APVS Applied Visual Sciences Inc (CE)

Healthcare Technology Solutions - Signature Mapping™

In an effort to expand upon the use of our core technology 3i™ “intelligent imaging informatics,” we have modified 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 our computer vision diagnostic radiology and pathology applications are being 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 have been 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.  As of the date of this report, we have developed and continue to develop two TB diagnostic products, TBDx™ and TBDxV™ and our SMDS™ product, an automated hardware-software laboratory solution.

Laboratory Pathology:  SMDS™

Signature Mapping Detection System (“SMDS™”) is an automated hardware-software laboratory solution designed to operate one or multiple infectious disease applications via multi-threaded detection algorithms.  SMDS™ automation software controls every movement of the integrated hardware components from slide management to image capture.  Where SMDS™ is integrated with a specific infectious disease detection application; the solution is capable of automatically analyzing each field-of-view for the presence of specific characteristics of the targeted disease.  The detection algorithms will perform with high sensitivity without sacrificing specificity.  The end product is a flexible; user defined diagnostic patient report that can be integrated to a laboratory information system.  Standard information includes patient information, processing date, field-of-view diagnostic findings and overall case severity or diagnostic finding.

In laboratory environments that use the image capture and visualization capabilities of Signature Mapping™ without specific infectious disease algorithms or in situations where the interface of the laboratory technician with the computer-aided identification software is a desired procedure, the SMDS™ laboratory platform includes the Decision Support Quick View (“DSQV”) module.  DSQV has been designed for rapid review of captured images and increased speed in diagnostic decision-making.  DSQV includes post-processing image tools to magnify, zoom or review images in alternative formats.  Using a high-resolution touch-screen monitor and an icon-driven menu system facilitates ease of use for even the most computer challenged individuals.  Signature Mapping SMDS™ includes built-in networking support to allow DICOM images to be transmitted for remote diagnosis or to be interfaced with an enterprise network.

When SMDS™ is integrated with a disease specific automated detection algorithm, such as Signature Mapping Tuberculosis Detection (“TBDx™”), the solution expands to a fully automated diagnostic system.  For high volume diagnostic laboratories, automation begins with a slide loader capable of processing up to 200 slides without human intervention.  At system initialization the slide loader automatically inventories every patient slide to be processed.  One-by-one the slides are moved from the holding cassettes

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onto the automated stage of the microscope.  A barcode reader collects information about the patient just prior to the slide being placed on the stage.  Information captured by the barcode reader can be automatically transferred to a laboratory information system along with the captured digital images and diagnostic case findings.

TBDx™ - TBDxV™

The Company has developed two fully-automated, computer-vision diagnostic products for the detection of tuberculosis (“TB”). Both Signature Mapping TBDx™ for use in laboratory environments using Auramine-O staining protocols and Signature Mapping TBDxV™, a decision support visualization technology, for use in laboratory environments using Ziehl-Neelsen staining protocols can address the approximately 80 million diagnostic slides analyzed by clinical lab technicians each year. Both products are targeted to government and private institutions that diagnose tuberculosis patients.

TBDx™ is a fully-automated hardware and software technology platform that is capable of: (i) automatically managing 1-200 slides without human intervention, (ii) digitally capturing patient information (eliminates human recordation errors), (iii) adjusting focus for variances in sputum location, quality and topology, (iv) capturing high-quality digital images (standard 100 images per slide or user-defined), (v) automated identification of M Tuberculosis bacilli if present, and (vi) robust user-defined reporting and communication of diagnostic results. Phase II clinical trials were undertaken and completed in South Africa during 2011. Slides used in the clinical trial were provided from the international Thibela TB Study trial conducted by The Aurum Institute for Health Research.

TBDxV™, the precursor to TBDx™, is a fully-automated visualization technology that maintains the same slide capacity range and digital image quality as TBDx™. TBDxV™, using high-resolution touch-screen monitors, provides the microscopist with a fast, easy-to-use system for the analysis of high-quality images, thereby alleviating the tedious and error prone diagnosis using a microscope. TBDxV™ assists microscopists in decision-making, specifically on the most difficult scanty cases, through access to advanced visualization tools. The visualization tools are applicable to both Auramine-O and Ziehl-Neelsen staining processes.

The Company believes that the performance of both products could be further enhanced through the exploration of new staining techniques. Further, design initiatives have been discussed that would allow the products to be deployed at the point-of-care, a major strategic initiative of The World Health Organization. To advance these design ideas from concepts - to proof of concept - to working models ready for clinical evaluation, the company will need to develop strategic partnerships with academic institutions capable of providing targeted technological input and research capabilities. The company has begun the process of reaching out to academic institutions.  One such potential institution is the Clinical Microbiology Laboratory at the Stanford University Medical Center.  The Medical Center has extensive expertise in infectious diseases and has expressed a willingness to assist the Company in planning and executing technology research and development.  A formal business relationship is under development.

Development continues in the refinement of TBDx™ and its detection algorithms.  Additional classifiers have been created to improve sensitivity, which is the measurement of correctly identifying positive cases, and specificity, which is the measurement of correctly identifying negative cases.  The underlying scripting language has been re-written to enable laboratories to either use TBDx™ as a diagnostic tool or as a pre-screening technology that identifies probable candidate TB cases that are confirmed by a secondary technology. The ability to communicate to and from the camera and TBDx™ technology will permit the system to acquire a pre-set number of images, then move to another location on the slide and capture additional images. Also, the system can monitor the acquisition of the images and stop the acquisition process once the algorithms have determined that a case is severely infected.  Internal testing continues to validate the progress of algorithm improvements. 

There is no current computer-aided-detection for TB sputum microscopy analysis that can be identified as competition to Signature Mapping™.  Although, there are substitute technologies that compete for sputum specimen analysis, such as the Cepheid Systems GeneXpert ^® System, a dip-stick or biomarker approach that is considered a 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.

Radiology:  BCDx™

The Company is adding vision to breast cancer diagnosis by developing a radiological suite of products, a breast cancer detection solution to be known as Signature Mapping™ Breast Cancer Detection (“BCDx™”). Annual estimates of breast cancer diagnostic activity within the U.S are: 35 million mammograms performed; 1.5 million biopsies performed; 87% of biopsies return a negative finding (mammogram ‘false positive’); 200,000 confirmed cancer cases; and immeasurable emotional, mental, and physical pain for the individuals and families of biopsy patients.  The 1.3 million biopsies undertaken that resulted in negative findings can be directly attributed to an inability to resolve areas of concern due to the limited information provided in the mammography images.  In addition, approximately 10% of cancerous lesions are missed – partly due to dense tissue obscuring the cancer or the appearance of cancer having common characteristics with the appearance of normal tissue.  The goal of BCDx™ is to deliver sophisticated image analysis

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processes that provide enhanced visualization capabilities and automated detection algorithms to help prevent unnecessary biopsies, while flagging previously unseen lesions for additional review.

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.  Management anticipates BCDx™ 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.

The Company has been engaged in discussions, negotiations, and due diligence on the formation of a strategic partnership focused exclusively on breast cancer computer vision detection technology.  Our subsidiary, Instasis Imaging, would license Applied Visual’s core analysis technology platform for research and development, as well as for inclusion in the diagnostic products to be commercialized.  Applied Visual would contribute its intellectual property, including patents, which are specific to the area of breast cancer detection.  In support of such negotiations, the Company paid a $400,000 non-refundable formation fee, of which $300,000 was paid in October 2011, and $100,000 in January 2012.  The formation fee was funded by promissory notes with interest at a rate of twelve percent (12%) per annum, which have been extended as indicated above. There can be no assurances that we will be successful in our efforts to establish a strategic partnership.

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:

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

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

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

Laboratory Pathology:  TBDx™

The Joint Clinical Research Center in Kampala, Uganda has approved a research protocol for the evaluation of the TBDx™ technology.  It is likely that this evaluation will occur in the 4th quarter of 2014.

On November 14, 2013, the Company shipped a TBDx™ system to Abuja, Nigeria in support of Dr. Luis Cuevas of the Liverpool School of Tropical Medicine who received funding from the European and Developing Countries Clinical Trials Partnership (EDCTP) to conduct a tuberculosis research project. A portion of this project funding is to be used to evaluate the TBDx™ technology.  Similar to the protocol in South Africa, the clinical evaluation is a triple blind study with TBDx™ compared against routine microscopy, using MGIT culture as the reference standard, and the use of a new molecular diagnostic test provided by Epistem. It is expected that the evaluation of TBDx™ will run through the 2nd Quarter of 2014.

On November 3, 2013, Dr. Nazir Ismail, from the National Institute for Communicable Diseases, made a presentation at the 44 ^th World Conference on Lung Health the International Union Against Tuberculosis and Lung Disease (The Union) and the Center for

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Disease Control and Prevention (CDC) Late-Breaker session, which was held in Paris, France. The Late-Breaker session is intended to present the latest findings from new, innovative, and substantial research initiatives.  Dr. Ismail presented “A novel TB diagnostic algorithm using automated microscopy achieves high sensitivity while reducing the volume of Xpert MTB/RIF testing” .  The basis of the presentation was the results of a TBDx™ triple blind study (organism culture, molecular testing, and independent microscopist) that was completed on May 3, 2013 in Johannesburg, South Africa of patients suspected of having tuberculosis.

During the 44 ^th Union World Conference on Lung Health held in November 2013, the company demonstrated the TBDx™ technology over a 4-day period. More than 50 demonstrations were held in the hall to more than 100 TB experts.  Attending these demonstrations included The World Health Organization (WHO), the Global Fund, the International Union Against Tuberculosis and Lung Disease (the UNION), the Foundation for Innovation in New Diagnostics (FIND), the Stop TB Partnership, PATH, the Research Institute of Japan, the KNTV Tuberculosis Foundation, and National TB Program Managers from Pakistan, India, Bangladesh, Brazil, Peru, Ukraine, Russia, Uganda, Zimbabwe, Nigeria, Malawi, South Africa, Turkey, Saudi Arabia, China, and Japan. Also attending presentations included representatives from Johns Hopkins University, the London School of Hygiene and Tropical Medicine, the Liverpool School of Tropical Medicine, The University of Illinois at Chicago, the University of Maryland - School of Medicine, the AGA KHAN University of Pakistan, the University of China, and the Chinese University of Hong Kong.

On May 3, 2013, the Company completed a triple blind study (organism culture, molecular testing, and independent microscopist) of TBDx™ in Johannesburg, South Africa of patients suspected of having tuberculosis.  The evaluation took place at the National Health Laboratory Services (“NHLS”) / Center for Tuberculosis.  In its most thorough external evaluation of TBDx™ to-date, the Company was assisted by the National Institute for Communicable Diseases (“NICD”), who dedicated considerable staff and material resources to execute a test protocol that was approved by the London School of Tropical Medicine.  During the technology evaluation, TBDx™ processed 1,249 patient slide specimens and acquired approximately 375,000 digital images. The total number of patient slide specimens available for analysis was 1,006, after consideration of specimens excluded from analysis due to contamination, missing culture, missing PCR tests, missing smear, and specimens mislabeled.

The results of the study, and the presentation by Dr. Ismail during the conference, provided significant diagnostic evidence that TBDx™ not only can be used by itself to outperform routine microscopists in detecting tuberculosis, but also it can be used as a “screening” or triage technology.

Reporting the results of the evaluation on behalf of a study team of renowned infectious disease professionals, Dr. Ismail concluded:

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As a stand-alone test TBDx™ provides a level of sensitivity and specificity that would be equivalent to microscopists with 80 years of experience, or more. Dr. Ismail noted that having microscopists with this level of experience is both extraordinary and almost impossible to replace.

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TBDx™ performance occurred among a low prevalence cohort (10%). It is very possible TBDx™ performance will be greater in a higher prevalence setting.

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One limitation of the study was the high performing standard of the microscopists participating in the study, which is well above the accepted norm. For example, comparing TBDx™ to a standard microscopist performance (60%), TBDx™ would show sensitivity improvements of 25%-30%, with equivalent specificity.

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Sensitivity = measures the proportion of actual positive cases, which are correctly identified as having tuberculosis.

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Specificity = measures the proportion of negatives cases, which are correctly identified as not having tuberculosis.

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TBDx™ performance shows it can be a triage tool for molecular testing, and can achieve high sensitivity:

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Sensitivity of 78%; Specificity of 98.8%, with 75% fewer polymerase chain reaction (“PCR”) tests.

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Sensitivity of 73%; Specificity of 99.3%, with 90% fewer PCR tests.

These conclusions led the study team to recommend demonstrations studies, similar to evaluations on molecular tests in recent years, should be conducted broadly on TBDx™ to test and confirm these findings. The evaluators can see several potential applications:

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If a laboratory can test ALL TB suspects utilizing PCR, use TBDx™ automated microscopy to monitor treatment.

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If a laboratory has a limited budget for PCR testing, and drug resistance is not a concern, use TBDx™ automated microscopy on ALL TB suspects and use PCR to confirm scanty cases. If drug resistance is a concern use PCR tests on all positive cases identified by TBDx™ automated microscopy.

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If there is no budget for PCR testing, use TBDx™ automated microscopy throughout, or use it in central locations.

On March 15, 2013, the Company completed an evaluation of TBDx™, which was in cooperation with The TB Clinical Diagnostic Research Consortium (“CDRC”), an organization funded by the National Institute for Allergy and Infectious Diseases of the National Institutes of Health and managed by Johns Hopkins University.  The evaluation consisted of the company correctly identifying 60 patient slides prepared from cases gathered from the CDRC’s work in Uganda.  The diagnosis, unknown to the company, was independently verified by two sets of 3 microscopists in two laboratories in Uganda. The CDRC conducts feasibility studies of new diagnostic technologies. Members include the Johns Hopkins University; Imperial College of London in the United Kingdom; Infectious Diseases Institute in Kampala, Uganda; Boston Medical Center, University of Cape Town, South Africa; Universidade

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Federal do Espirito Santo in Vitoria, Brazil; University of Medicine and Dentistry of New Jersey – New Jersey Medical School; National Masan Tuberculosis Hospital-Yonsei University College of Medicine in the Republic of Korea; Foundation for Innovative New Diagnostics (FIND), and Westat Inc.

Other Developments - TBDx™

On November 29, 2012, the Public Library of Science One (“PloS One”) published the initial evaluation of TBDx™ entitled “Proof-of-Concept” Evaluation of an Automated Sputum Smear Microscopy System for Tuberculosis Diagnosis , which was undertaken by The Aurum Institute.  PLoS One is a highly regarded and open source of scientific research in the TB community. This peer-reviewed evaluation represents the state of the TBDx ^TM technology development as it existed in May, 2011.

On November 14, 2012, Dr. David Clark, Deputy CEO of The Aurum Institute, presented an update on the latest TBDx™ performance metrics and algorithm improvements during the 43 ^rd Union World Conference on Lung Health in Kuala Lumpur, Malaysia.  Dr. Clark made the poster presentation entitled Automated TB Microscopy – Recent results and a model to increase pre-test probability to gene-based diagnostics . Dr. Clark presented the results of recent performance testing using multiple TBDx™ detection algorithms, and described the potential of TBDx™ to reduce laboratory costs by directing the most highly probable TB positive cases to more expensive molecular tests.

On April 26, 2012, the Company held a meeting in New Delhi, India, at the LRS Institute of Tuberculosis and Respiratory Disease to finalize the technical components and operating budget of a multi-site, nine-month project.  The proposed project contains three phases: (i) clinical evaluation of TBDxV™ (tuberculosis visualization software), (ii) development of automated detection algorithms for use in Ziehl-Neelsen (ZN) laboratory settings; and, (iii) clinical evaluation of TBDx™ for the automated detection of TB in ZN stained sputum slides.  The grant funding proposal was submitted to the Department of Biotechnology (“DBT”) on April 30, 2012.  The Company received notification that DBT and its affiliates would participate in a clinical study upon the Company funding the program.  The company is working towards an equitable solution.

On March 28, 2012, the Company held a demonstration of TBDx™ at the National Health Laboratory Services (“NHLS”) in Johannesburg, South Africa. The attendees included Dr. Michael Kimerling, Senior Program Officer in Tuberculosis for the Bill & Melinda Gates Foundation, Dr. Ishmail, Director of the Center for Tuberculosis (National Institute for Infectious Diseases), and Dr. David Clark, Deputy CEO of The Aurum Institute. The demonstration was at the request of Dr. Kimerling following a presentation he attended at the 2012 Conference on Retrovirals and other Opportunistic Infections (“CROI”) where results of our TBDx™ clinical trial were presented.  Dr. Kimerling was especially interested in the results of our recent internal testing and a presentation illustrating the per-positive case cost advantages of using TBDx™.

On March 8, 2012, Dr. Gavin Churchyard, CEO of The Aurum Institute presented the first summary analysis of our initial clinical evaluation of TBDx™ conducted in South Africa, at the 2012 Conference on Retrovirals and other Opportunistic Infections held in Seattle, Washington. The presentation entitled “ Automated AFB Microscopy Substantially Reduces Microscopists Work Load ” was followed by a panel discussion on our technology and infectious diseases. The TBDx™ presentation was focused on the productivity gains to be realized as a result of automating smear microscopy and using detection algorithms to diagnose patient sputum specimens.  TBDx™ automated detection increases the sensitivity of smear microscopy while reducing the reliance on human visual inspection.  In a single laboratory shift, TBDx™ can handle the diagnostic workload of four microscopists while reducing errors that normally occur due to human factors.  In a global environment of increasing growth in TB diagnostic needs to maintain status quo, resource challenged countries will need less capital investment to build new laboratories, with less stress on the human resource requirements for hiring, training and retaining laboratory technicians.

On February 4, 2012, Dr. Fleming Lure, VP for Signature Mapping, presented an abstract at the SPIE Medical Imaging Conference in San Diego, CA.  SPIE is an international society for optics and photonics.  The abstract presented by Dr. Lure is entitled “ Automated Detection Of Tuberculosis On Sputum Smeared Slides Using Stepwise Classification.”

Breast Cancer Detection:  BCDx™

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.  Competition is expected with existing computer-aided-detection (“CAD”) manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health.  We may partner with one or more of these existing CAD manufacturers, or with 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.

Early detection is a critical factor for controlling survival. Early detection provides increased therapeutic options and improved probability of survival. Mammography is a reliable and cost-effective screening technology. When properly conducted, mammography has been estimated to reduce breast cancer mortality by 20-30%.  Currently, ductal carcinoma-in-situ (DCIS)

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represents 25%-30% of all reported breast cancers.  Approximately 95% of all DCIS are diagnosed because radiologists identify them in mammograms. However, reading mammograms is difficult and prone to misinterpretation, subjectivity, and misreads.  Studies have found that screening x-ray exams are about 80% accurate at best and that lesions are simply not detected 10% to 15% of the time. The National Cancer Institute reported that 25% of breast tumors are missed in women in their forties. (See Liu B, Z. M., Document J (2005, "Utilizing data grid architecture for the backup and recovery of clinical image data." Comput Med Imaging Graph. 29(2-3): 95-102, and National Cancer Institute, "Cancer in African American Women."). Dense breasts pose a greater challenge to cancer detection using mammograms, especially early-stage breast cancers. Approximately 25% of women have dense breasts; thus a large number of mammograms, especially in AAW, are more difficult to clinically interpret. The risk of breast cancer associated with the highest category of density is estimated to be two to six times greater than for women with the lowest category of breast density.

On the basis of our initial studies, the signatures of malignant tumors in mammograms exhibit significant differences when compared with cysts, benign lesions, or dense breast tissue after being processed with Signature Mapping™.  Measurable differences exist among different breast structures in both the spatial and frequency domains.  Signatures of different tissues vary in their entropy, linearity, boundary gradients, and homogeneity. As a result, the internal structure of masses in dense breast tissue can be characterized and identified and displayed radiographically to the clinician. Signature Mapping™ is expected to visually display levels within the tumor and distortions in the breast geometry outside the tumor.

The effectiveness of these algorithms was evaluated through a pilot study conducted with the Norris Cancer Center at the University of Southern California. The study consisted of two sets of mammographic cases, a training set and a testing set.  Both sets contained 40 normal and 40 confirmed solid cancer masses and were matched for levels of interpretation difficulty and patient age, variations in breast density, and types of tumors. Applied Visual used the training set for the development of its algorithms and for training the participating radiologists in the study.  The test set was used in the pilot study to gain clinical feedback and determine the effectiveness of the radiologist’s interpretations using Signature Mapping™. Preliminary clinical results based on the visual performance of five highly-skilled and experienced mammographers using the mammography-specific Signature Mapping™ process demonstrated improved accuracy and ease of use in the study.

Clustered micro-calcifications may be the only visually detectable manifestation of early breast cancer. Mammography is very responsive to the presence of micro-calcifications, however, the specificity of mammography remains low.  Benign calcifications cannot always be distinguished from those indicating malignancy resulting in a large population of women who do not have cancer, but are subjected to biopsy.  Using Signature Mapping™ we expect that the miniscule structures within micro-calcifications can be characterized and their potential for pathology identified by the radiologists.

While carcinomas are rarely found in cysts, they are difficult to accurately diagnose through the use of mammography because they cannot be distinguished from other well circumscribed solid masses unless they display several characteristic patterns of calcification. Applied Visual is optimizing Signature Mapping™ for the accurate characterization of cysts as part of ongoing development that includes an early-onset cancer detection model.

Markets and Competition

Aviation/Homeland Security Technology Solution - PinPoint™

Market

Initially, management has focused its principal development and marketing efforts for its PinPoint™ product on the market for airport baggage screening technology solutions. However, as discussed further below, and although there can be no assurance, management believes that its PinPoint™ solution is also capable of being adapted for use in the people portal and cargo screening markets.  The following discussion focuses on the market for baggage screening solutions; however, we have also provided an overview of the potential market for baggage screening, whole body imagery, and cargo screening technology solutions, potential future markets for our PinPoint™ product.

Baggage Screening

Security oversight of airports in the United States is overseen by the Transportation Safety Administration (“TSA”) with an annual operating budget in excess of $5 billion.  TSA has the responsibility for over 480 U.S. airports with a combined inventory of baggage scanning equipment (checked baggage area and the carry-on baggage area) in excess of 6,000 scanners.  While exact statistics on the number of scanners deployed in the rest of the world are not readily available, management estimates that the market is four times greater than the U.S.  In addition to baggage scanners, airports worldwide are faced with replacing or supplementing existing metal detectors for passenger processing.  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.

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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.  It was expected that a major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) would 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.  To date DHS has not made this standard a mandatory requirement for proposals or procurements which, as a result, has not enabled third party detection software providers the ability to enter the marketplace which has given an undue advantage to the existing security equipment providers.  

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 people portals and cargo scanning.  Additionally, we will seek support of the U.S. Congress and the equipment manufacturers through lobbying and other efforts.  We continue the ongoing development of PinPoint™.  This focus must be even sharper when 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.

Whole Body Imagers

Almost every threat that requires people screening is currently monitored by a different system (explosives, weapons, biological, chemical, and nuclear/radiological).  Management believes that today's people screening systems deliver unacceptable performance (high ‘false alarm’ rates, slow processing throughput, continued dependence on human detection, and high transaction costs. Management believes that the market for people portals that utilize imaging as its detection methodology is a sub-set, to which we believe PinPoint™ can address. It is management’s belief that the current people portal technology fails to meet the post-9/11 requirements. It is management’s belief that the technology will undergo dramatic technological changes when the multiple-threats "checkpoint of the future" is introduced.

Competition

The competition between the manufacturers of baggage (hand-held and small parcel) screening, luggage and large parcel screening, people screening for weapons and explosives detection, container and vehicle screening, and cargo screening is intense.  These same equipment manufacturers represent Applied Visual Sciences, Inc.’s major competition, and include: AS&E, Smiths-Detection, OSI Rapiscan and L3, each of which is better capitalized and has greater marketing and other resources than Applied Visual Sciences, Inc. The competition between manufacturers is intense in view of amounts appropriated by the U.S. Government for threat detection technologies. What is not so obvious is that the manufacturers that once held the largest share of installed base are at risk due to aging and inadequate technology. Due to the agnostic nature of PinPoint™, we believe we can integrate PinPoint™ with any manufacturer’s scanning equipment. We believe our technology improves the efficiency of the underperforming hardware and extends the obsolescence of the existing scanning equipment.  Funds previously appropriated for the upgrade or replacement of the in-place scanners could then be redeployed for the acquisition of required technologies such as body scanners or cargo scanners.

The equipment manufacturers in conjunction with software companies and academic institutions are attempting to develop sophisticated solutions to aid in the detection of contraband substances.  To date there has been no known solution developed.  We believe that Applied Visual Sciences, Inc.’s approach is unique in that it is a non-intrusive adjunct to the current manufacturers’ products.  The enhancement identifies contraband at an accuracy level that is higher than the methodology used today by TSA.

The market for contraband detection systems software is anticipated to become intensely competitive and is characterized by continuously developing technology and frequent introductions of new products and features. We expect competition to increase as other companies introduce additional and more competitive products in the aviation security market and as we develop additional capabilities and enhancements for PinPoint™ and new applications for our technology. Historically, the principal competitors in the market for explosive detection systems have been GE-InVision, Vivid Technologies, Inc., EG&G Astrophysics, Smiths-Detection, Thermedics Detection Inc., and Barringer Technologies Inc. Each of these competitors provides aviation security solutions and products for use in the inspection of checked and carry-on luggage.  We expect certain major corporations competing in other markets to enter the aviation security market.

Applied Visual Sciences, Inc. believes that its ability to compete in the aviation security market is based upon such factors as: product performance, functionality, quality and features; quality of customer support services, documentation and training; and the capability of the technology to appeal to broader applications beyond the inspection of checked and carry-on baggage. Although we believe that PinPoint™ is superior to our competitors’ products in its detection capability and accuracy, PinPoint™ must also compete on the basis

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of price, throughput, and the ease of integration into existing baggage handling systems. Certain of our competitors may have an advantage over our existing technology with respect to these factors.

Healthcare Technology Solutions - Signature Mapping™

Market

CAD vendors today have developed and sold clinical products in three major applications segments; mammography as a second look for the screening and early detection of breast cancer; chest CT for the early detection of nodules and CT of the colon for the non-endoscope screening of polyps.

Integrated CAD solutions is critical for gaining market share and may lead to higher profits…These new systems will enable workflow improvements while providing a smooth migration to the digital solution. This will increase the viability and broaden the appeal of these systems, and is likely to result in increased sales and revenues." These are new markets with new applications. The market is shifting towards CAD as physicians’ confidence levels continue to grow. For example, the radiologist who uses CAD for Mammography (one of the most prevalent today) would most likely be very willing to trying new clinical applications.  This is true for general radiologists and specialty radiologists.  Frost and Sullivan studies published in 2006 estimated world wide radiology imaging procedures for all modalities at slightly a billion procedures per year and estimated that approximately 300 million to 350 million procedures were attributed to the USA.

Replacement is expected in the two segments with the most demand expected to be the breast MRI CAD segment and the mammography CAD segment. With each new CAD technology introduced to the market, the potential size of this new market grows exponentially “Given the myriad of body parts and systems that CAD technology could be applied to in the future, as well as the different imaging modalities associated with each, growth in this market could be virtually unstoppable.” Such as, new technology introduced for CT would be applicable to the brain, chest, neck, abdominal and other areas of the body; and new technology for Ultrasound would be applicable for the breast, liver, prostate and abdominal.

Shalom S. Buchbinder, M.D., FACR, Chairman, Department of Radiology, Staten Island University Hospital, and Clinical Associate Professor of Radiology, Obstetrics, Gynecology and Women’s Health, Albert-Einstein College of Medicine of Yeshiva University, New York, U.S.A. (Changing the Way Healthcare is Delivered, RSNA 2004, p89) states “This relatively new technology improves the decision making compatibilities of clinicians…In my opinion mammography CAD has proven its clinical value and the future is about more robust and sophisticated tools that can, in addition to detection, help in the analysis of lesions. Innovative technologies can provide valuable information to support lesion classification.”

Financial support to fight TB comes from multiple sources world leaders, public health officials and international donors have taken action against TB and financial resources for control and research have increased dramatically in recent years. Public-private partnerships like the Foundation for Innovative New Diagnostics (“FIND”) have emerged to bring together key players in these sectors to move research and development forward for the needs of patients.  Primarily, the government of each country is financially responsible for fighting TB with outside support of international organizations.

Market Conditions

Management’s review of current market conditions has identified the following trends:

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TB is becoming a worldwide epidemic

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Automatic differentiation of TB bacilli is a very challenging issue

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Currently no such CAD product exists

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Steady adoption of digital microscopy

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Need for higher throughput and continued cost reduction without sacrificing quality

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CAD is evolving as a clinical tool and physicians are adopting it

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Current graphics cards and computational processing power are sufficient

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Retiring workforce and  the current  prediction that there will be a shortage of pathologists

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Economic pressures and increasing clinical demands

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Facilitates productivity gains with inclusion of CAD

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Pathologist can performs diagnosis on digital images and monitor

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PMA FDA approvals of digital pathology tests is increasing

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Facilitates improved workflow efficiency and enhances patient management practices

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Pathology lab is poised for digital revolution

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Pressures on the anatomical pathology sciences will drive change

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STOP TB has stated they want “effective, efficient and validated clinical algorithms”

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Potential Market For New TB Diagnostics

The persistent TB epidemic and expanding global population ensure that the total market for a range of TB diagnostic products is likely to increase yearly over the next decade by approximately 16%.  The current international policy on TB case detection recommends the examination of three sputum smears for the diagnosis of pulmonary tuberculosis (PTB). The present definition of a smear-positive case states "Tuberculosis in a patient with at least two initial sputum smear examinations (direct smear microscopy) positive for acid fast bacilli (AFB+)".

Worldwide, the WHO estimates that the largest potential available market for a new TB diagnostic would be for a test that both detects latent infection and predicts progression to active disease. Such a test, if widely implemented and accompanied by successful treatment, has the potential to revolutionize TB control.  The infrastructure to achieve this globally is not available at this moment.

The next largest total available market is for a point-of-care screening test, which is estimated to be 193 million patient’s evaluations/year, of which approximately 70%, or 137 million patient’s evaluations/year is concentrated in the 22 high-burden countries.  Substantial markets also exist for less revolutionary replacement technologies.  Specifically, the total available markets for smear, culture, and monitoring and DST replacement tests are 83 million, 57 million, 40 million, and 6 million patient evaluations, respectively in 2005.  We estimate that replacement technologies could capture a greater proportion of the market by 2020: smear 59% (49 million), culture 35% (20 million), monitoring 58% (23 million) and DST 45% (3 million).  Without exception, between 70%–90% of the potential available markets for these replacement technologies are in the 22 high-burden countries.  The continued emphasis on improving market conditions will encourage market growth in the high-burden countries and increase the accessibility to new products.  (See “Global Tuberculosis Control - surveillance, planning and financing,” WHO Report 2008.)

Competition

We expect to compete with existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health and manufacturers of dipstick or biomarker manufacturers, including SPAN Diagnostics Ltd., India,  Yayasan Hati Sehat (YHS), Indonesia and Wiener Laboratorios, Argentina.  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.

While we are unaware of any computer-aided-detection for TB sputum microscopy analysis that can be identified that competes with our Signature Mapping™ products, there are substitute technologies that compete with sputum specimen analysis, such as the Cepheid Systems GeneXpert ^® System, a dip-stick or biomarker approach. Management believes that competition will be driven by cost per procedure, ease-of-use, sensitivity and specificity, and the ability to be used by non-trained or lightly trained personnel in the point of care environment. These emerging tests include: 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.

Sales, Marketing, and Distribution

Sales

Sales for products within our specific markets are conducted through both direct sales and indirect distribution channels worldwide.

Product Distribution and Marketing

We have entered into the following distributor, strategic partnership, development, and consulting agreements with regard to our products, although they have not produced revenue for the Company:

Preferred International Distributor Agreement with Rodash 136 (Pty) Ltd, of South Africa

On May 25, 2010, the Company and Rodash 136 (Pty) Ltd, of South Africa, entered into a Preferred International Distributor Agreement.  Under the agreement, Rodash has agreed to promote the licensing and distribution of Applied Visual Sciences’ PinPoint™ suite of software. Rodash will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the end of the then-current period. The Company appointed Rodash as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of PinPoint™ products.

Preferred International Distributor Agreement Romador 168 (Pty) Ltd, of South Africa

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On May 25, 2010, the Company and Romador 168 (Pty) Ltd, of South Africa, entered into a Preferred International Distributor Agreement.  Under the agreement, Romador has agreed to promote the licensing and distribution of Applied Visual Sciences’ Signature Mapping™ suite of software. Romador will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the then-current period. The Company appointed Romador as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of Signature Mapping™ products.

Memorandum of Understanding with Aurum Innova (Pty) Limited and the National Health Laboratory Services of South Africa

On March 24, 2009, Applied Visual Sciences, Inc. signed a Memorandum of Understanding (“MOU”) with Aurum Innova (Pty) Limited (“Innova”) and the National Health Laboratory Services of South Africa (“NHLS”).  The purpose of the agreement is for the parties to jointly undertake activities for the completion of our Signature Mapping™ Tuberculosis (“TBDx™”) product for deployment in the NHLS laboratories.  The parties will collaborate to enhance TBDx™’s overall performance, customize its use for application in the National Health Laboratory Services tuberculosis diagnosis and quality management program, and clinically evaluate, measure, and test TBDx™ performance.  The collaboration includes conducting the clinical evaluation at selected NHLS laboratories that conduct sputum slide tuberculosis analysis and diagnosis.

Master Development Agreement with Aurum Innova (Pty), Ltd.

On February 4, 2009, Applied Visual Sciences, Inc. signed a Master Development Agreement Aurum Innova (Pty), Ltd., a company related to the Aurum Institute for Health Research, and installed in February 2009 an alpha product of Signature Mapping™ tuberculosis (“TBDx™”) software in a “retrofit configuration” for an evaluation by the National Health Laboratory Services (“NHLS”) in South Africa. This agreement extends the Company’s contractual relationship with Aurum that was first established with the signing of a Memorandum of Understanding on July 25, 2008.  The new agreement provides for the joint development of products and services aimed at the screening, early detection and staging of diseases including TB, silicosis, and malaria.  Each product will be the subject of a separate project specifications and the MDA included project specifications for our joint development of an automated TB sputum detection product.  Aurum has agreed to clinically evaluate the products, and the parties agreed to jointly market and sell, initially in South Africa but eventually in sub-Saharan Africa, the jointly developed products, including our Signature Mapping™ TBDx™ product, through third parties and/or through Aurum.  The Company agreed to pay Aurum a royalty on a product by products basis, based on the net revenue received by us through our distributors, and to be delineated by the parties.  Also, the Company agreed to pay Aurum a commission with regard to sales of the products by Aurum.  Further, Aurum has agreed to use every reasonable effort to raise funding to complete the development of a product following completion of the initial proof of concept.  Any intellectual property jointly developed by us and Aurum will be jointly owned.  The agreement may be terminated on one year’s prior written notice by either party, automatically terminates upon completion of project specifications and if no products are being marketed under the agreement, or for cause.  The agreement also contains certain confidentiality and indemnification provisions.

Patents and Proprietary Rights

We rely on a combination of common law trademark, service mark, copyright and trade secret law and contractual restrictions to establish and protect our proprietary rights and promote our reputation and the growth of our business.  We do not own any patents that would prevent or inhibit our competitors from using our technology or entering our market, although we intend to seek such protection as appropriate.  It is our practice to require all of our employees, consultants and independent contractors to enter into agreements containing non-disclosure, non-competition and non-solicitation restrictions and covenants, and while our agreements with some of our customers and suppliers include provisions prohibiting or restricting the disclosure of proprietary information, we can not assure you that these contractual arrangements or the other steps taken by us to protect our proprietary rights will prove sufficient protection to prevent misappropriation of our proprietary rights or to deter independent, third-party development of similar proprietary assets.

The United States Patent & Trademark Office (“USPTO”) has granted the Company six patents, and we were granted one foreign patent, all of which are related to our underlying 3i™ technology.  We also have three pending patents applications (U.S. and foreign) that further cover the implementation of our core 3i™ technology. We cannot provide assurance that any or all of the remaining patent applications or provisional applications will be issued 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.

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Due to the rapid pace of technological change in the software industry, we believe patent, trade secret and copyright protection are less significant to our competitive edge than factors such as the knowledge, ability and experience of our personnel, new product development, frequent product enhancements, name recognition and the ongoing reliability of our products.

Principal Offices

We maintain our principal office at 525K East Market Street, # 116, Leesburg, Virginia, 20176.   Our telephone number in the U.S. is (703) 539-6190.  Our Internet address is www.appliedvs.com , and the Company also disseminates information on Facebook at https://www.facebook.com/appliedvs and Twitter at https://mobile.twitter.com/appliedvs .  Such information on our website, Facebook and Twitter is not deemed to be part of this Quarterly Report on Form 10-Q.

CONSOLIDATED RESULTS OF OPERATIONS

Results of Operations

Three months Ended March 31, 2014 Compared to the Three months Ended March 31, 2013

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

Net Revenues . There were no revenues for three months ended March 31, 2014, or for the same period in 2013.

Cost of Sales.  There was no cost of sales for three months ended March 31, 2014, or for the same period in 2013.

Selling, General and Administrative Expenses.   Selling, general and administrative expenses for the three months ended March 31, 2014 of $283,504, decreased by $321,809 (53.2%), as compared to $605,313 for the same period in 2013. 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.

Payroll and related costs, which includes salaries, commissions, taxes and benefits, decreased $29,375 (11.3%). The Company currently employs four full-time, two part-time employees, and one employee on a temporary leave of absence who assists the Company upon request, and during 2013 we employed five full-time, one part-time employee, and one employee on a temporary leave of absence who assists the Company upon request.

Professional fees include legal, accounting, stock transfer agent, SEC filing, and general consulting fees. Professional fees decreased for the three months ended March 31, 2014 versus the same period last year by $56,842 (85.9%) due to: (i) a decrease in general consultants, and miscellaneous services and fees of $148, (ii) an increase in immigration, patent, and other legal fees of $3,304, (iii), a decrease in audit fees of $10,000 due to timing of the completing the December 31, 2013 audit, and (iv) a decrease in information technology consulting fees of $49,998.

Research and development (“R&D”) costs increased for the three months ended March 31, 2014, compared to the same period last year by $4,852 (90.1%), due to increased development activities on performance metrics and algorithm improvements for Signature Mapping TBDx™.

Other operating expenses decreased by $22,990 (83.0%) to $4,698 for the three months ended March 31, 2014, compared to $27,688 for the same period in 2013. The decrease is attributed to: (i) increased equipment repair and maintenance costs of $2,003, (ii) lower

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other administrative expenses of $1,529, (iii) decreased utilities and phone costs of $6,769, and (iv) a decrease in rent expense of $16,695.

Depreciation and amortization expense in selling, general, and administrative for the three months ended March 31, 2014 is $17,537, compared to the same period in 2013 of $18,684, or a decrease of $1,147 (6.1%).  The decrease is due to the sale of furniture in March 2013, which reduced the depreciable base amount.

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. The Company granted stock options to employees in January and August of 2013, and no stock options were issued to employees during 2014.  During the three months ended March 31, 2014, the Company recognized stock-based compensation expense associated with employees, including its named executives, of $10,255, and for consultants of $0. During the same period of 2013, the Company recognized stock-based compensation expense for employees and directors of $221,062, and an expense of $5,500 for consulting services. Stock-based compensation expense for the current period decreased $210,807 for employees and $5,500 for consultants.

Employee stock option expense in 2014 and 2013 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 and expense. Net other income for the three months ended March 31, 2014 was $106,608, compared to net other expense of $79,846 for the same period last year, for a decrease in other expense of $186,454 (233.5%).

There was no interest income from interest bearing accounts for the three months ended March 31, 2014, or for the same period in 2013, due to low average daily cash balances in interest bearing accounts during the periods.

For the three months ended March 31, 2014, the Company had other non-operating income of $106,608, compared to an expense of $79,846 for the same period in 2013, or a decrease in non-operating expense of $186,454 (233.5%).  The components of non-operating income (expense) for the first quarter of 2014 and 2013, and the variances include: (i) financing costs for commissions on short-term notes of $0 in 2014 versus $225 for the same period in 2013, or a decrease of $225 (100.0%), (ii) debt discount amortization costs in 2014 of $10,004 and $3,002 in 2013, or an increase in expense of $7,002 (233.1%), (iii) a gain from the sale of furniture of $0 in 2014, and a gain in 2013 of $8,338, (iv) interest expense in 2014 for short-term notes of $18,445, whereby $17,429 for the same period in 2013, or an increase in expense of $1,016 (5.8%), (v) income of $135,057 in 2014 for the revaluation of derivative liability related to the outstanding debentures, compared to an expense of $67,528 in 2013, or a decrease in expense of $202,585. Non-cash other income included above for the three months ended March 31, 2014 was $125,053, compared to other expense of $70,530 for the same period in 2013, or a decrease in non-cash other expense of $195,583.

Net Loss and Net Loss per Common Share.  Net loss for the three months ended March 31, 2014 was $176,896, compared to $685,159 for the same period in 2013, for a decrease in net loss of $508,263 (74.2%). Net 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 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 EPS computations is as follows:

LIQUIDITY AND CAPITAL RESOURCES

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

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Net Cash Used in Operating Activities

Net cash used in operating activities for the three months ended March 31, 2014, was $91, compared with net cash used in operating activities of $114,509 during the same period for 2013, or a decrease in the use of cash for operating activities of $114,418 (99.9%). The decrease in the use of cash is due to: (i) lower operating costs including, but not limited to a decrease in selling, general and administrative costs (other than depreciation and amortization, and stock based compensation) of $104,355 (29.0%), and an increase in non-operating expense (other than noncash items) of $791 (4.5%); and (ii) offset by a net increase in components of operating assets and liabilities of $10,854 (4.1%).

Net Cash Provided by Investing Activities

Net cash provided by investing activities of $0 for the three months ended March 31, 2014, and for the same period in 2013 of $28,934 for the sale of furniture, or a net decrease in cash provided by investing activities of $28,934 (100.0%). The Company anticipates it will incur equipment costs during the current fiscal year ending December 31, 2014, 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 $0 for the three months ended March 31, 2014, compared with $135,000 for the same period in 2013, or a decrease of $135,000 (100.0%). The decrease in the net cash provided by financing activities of $135,000 is due to a decrease from the issuance of short-term notes.  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

Our cash decreased during the three months ended March 31, 2014 by $91, compared to an increase in cash during the same period in 2013 of $49,425. As outlined above, the decrease in cash for the current period in 2014 was the result of; (i) cash used in operating activities of $91, (ii) cash provided by investing activities of $0, and (iii) cash from financing activities of $0.  The net change in cash for the three months ended March 31, 2014, as compared to the same period in 2013, was $49,516, and is the result of (i) a decrease in cash used in operating activities of $114,418 (99.9%), (ii) a decrease from investing activities $28,934 (100.0%), and (iii) a decrease in financing activities of $135,000 (100.0%).

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

Cash is stated at cost, which approximates fair value, and consists of interest and noninterest bearing accounts at a bank.  Balances may periodically exceed federal insurance limits. The Company does not consider this to be a significant risk. The Company considers all highly liquid debt instruments with initial maturities of 90 days or less to be cash equivalents. There were no cash equivalents as of March 31, 2014 and December 31, 2013, respectively.

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As of March 31, 2014, the Company had a working capital deficit of $13,434,172, compared to $13,296,950 at December 31, 2013, or an increase in working capital deficit of $137,222 (1.0%).  As of March 31, 2014, the Company had cash of $1,017 as compared to $1,108 on December 31, 2013. The decrease in cash of $91 is the net result of our operating, investing and financing activities outlined above. For the three months ended March 31, 2014, current liabilities increased $137,131 (1.0%), with specific decreases in current liabilities of $146,937 including: (i) $11,880 for conversion of accrued wages for stock, (ii) $135,057 for the revaluation of derivative liabilities related to the outstanding debentures, and specific increases in current liabilities of $284,068, including: (i) $10,004 short-term note payable due to reduction of debt discount, (ii) $13,962 in trade and accrued payables, (iii) $18,445 in accrued interest, and (iv) $241,657 for the continued accrual of unpaid wages and related expenses for all employees.

Our revenue generating activities during the period, as in previous years, have not produced sufficient funds for profitable operations, and we have incurred operating losses since inception. Accordingly, we have continued to utilize the cash raised in our financing activities to fund our operations. In addition to raising cash through additional financing activities, we may supplement our future working capital needs through the extension of trade payables and increases in accrued expenses. In view of these matters, realization of certain of the assets in the accompanying balance sheet is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing, and the success of our future operations.

Other Liabilities

2013 Short-Term Promissory Notes

During 2013, the Company issued nine promissory notes to eight accredited investors in the aggregate principal amount of $179,500 ($179,275, net of commissions and expenses in the amount of $225), of which five notes for an aggregate of $48,500 originally matured during 2013 and were amended to mature on June 30, 2014, $14,000 matures on June 30, 2014, $100,000 matures on September 21, 2014, and $17,000 matures on October 25, 2014.  The terms of the notes are essentially the same as the 2011 and 2012 short-term promissory notes, except that $40,000 of the notes accrue interest at a rate of 12% per annum, one note for $8,500 was noninterest bearing during 2013 and accrues interest at a rate of 10% effective January 1, 2014, one note for $14,000 accrues interest at a rate of 10% per annum, one note for $8,500 accrues interest at a rate of 5.9%, with two notes for $108,500 being noninterest bearing.  Consideration for one $8,500 noninterest bearing note during 2013 received a modification to 540,000 warrants to include a cashless provision, one note of $8,500 received an extension of 4,632,725 warrants to December 31, 2018, and one for $100,000 received a 2% royalty payment of future TBDx™ net revenue in South Africa up to $300,000.  The Company issued to six of the note holders an aggregate of 450,000 shares of common stock, and the relative fair value of the common stock of $31,100 will be amortized over the term of the notes.

2012 Short-Term Promissory Notes

During 2012, the Company issued six promissory notes to accredited investors in the aggregate principal amount of $160,000.  The twelve-month notes accrue interest at a rate of 12% per annum.  The Company also issued to the note holders an aggregate of 285,000 shares of common stock.  The relative fair value of the common stock of $11,715 will be amortized over the term of the notes.  The Company also issued 10,800 shares of common stock as compensation in connection with the financing for a fair value of $2,700.

2011 Short-Term Promissory Notes

During October and November 2011, the Company issued twelve-month promissory notes to accredited investors in the aggregate principal amount of $400,000.  The twelve-month notes accrue interest at a rate of 12% per annum.  The Company also issued to the two note holders an aggregate of 400,000 shares of common stock.  The relative fair value of the common stock of $34,700 will be amortized over the term of the notes.  The Company also issued 250,000 shares of common stock as compensation in connection with the financing for a fair value of $25,000.

2006 through 2013 Short-Term Promissory Notes, Related Party

On October 18, 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 $100,000. The Company issued a non-negotiable promissory note, dated effective October 18, 2006, to Mr. Trudnak in the principal amount of $100,000. 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

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$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 November 10, 2006, Mr. Trudnak extended the due date of the note to May 31, 2007.  Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, and $5,000 on September 14, 2011, for cumulative outstanding loans of $129,000. The maturity date of the outstanding loans was extended to May 31, 2009, then to May 31, 2010 and June 30, 2011, and subsequently to December 31, 2011 and then to June 30, 2012.  On June 30, 2012, the outstanding loans were extended to December 30, 2012, and then to June 30, 2013, and subsequently to December 31, 2013. On December 31, 2013, the outstanding loans were extended to June 30, 2014. The Company repaid an aggregate of $6,900 of the notes during 2010, an aggregate $33,100 during 2011, an aggregate of $8,500 during 2013, resulting in an outstanding balance at March 31, 2014 of $80,500. The terms of the above transaction were reviewed and approved by the Company’s audit committee and by the independent members of our Board of Directors.

2006 and 2007 Series A Debentures (as Amended on October 15, 2010)

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.  On November 8, 2006, the Company issued to the institutional investors an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants.  On April 12, 2007, the Company issued an additional $2,575,000 in principal amount of the Series A Debentures, which followed the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. Proceeds of the two offerings were used for the purpose of 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. The Company allocated proceeds from each closing to the derivative liability features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles.  We also issued at the first closing an aggregate of 623,520 common stock purchase warrants to the placement agent as compensation in the offering, which were upon terms substantially similar to the Series D Warrants. One-half of the Series D Warrants (2,226,854 warrants) and the placement agent warrants (311,760 warrants) became exercisable on November 8, 2006. The remaining one-half of the Series D Warrants (2,226,855 warrants) and the placement agent warrants (311,760 warrants) became exercisable on April 12, 2007. The Series D Warrants and the placement agent’s warrants may be exercised via a cashless exercise if certain conditions are met. Due to the potential of the 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 at that time indeterminable, and the Company considered the guidance of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, whereby public companies that are or 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, and concluded that the potential of the milestone-related adjustments at that time may cause insufficient shares to share settle the contracts.  On April 1, 2007, due to the various milestone-related provisions, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agent’s Warrants were reset to a price of $0.7453 per share, then to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. The Series A Debentures and Series D Warrants also have a fully ratchet anti-dilution provision, whereby any subsequent equity transaction entitling a person to acquire shares of common stock at an effective price per share that is lower then the then conversion price, then the conversion price of the Debentures and Warrants shall be reduced to equal the lower subsequent equity transaction price.  Subsequently, as a result of a June 2009 financing in which the Company elected to issue shares of common stock and warrants at $0.25 per share, 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 2,677,417 Series D warrants.  On July 10, 2007, a debenture holder exercised 864,798 Series D Warrants for 864,798 shares of common stock, and 914,798 warrants were exercised during 2010 under the cashless provision for 420,166 shares of common stock. Of the remaining Series D Warrants and Placement Agent Warrants, 3,062,527 warrants expired on November 11, 2011, and 3,012,523 warrants expired on April 12, 2012.

As of March 31, 2014, 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, 2014, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted.

Our outstanding Series A 10% 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 that originally became due on November 7, 2008.  Under the amendment agreement, the Company and two debenture holders agreed: (i)

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to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the payment in cash of 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”) under our debentures and 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 if our common stock equals or exceeds certain price and volume conditions. There were no conversions of our debentures during 2013 or 2014.

Under the Debenture amendment agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures.  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 principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law.  We are in discussions with the debenture holders 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 we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension.  Our 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. When an event of default occurs under the debentures, the debenture holders may 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, or (b) the outstanding principal amount unpaid 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.  In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 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 mandatory default amount as of March 31, 2014 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

Prior to the Debenture amendment agreement and absent a default, the Debentures bore interest at the rate of 10% per annum.  The Debenture agreement, as amended on October 15, 2010, states no interest and that from July 1, 2010 through the maturity date of June 30, 2011, the principal amount of this Debenture shall bear no interest.” Any reference to the accrual of interest or late fees, beyond the maturity date, was specifically deleted from the Debenture agreement. If an Event of Default occurs, the outstanding principal amount of the Debenture, plus accrued but unpaid interest, liquidated damages and other amounts owing in respect thereof through the date of acceleration, shall become, at the holder’s election, immediately due and payable in cash at the mandatory default amount. Commencing 5 days after the occurrence of any Event of Default that results in the eventual acceleration of the Debenture, the interest rate on the Debenture shall accrue at an interest rate equal to the lessor of 18% per annum or the maximum rate permitted under applicable law. In accordance with the terms of the amendment agreement, management believes there is no legal requirement to continue the accrual of interest or late fees. Management also determined that there are two (2) events that must take place before the default interest rate of 18% takes effect. One is an event of default, which occurred when the Company did not make payment of the outstanding principle amount on the amended due date of July 1, 2011. The other event is an “eventual acceleration” of the mandatory

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default amount, which did not take place since the default did not occur before the maturity date of June 30, 2011, and the event of default occurred on the due date of July 1, 2011 when payment was not made by the Company.  Since the default did not take place before the maturity or due date, no acceleration of the payment for the outstanding principal amount of the Debentures took place, and the 18% default interest provision does not apply.

The Debenture agreement, as amended on October 15, 2010, continues to permit the payment of interest, if due, 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. 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 Markets, OTCQB 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%.

An event of default may occur under the Debentures if (a) the Company defaults in the payment of principal or, liquidated damages , (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 warranty 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 Markets 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 Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (j) the Company has a judgment against it for more than $150,000. 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.

The conversion price of the Debentures or the number of shares to be issued upon conversion or exercise of the Debentures 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 (“subsequent equity sales anti-dilution adjustment provisions”), 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.

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We were 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 pursuant to the subsequent equity sales anti-dilution adjustment 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, (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, or (D) 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.

In connection with our Series A Debenture financing, we entered into a registration rights agreement with purchaser of our debentures pursuant to which 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 debenture holders 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. Pursuant to the amendments we entered into with the current debenture holders on October 15, 2010, the debenture holders agreed to terminate their registration rights agreements with us. Accordingly, we are not required to register or maintain the registration of the shares underlying the Series A Debentures, however, the Company was obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture.

We also granted to each purchaser of the Debentures 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 Debenture holders 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.

The Company had interest expense of $18,445, $17,429, and $139,632 for the three months ended March 31, 2014, the same period in 2013, and the period of April 1, 2012 through March 31, 2014 (the development stage), respectively. Debt discount amortization costs of $10,004, $3,002, and $51,000 for the three months ended March 31, 2014, the same period in 2013, and the period of April 1, 2012 through March 31, 2014 (the development stage), respectively

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 or future effect upon our financial condition, or results of operations as of March 31, 2014 and December 31, 2013.

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Financial Condition, Going Concern Uncertainties and Events of Default

The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom.  During the three months ended March 31, 2014, 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, 2013, 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 opinion should be given in determining whether to continue or become our stockholder.

As of March 31, 2014, the Company has outstanding trade and accrued payables of $1,703,109, other accrued liabilities of $163,024, and accrued salaries and related expenses due to our employees and management of $8,329,722. Also, the Company has an outstanding noninterest-bearing loan from its previous Chief Executive Officer of $80,500, and $739,500 short-term notes from eleven (11) investors, which has debt discount outstanding of $10,566.

The principal amount of our outstanding Series A Debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Therefore, the Company could be considered in default and may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law.  We are in discussions with the debenture holders 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 we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension.  Our 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. When an event of default occurs under the debentures, the debenture holders may 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, or (b) the outstanding principal amount unpaid 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.  In anticipation of such election by the debenture holders, due to the nonpayment of principal amount on the due date of July 1, 2011, we measured the mandatory default at approximately $337,641 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 mandatory default amount as of March 31, 2014 at approximately $337,641. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount, although there can be no assurance they will not do so. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

As of March 31, 2014, we had a cash balance of $1,017. Subsequently and through May 14, 2014, we issued five promissory notes to three accredited investors in the aggregate principal amount of $25,000. The notes are non-interest bearing, and as consideration to the note holders, the Company shall pay a total premium of 50% (total payment due of 1.5 times principal) of such note, and the entire unpaid principal and premium amounts shall become immediately due on or before September 30, 2014. If such note is not paid by September 30, 2014, then the Company shall pay a total premium of 100% (total payment due of 2 times principal), and such payment of total principal and premium amounts shall be from net revenue of future TBDx™ sales.  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, will require an aggregate of approximately we are spending or incurring (and accruing) expenses of approximately $190,000 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 an aggregate of approximately $2,280,000 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 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.

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 have been and continue to be insufficient to fund our operations, pay our trade payables, and repay our

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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 continue to be unable to pay our employees, we may suffer further 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 and limited trading volume in 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 below the current conversion price or 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 the three months ended March 31, 2014, our total stockholders’ deficit increased by $154,759 to $13,080,836, and our consolidated net loss for the period was $176,896. 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.

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.  The Company, previously an operating stage company, became a development stage company on April 1, 2012, the date of inception as a development stage company for financial reporting. A development stage company, as defined by ASC-915-10 “Accounting and Reporting by Development Stage Enterprise”, is an entity that devotes substantially all of its efforts to establish a business and either of the following conditions exists: 1) the principal operations have not commenced, or 2) the principal operations have commenced, but there has been no significant revenue therefrom.  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, 2013.  Except as disclosed in Part I, Item 4, Controls and Procedures of this report, and in Note 2 of our 2013 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, 2014.