representations and warranties of the Company and investor, certain indemnification provisions and customary conditions to each closing. We may terminate the SPA on ten days prior written notice to the investor, and the investor may terminate the SPA at any time prior to a subsequent financing upon written notice to us if we consummate a reverse stock split or a subsequent financing to which the investor is not a party.

We have agreed to pay the investor’s counsel with regard to the first closing in the amount of $25,000, $5,000 of which was paid at the first closing and $5,000 will be paid at each of the first four subsequent closings. We have also agreed to pay additional fees for their counsel for each subsequent closing in the amount of $2,500. A broker has acted as placement agent for the offering. Under the terms of a Non-Circumvention and Compensation Agreement, dated January 12, 2011, between the Company and the broker, in connection with the offering, we agreed to pay or issue the broker at a closing a placement fee equal to 6% of the proceeds received by us at the closing and placement agent’s warrants equal to 6% of the shares sold at the closing (including the shares underlying the Warrants).

Additional Capital

To the extent that additional capital is raised through the sale of our equity or equity-related securities of our subsidiaries, the issuance of our securities could result in dilution to our stockholders. No assurance can be given that we will have access to the capital markets in the future, or that financing will be available on terms acceptable to satisfy our cash requirements, implement our business strategies, and meet the restrictive requirements of the debenture financing described above. If we are unable to access the capital markets or obtain acceptable financing, our results of operations and financial condition could be materially and adversely affected. We may be required to raise substantial additional funds through other means. We have not begun to receive material revenues from our commercial operations associated with the software products. Management may seek to raise additional capital through one or more equity or debt financings or have discussions with certain investors with regard thereto. We cannot assure our stockholders that our technology and products will be commercially accepted or that revenues will be sufficient to fund our operations.

If adequate funds are not available to us, we may be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

Off-Balance Sheet Arrangements

We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current of future effect upon our financial condition or results of operations as of March 31, 2011 and December 31, 2010.

Financial Condition, Going Concern Uncertainties and Events of Default

During the three-months ended March 31, 2011, Applied Visual Sciences’ revenue generating activities have not produced sufficient funds for profitable operations and we have incurred operating losses since inception. In view of these matters, realization of certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in our annual report on Form 10-K for the year ended December 31, 2010, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.

such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.

In view of the our limited revenues to date, the Company has relied and continues to rely substantially upon equity and debt financing to fund its ongoing operations, including the research and development conducted in connection with its products and conversion of accounts payable for stock. The proceeds from our financings are insufficient to fund our operations, pay our trade payables, repay our unconverted debentures, or accrued and unpaid wages to our employees. Therefore, the debentures holders, our employees, or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations. Also, in the event we are unable to pay our employees, we may suffer employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of our stock, we may have limited or no access to the capital markets. Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.

Significant Accounting Policies

The preparation of the Company’s financial statements requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods presented. For a discussion of the Company’s critical accounting policies and estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Except as disclosed in Note 2 of our 2010 Form 10-K, there have been no material changes to these critical accounting policies that impacted the Company’s reported amounts of assets, liabilities, revenues or expenses during the three-month period ended March 31, 2011.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Our market risk is confined to changes in foreign currency exchange rates and potentially adverse effects of differing tax structures. There were no international revenues in the three-month period ended March 31, 2011. International activities were mostly from our Signature Mapping™ revenue opportunities in South Africa and India. Therefore, we may be exposed to foreign exchange rate fluctuations as the Company continues to pursue the revenue opportunities outside the United States. As exchange rates vary, results when translated may vary from expectations and adversely impact overall expected profitability. As of March 31, 2011, the Company’s foreign currency exposure is related to accounts payable trade in the amount of $30,371.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Report, the Chief Executive Officer and Chief Financial Officer of the Company (the “Certifying Officers”) conducted evaluations of the Company’s disclosure controls and procedures. As defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure the information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the Certifying Officers, to allow timely decisions regarding required disclosure.

Based on this evaluation, the Certifying Officers determined that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and to ensure that information required to be disclosed by the Company in the Reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s

principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosure.

Although the Certifying Officers have determined that our disclosure controls and procedures were effective, management continues to believe that a refinement to our disclosure controls is an ongoing process. The Audit Committee believes the Company should continue the following activities: (a) additional education and professional development for the Company’s accounting and other staff on new and existing applicable SEC filing requirements, certain applicable SEC disclosure requirements, and the timing of the filing thereof, and (b) reviewing disclosure requirements, including Form 8-K and Regulation S-K disclosure requirements, SEC staff guidance and interpretations related thereof, as well as Accounting Standards Codification (“ASCs”) and updates.

Changes in Internal Controls

There were no changes in the Company’s internal controls over financial reporting during the period covered by the Report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 1A. RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below (which reflect changes to certain of the risk factors we disclosed in our 2010 Form 10-K) and other information contained in this Report in deciding whether to invest in our common stock, as well as certain risk factors set forth under Part I, Item 1A of our 2010 Form 10-K. Additional risks not presently known to us or which we currently consider immaterial may also adversely affect our company. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected. In such case, the trading price of our common stock could decline, and you could lose a part of your investment.

Risks Related to Our Company and Our Operations

We have incurred substantial debt which could affect our ability to obtain additional financing and may increase our vulnerability to business downturns. We may be unable to repay our Series A Debentures when they become due.

As of March 31, 2011, the aggregate principal due under our outstanding Series A Debentures was $1,688,205, which matures on June 30, 2011. Also, we have outstanding trade and accrued payables of $1,347,819, other accrued liabilities of $454,648, and accrued salaries due to our employees and management of $4,986,115. Also, we have outstanding trade and accrued payables of $1,165,400, other accrued liabilities of $485,063, accrued salaries due to our employees and management of $5,210,825, and an outstanding noninterest-bearing loan from our Chief Executive Officer of $96,400. We are subject to the risks associated with substantial indebtedness, including that we may be unable to repay our Debentures when they come due; it may be more expensive and difficult to obtain additional financing; we are more vulnerable to economic downturns; and if we default under our indebtedness, we may not have sufficient funds to repay any outstanding principal.

We have a severe working capital deficit and, in addition to proceeds from financings, we continue to have outstanding loans from our chief executive officer and deferrals of salaries by our executive officer, employees and a consultant to indirectly continue to fund operations. In the event we are unable to pay our employees salaries, we may experience employee attrition which could materially and adversely affect our business and operations.

During the three months ended March 31, 2011, our total stockholders’ deficit decreased by $1,123,787 to $9,040,728, and our consolidated net income was $147,930 for the period, mainly due to the change in the fair value of the derivative liability that increased net income by $1,012,923. During 2011, our revenue generating activities had not produced sufficient funds for profitable operations and we have incurred operating losses since inception. Although we have obtained cash from certain financings, we continue to have outstanding loans from our chief executive officer of approximately $96,400, and accrued and unpaid salaries of our executive officers in the amount of $2,491,225 and to other employees of $2,719,600. In the event we are unable to pay our employees, we may continue to experience employee attrition which could materially adversely affect our business and operations, including our ongoing research and development activities. As of March 31, 2011, we employed 7 full-time employees, and two prior full-time employees that continue to support the Company on a part-time as needed basis, although their return to full-time is uncertain. We also have 10 employees that are on a temporary leave of absence, and their return is also uncertain.

Dilutive effect of conversion of Series A Senior Convertible Debentures, exercise of Series D Warrants and Midtown placement agent’s warrants, and other warrants.

Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. The Company issued an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants at a first closing held on November 8, 2006 and, due to the price reset conversion feature embedded in the notes and the warrants, the transaction was recognized as a liability under generally accepted accounting principles. We also issued an aggregate of 623,520 common stock purchase warrants to the placement agent in such financing which were upon terms substantially similar to the Series D Warrants. Due to milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was indeterminable as of December 31, 2007. The Company issued an additional $2,575,000 in principal amount of the Series A Debentures at a second closing held on April 12, 2007, following the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. The Company allocated proceeds from the second closing to the embedded conversion features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. One-half of the Series D Warrants became exercisable on November 8, 2006 (2,226,854 warrants), and the remaining one-half became exercisable on April 12, 2007 (2,226,855 warrants). The Series D Warrants and the placement agent’s warrants issued as compensation in the offering to Midtown Partners & Co., LLC, may be exercised via a cashless exercise if certain conditions are met. The Company considered ASC 815-40 (formerly EITF 00-19, relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock), and concluded that there were insufficient shares to share settle the contracts. The Series D Warrants that became exercisable at the first closing will expire on November 8, 2011, and those related to the second closing will expire in April 12, 2012. On April 1, 2007, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agent’s Warrants issued as compensation to Midtown Partners & Co., LLC, were reset to a price $0.7453 per share, to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. As a result of a June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,281,109 Series D warrants. Our outstanding Series A 10% Convertible Debentures originally became due on November 7, 2008. As of March 31, 2011, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of March 31, 2011, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted, and 4,995,222 Series D Warrants remain unexercised. Proceeds of the two offerings were used for the purpose of hiring new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO.

Our directors and named executive officers own a substantial percentage of our common stock.

As of March 30, 2011, our directors and executive officers beneficially owned approximately 23.7% of our shares of common stock. Accordingly, our directors, executive officers and two most highly compensated employees are entitled to cast an aggregate of 10,871,752 votes on matters submitted to our stockholders for a vote or approximately 12.8% of the total number of votes entitled to be cast at a meeting of our stockholders. These stockholders, if they acted together, could exert substantial control over matters requiring approval by our stockholders. These matters would include the election of directors and the approval of mergers or other business combination transactions. This concentration of ownership may discourage or prevent someone from acquiring our business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On February 24, 2011, we sold to an institutional accredited investor an aggregate of 600,000 shares of common stock and common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds to us of $150,000 (or $136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor. We paid a commission to the broker in the aggregate amount of $9,000 in connection with the offering. The Common Stock and Warrants

were sold to an accredited investor in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

From February 1 - 23, 2011, the Company sold an aggregate of 800,000 shares of Common Stock and an aggregate of 800,000 Class Q Common Stock Purchase Warrants to three accredited investors for gross proceeds to the Company of approximately $200,000 ($197,000, net of commissions and expenses in the amount of $3,000). In connection with the sale of securities, a placement agent fee of $3,000 was paid. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in thirty-six (36) months from the date of issuance. The Common Stock and Class Q Warrants were sold in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

On February 7, 2011, the Company issued to a vendor 678,861 shares of common stock as full payment towards an outstanding accounts payable, with the fair value of the common stock of $213,163. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

On January 31, 2011, the Company issued to a vendor 89,355 shares of common stock as final payment towards an outstanding accounts payable, with the fair value of the common stock of $29,487. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

On January 4, 2011, the Company issued to a consultant 175,000 shares of common stock. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Our outstanding Series A 10% Senior Convertible Debentures originally became due on November 7, 2008. On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (“Interest and Default Amounts”) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (“Defaults”) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. There were no such conversions of our debentures during the three months ended March 31, 2011. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures.

ITEM 5. OTHER INFORMATION

Not Applicable

ITEM 6. EXHIBITS

Copies of the following documents are included as exhibits to this report pursuant to Item 601 of Regulation S-K.


			Incorporated by Reference		Filed Herewith
Exhibit No.	Exhibit Description		Form	Filing Date
31.1		Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CEO)				X
31.2		Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CFO)				X
32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO)				X
32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO)				X

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

APPLIED VISUAL SCIENCES, INC.

By: /s/ Michael W. Trudnak

Michael W. Trudnak

Chief Executive Officer

(Principal Executive Officer)

By: /s/ Gregory E. Hare

Gregory E. Hare

Chief Financial Officer

(Principal Financial and Accounting Officer)

Date: May 13, 2011

Applied Visual Sciences, Inc. - FORM 10-Q - May 13, 2011

Attached files

Applied Visual Sciences, Inc. Reports