10-K 1 i310k2008vfinal.txt FORM 10-K U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2008 COMMISSION FILE NUMBER 0-13215 IMAGING3, INC. ------------------------- (Exact name of registrant as specified in its charter) CALIFORNIA 95-4451059 ------------------- ---------------------------- (State of Incorporation) (I.R.S. Employer Identification No.) 3200 W. VALHALLA DRIVE, BURBANK, CALIFORNIA 91505 ----------------------------------------------- (Address of principal executive offices) (Zip Code) (818) 260-0930 --------------------------------------- Registrant's telephone number, including area code SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ----------------------- ---------------------------- COMMON STOCK OTC Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X| Indicate by check mark if the registrant is not required to filed reports pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X| Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [___] Accelerated filer [___] Non-accelerated filer [___] Smaller reporting company [_X_] (Do not check if a smaller reporting company) Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $7,550,007 as of February 28, 2009 (computed by reference to the last sale price of a share of the registrant's Common Stock on that date as reported by OTC Bulletin Board). There were 257,474,052 shares outstanding of the registrant's Common Stock as of February 28, 2009.
TABLE OF CONTENTS PART 1 ITEM 1 Business 2 ITEM 2 Properties 15 ITEM 3 Legal Proceedings 16 ITEM 4 Submission of Matters to a Vote of Security Holders 16 PART II ITEM 5 Market for Common Equity and Related Stockholder Matters 16 ITEM 6 Selected Financial Data 17 ITEM 7 Management's Discussion and Analysis or Plan of Operation 17 ITEM 8 Financial Statements and Supplementary Data 22 ITEM 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37 ITEM 9A(T) Controls and Procedures 37 ITEM 9B Other Information 38 PART III ITEM 10 Directors, Executive Officers, and Corporate Governance 39 ITEM 11 Executive Compensation 42 ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related 43 Stockholder Matters ITEM 13 Certain Relationships and Related Transactions, and Director Independence 44 ITEM 14 Principal Accounting Fees and Services 44 ITEM 15 Exhibits, Financial Statement Schedules 45 SIGNATURES 46
-1- PART I ITEM 1. BUSINESS GENERAL Imaging3, Inc. (the "Company" or "Imaging3") has developed a proprietary medical technology designed to produce 3D medical diagnostic images in real time. In the future, healthcare workers using Imaging3 devices will potentially be able to instantly view 3D, high-resolution images of virtually any part of the human body. HISTORY The Company was founded as Imaging Services, Inc. ("ISI") on October 29, 1993, by Dean Janes. The Company initially served as a low cost, third party service alternative for equipment made by Orthopedic Equipment Company Medical Systems ("OEC"). OEC is the largest manufacturer of mobile surgical C-arms with over a 60% market share in the United States. A C-arm is an integral component of a fluoroscopic imaging system used for various types of surgery. Management believes that prior to the Company's inception, no company solely focused on providing third party service for OEC equipment. In early 1994, Imaging3 began offering upgrades for OEC C-arms. The most successful upgrade was a CCD (Charged Coupled Device) camera, which improved image quality of older systems comparable with that of brand new products. This offering became so successful that the Company integrated this upgrade with used OEC C-arms and built custom units for NASA, Harvard, University of California at Irvine, University of California at Davis, Baylor University, Baxter Healthcare and other prestigious healthcare organizations. Later that year, Imaging3 applied for and received United States Food and Drug Administration ("FDA") approval for this device described as the NASA II CCD C-arm. In mid 1995, Imaging3 purchased the assets of ProMedCo. ProMedCo had an exclusive agreement with OEC to remanufacture OEC C-arms for OEC Medical Systems. Though the purchase did not transfer the agreement, it eliminated one of the Company's competitors and provided a substantial inventory of replacement parts. Access to these replacement parts allowed Imaging3 to increase immediately its production levels and created the opportunity to remanufacture OEC's complete product line, thereby increasing the models ISI could offer its customers. Also, this purchase allowed the Company to enter the lucrative parts sales business. In 2000, the Company continued its expansion by purchasing a sales company in San Diego, California. This asset purchase brought an extensive database with over 43,000 physician names, hospitals, medical centers and surgery centers contact information as well as a streamlined automated sales force. Also, as part of this expansion, several key employees, most of whom were former employees of OEC, were hired to increase the Company's service presence in Arizona, Washington, Nevada, Florida and Hawaii with a national service presence as the ultimate goal. In 2002, the Company closed the San Diego office and consolidated operations in Burbank, California. On February 19, 2002, a fire gutted the Company's principal operating facility, causing an estimated $4.3 million in damage. The 10,800-square-foot structure was subsequently rebuilt and the Company has reoccupied it. In the interim, the Company previously leased temporary facilities. The damage to the building and the loss of the Company's equipment were partially covered by liability insurance. Nevertheless, the fire disrupted the Company's operations. In order to better position the Company for its future direction, away from service and toward providing proprietary medical imaging products, the Company changed its name from Imaging Services, Inc. to Imaging3, Inc. on August 20, 2002. On June 15, 2007, the Company filed with the FDA a 510(k) application for approval of the Company's medical diagnostic imaging device for sale in the United States. Assuming that the FDA grants approval, the Company intends to -2- follow up and apply to sell the product on the European and then worldwide markets. The FDA is currently reviewing the application, and management is not certain if or when FDA approval will be granted. The Company completed building its first prototype medical diagnostic imaging device in April 2007. BUSINESS OPERATIONS Imaging3 technology has the potential to contribute to the improvement of healthcare. The Company's technology is designed to cause 3D images to be instantly constructed using high-resolution fluoroscopy. These images can be used as real time references for any current or new medical procedures in which multiple frames of reference are required to perform medical procedures on or in the human body. Imaging3 technology has extraordinary market potential in an almost unlimited number of medical applications, including: o TRAUMA CENTER. Imaging3 technology would allow a surgeon to immediately view exactly where a bullet is lodged in a gunshot victim. At any point during the procedure, the surgeon could continue to view 3D images in real-time. o CARDIOLOGY. Imaging3 technology could provide a 3D view of a heart and allow a cardiologist to record the heartbeat in real-time. The entire heart would be visible, including veins that are wrapped around the "back" side. o PAIN MANAGEMENT. Imaging3 technology could provide a 3D view of the spine, nerve endings, injection points and help guide the needle for spinal procedures. 3D images in real-time could also be used to view disk compression. o NEURO-VASCULAR. Imaging3 technology could provide a 3D view of the skull and brain to diagnose neuro-vascular diseases. 3D images in real-time could be used to view the rupture of vessels or arterial blockages diminishing blood flow to the brain. o ORTHOPEDIC. Imaging3 technology could provide a 3D view of bones and joints to help diagnose orthopedic conditions. An orthopedic surgeon could view a 3D image in real-time to line up a screw with the hole in a hip pinning. o VASCULAR. Imaging3 technology could provide a 3D view of veins throughout the body. After injecting dye, a 3D image in real-time could pinpoint clots and occlusions and help diagnose vascular diseases. MULTI-FUNCTION DEVICE A diagnostic medical imaging device built with Imaging3 technology can perform several functions and can replace or supplement a number of exiting devices, resulting in considerable cost savings for hospitals and healthcare centers. These functions include: o Perform real-time, 3D medical imaging; o Emulate a computerized tomography ("CT") scanner (at a fraction of the capital cost); and o Perform standard fluoroscopy. The Company's management believes that this multi-function capability will be especially attractive in foreign markets, where the cost of a CT scanner is beyond the means of most hospitals and healthcare centers. EXISTING BASE OF BUSINESS TO LAUNCH A PROPRIETARY PRODUCT Imaging3 is an established company with revenues and an industry reputation. While the Company began as a service provider, it quickly expanded to include equipment and parts sales, both new and renewed. Management believes that Imaging3 is the largest remanufacturer of C-arms in the world. The Company offers new, demonstration, remanufactured, refurbished and pre-owned systems in all price ranges from every major manufacturer including OEC, General Electric ("GE"), ISI, Philips, Siemens, FluoroScan, XiScan and Ziehm. The Company supplies full-size, compact and mini C-arms. -3- Management believes that Imaging3 is also the largest distributor of C-arm tables in the United States. The Company offers new, demonstration, remanufactured, refurbished and pre-owned C-arm tables in all price ranges from every major manufacturer. The Company also supplies pain management tables, surgery tables, urology tables and vascular tables. Imaging3's management intends to use the Company's base of operations and channels of distribution to launch its new medical imaging devices business, based on its breakthrough Imaging3 technology. BUSINESS AND REVENUE MODELS The Company's business strategy is straight-forward: (1) continue to build the Company's base of C-arm remanufacturing and service business, (2) develop medical diagnostic imaging devices, based on the Company's breakthrough Imaging3 technology for the $5 billion medical imaging market, (3) sell the Company's new medical diagnostic imaging devices directly to healthcare providers, as well as through channel partners and distributors, and (4) license the Company's breakthrough Imaging3 technology to other medical diagnostic imaging device manufacturers. The Company's management believes that most of the Company's future revenues will come from the sale of medical imaging devices, based on the Company's Imaging3 technology. Other revenues are expected to be derived from the licensing of its proprietary technology to other medical diagnostic imaging device manufacturers. The smallest portion of the Company's future revenue is projected to come from the sale and service of C-arms. PROPRIETARY TECHNOLOGY PATENT On June 23, 2004, U.S. Patent No. 6,754,297 was granted in the name of Dean Janes, entitled Apparatus and Method for Three-Dimensional Real-Time Imaging System. The rights to this patent have been assigned to the Company. ABSTRACT OF THE PATENT DISCLOSURE A computing device in a three-dimensional imaging system utilizes a plurality of distance readings and reference readings from at least one subject sensor to determine a subject location and a subject volume and establish a base-three dimensional map of a subject. A plurality of two-dimensional image exposures along with a plurality of associated reference locations are created by rotating an image source and an image receptor around an inner circumference of an imaging gantry. The plurality of two-dimensional image exposures is digitized to create a plurality of digital two-dimensional image exposures. The computing device receives the plurality of digital two-dimensional image exposures and the plurality of associated reference locations. The overlaying, interpolating and pasting of the plurality of digital two-dimensional image exposures on the base three-dimensional map creates a base three-dimensional image exposure, which is displayed on a display device. GENERAL DESCRIPTION Real-time 3D medical diagnostic imaging will be accomplished by scanning the patient, either partially or completely in a 360-degree circumference under fluoroscopy (or other type of image exposure), utilizing a single or multiple x-ray source and image receptor. The information acquired under fluoroscopy (or other type of image exposure) will be digitized at a frame rate of between 30 to 60 frames per second. This information will be sent to a computer system to be incorporated into a three dimensional image to be displayed on a computer monitor. The image created can then be manipulated and/or rotated to view the scanned image of the patient's anatomy in any direction or orientation desired by the user. The user could then choose a specific area of the image to update. Once an area is selected, the computer displaying the image would then "gang" or align the x-ray source(s) and image receptor(s) to begin updating scans of new images to be overlaid upon the existing three dimensional model. This process would then be updated and/or repeated as many times necessary for the specific procedure to be completed. At any time, a new reference area or scan could be selected or initiated. -4- THE "O" DEVICE Part of the Company's invention is based on an "O" device to create a circular gantry similar to that used with CT to scan a patient a full 360 degrees with fluoroscopic radiation. This approach is expected to allow imaging of the patient from any frame of reference or angulation. (Current medical imaging devices are limited to 150 degrees to 360 degrees with mechanical orientation or manipulation.) 3D imaging requires an "O" device to scan the patient in increments of 360 degrees to allow construction of a three dimensional image. By scanning the patient in 360 degrees and acquiring images at 30 to 60 frames per second, management believes a three dimensional image can be constructed. IMAGING3 TECHNOLOGY DIFFERS FROM OTHER APPROACHES The "O" device approach is similar to that used in a CT scan. The difference is CT is used to image a "slice" of the anatomy and not intended for real-time fluoroscopic imaging. The slice is obtained by using a fulcrum reference point and rotating the X-ray source and image receptor in reference to that point. This basic geometry creates a 2D image in any depth desired, in any region of the body. The "O" device would use a similar fulcrum point to reference depth, but the scan would not create a slice but instead a real-time image captured at 30 to 60 frames per second in 360 degrees. Further, management believes that the "O" device would be used for conventional fluoroscopic imaging with the advantage of positioning the X-ray source and receptor at any angulation desired. Currently, 3D imaging is used only for reconstructive post processing reference images. Magnetic resonance imaging ("MRI"), CT and ultrasound currently have this capability. The 3D images are created by multiple scans of 2D images that require a long period of time to process into a three dimensional image. The image created is then used only for reference, not real time manipulation in the body. The Company anticipates that it's 3D images will be constructed almost instantly and will available to be used as real time references whenever multiple frames of reference are required to perform medical procedures on or in the human body. THE MARKET The Company competes in the medical diagnostic imaging market and this market has never been healthier than it is today. This vitality is due primarily to continual technological improvements that lead to faster and better-resolution imaging, greater patient safety, and the provision of these capabilities to a growing and aging population. The result has been a vigorous competition to create the most cost-effective diagnostic imaging systems. Diagnostic imaging is an evolving part of modern medicine and is now entering a new era of digital imaging. The field has evolved from the early X-rays by Roentgen over 100 years ago to imaging of organs by CT and MRI that are 20 years old. Medical imaging is used for diagnosis in the leading causes of death, heart attacks, strokes, and cancer. What was once called the radiology department is now called the diagnostic imaging department because of the wealth of new technologies available beyond x-rays. A trauma victim's internal injuries are imaged with a CT scanner. Breast cancer, a leading cause of death in women, is detected with mammography and ultrasound. According to a Freedonia Group study, the medical imaging equipment market in the U.S. will register gains of 7.6 percent per year through 2008 to $9.5 billion, faster than projected growth in national health expenditures. Growth will be stimulated by an increasing incidence of patient procedures involving diagnostic imaging, partly the result of an aging population and partly reflecting advances in noninvasive imaging technology. The Company's management believes that opportunities exist not only for new companies in imaging products but also software companies for image processing and Picture Archiving and Communication Systems ("PACS") networks. Technological developments continue, which consistently result in new products. Diagnostic imaging is an important part of medical diagnosis. It ranges from a dentist's X-ray to find tooth decay to angiograms done to aid a cardiologist in performing an angioplasty. The aging baby boomer population will need the new imaging capabilities for cancer and heart disease detection. The revolution in medical imaging is being fueled not only by new medical imaging technology, but also by advances in computer hardware and software. New systems -5- such as spiral CT or multi-slice CT would not be possible without today's faster processors. Better software algorithms for image analysis and compression make the process more accurate and efficient. The growth of diagnostic imaging could be an important source of revenue for computer manufacturers, and software companies specializing in diagnostic imaging. INDUSTRY OVERVIEW Diagnostic imaging services are noninvasive procedures that generate representations of the internal anatomy and convert them to film or digital media. Diagnostic imaging systems facilitate the early diagnosis of diseases and disorders, often minimizing the cost and amount of care required and reducing the need for costly and invasive diagnostic procedures. MAGNETIC RESONANCE IMAGING ("MRI") MRI involves the use of high-strength magnetic fields to produce computer-processed cross-sectional images of the body. Due to its superior image quality, MRI is the preferred imaging technology for evaluating soft tissue and organs, including the brain, spinal cord and other internal anatomy. With advances in MRI technology, MRI is increasingly being used for new applications such as imaging of the heart, chest and abdomen. Conditions that can be detected by MRI include multiple sclerosis, tumors, strokes, infections, and injuries to the spine, joints, ligaments, and tendons. Unlike x-rays and computed tomography, which are other diagnostic imaging technologies, MRI does not expose patients to potentially harmful radiation. MRI technology was first patented in 1974, and MRI systems first became commercially available in 1983. Since then, manufacturers have offered increasingly sophisticated MRI systems and related software to increase the speed of each scan and improve image quality. Magnet strengths are measured in tesla, and MRI systems typically use magnets with strengths ranging from 0.2 to 1.5 tesla. The 1.0 and 1.5 tesla strengths are generally considered optimal because they are strong enough to produce relatively fast scans but are not so strong as to create discomfort for most patients. Manufacturers have worked to gradually enhance other components of the machines to make them more versatile. Many of the hardware and software systems in recently manufactured machines are modular and can be upgraded for much lower costs than purchasing new systems. The MRI industry has experienced growth as a result of: o Recognition of MRI as a cost-effective, noninvasive diagnostic tool. o Superior soft-tissue image quality of MRI versus that of other diagnostic imaging technologies. o Wider physician acceptance and availability of MRI technology. o Growth in the number of MRI applications. o MRI's safety when compared to other diagnostic imaging technologies, because it does not use potentially harmful radiation. o Increased overall demand for healthcare services, including diagnostic services, for the aging population. POSITRON EMISSION TOMOGRAPHY ("PET") PET is a nuclear medicine procedure that produces pictures of the body's metabolic and biologic functions. PET can provide earlier detection of certain cancers, coronary diseases or neurologic problems than other diagnostic imaging systems. It is also useful for the monitoring of these conditions. COMPUTED TOMOGRAPHY ("CT") In CT imaging, a computer analyzes the information received from an x-ray beam to produce multiple cross-sectional images of a particular organ or area of the body. CT imaging is used to detect tumors and other conditions affecting bones and internal organs. -6- OTHER SERVICES Other diagnostic imaging technologies include x-ray, single photon emission computed tomography, and ultrasound. DIGITAL IMAGING TECHNOLOGIES New techniques for the digital capture, display, storage, and transmission of X-ray images are poised to revolutionize the diagnostic imaging market. Although digital technologies and techniques have been in use in other diagnostic imaging areas (such as CT scans, MRI scans, and ultrasound), technical problems have kept X-ray technologies in the era of film. However, new methods of digitally capturing X-ray images are under development and promise to revolutionize X-ray imaging. The need to cut costs and improve services in healthcare delivery is driving the move to digital systems. The requirement for hospitals to implement electronic access to medical images and other types of information is now widely accepted and regarded as inevitable. The trend toward storing, distributing and viewing medical images in digital form is being fueled by both changes in the economic structure of the healthcare system and by rapidly evolving technologies. In particular, the new economics of health care will mandate a shift from film-based radiology to the electronic delivery of digital images, while new technology promises the additional benefit of vastly improved diagnostic power. USERS OF DIAGNOSTIC IMAGING MRI and other imaging services are typically provided in one of the following settings: HOSPITALS AND CLINICS Imaging systems are located in and owned and operated by a hospital or clinic. These systems are primarily used for the patients of the hospital or clinic, and the hospital or clinic bills third-party payors, such as health insurers, Medicare or Medicaid. INDEPENDENT IMAGING CENTERS Imaging systems are located in permanent facilities not generally owned by hospitals or clinics. These centers depend upon physician referrals for their patients and generally do not maintain dedicated, contractual relationships with hospitals or clinics. In fact, these centers may compete with hospitals or clinics that have their own systems to provide Imaging3 to these patients. Like hospitals and clinics, these centers bill third-party payors for their services. OUTSOURCED Imaging systems, largely located in mobile trailers but also provided in fixed facilities, provide services to a hospital or clinic on a shared-service or full-time basis. Generally, the hospital or clinic contracts with the imaging service provider to perform scans of its patients, and the imaging service provider is paid directly by that hospital or clinic instead of by a third-party payor. INDUSTRY CHALLENGES In a recent report, U.S. MEDICAL IMAGING INDUSTRY OUTLOOK, Frost & Sullivan identified several challenges facing the diagnostic imaging industry. Low reimbursement rates have become a major challenge, not only for end users, but for manufacturers as well. Imaging reimbursements for many procedures may be inadequate given the expense of the equipment and the expertise required to create and interpret results. Lack of adequate compensation is a concern for all industry participants, as many healthcare centers are delaying or canceling purchases of high-priced items. Until the financial rewards for imaging are increased substantially, and definitively, low reimbursement will be the foremost hurdle for manufacturers. -7- COMPETITION COMPETITIVE LANDSCAPE The healthcare industry in general and the market for imaging products in particular is highly competitive. The Company competes with a number of companies, many of which have substantially greater financial, marketing, and other resources than the Company. The Company's competitors include large companies such as GE, Philips, Siemens Toshiba and Hitachi, which compete in most medical diagnostic imaging modalities, including X-ray imaging. A study by Theta Reports, DIAGNOSTIC IMAGING EQUIPMENT AND SYSTEMS WORLD MARKET, identifies the following 17 key players in the medical diagnostic imaging market: o ADAC Laboratories o Eastman Kodak Co. o Fonar Corp. o Fuji Medical Systems U.S.A., Inc. o General Electric Medical Systems o Hitachi Medical Systems America, Inc. o Hologic, Inc. o Imaging Diagnostic Systems, Inc. o Imatron, Inc. o Lumisys, Inc. o Marconi Medical Systems o Philips Medical Systems Nederland BV o PhorMax Corp. o Siemens Medical Engineering Group o Sterling Diagnostic Imaging, Inc. o Trex Medical Corp. o Varian Medical Systems, Inc. DIRECT COMPETITORS At this time, the Company is not aware of any existing devices in the marketplace that provide 3D, real-time diagnostic medical imaging, with the exception of ultrasound. Ultrasound is a real-time tomgraphic imaging modality. Not only does it produce real-time tomograms of the position of reflecting surfaces (internal organs and structures), but also it can be used to produce real-time images of tissue and blood motion. However, ultrasound is a low-resolution imaging modality that does not produce an image as precise and clear as fluoroscopy. The Company's devices will rely instead on the use of fluoroscopy, a high-resolution imaging modality, to produce "live" X-ray images of living patients in 3D. MARKETING AND SALES PLAN MARKETING STRATEGY Imaging3's marketing strategy is to create a favorable environment to sell its medical diagnostic imaging devices. The Company intends to enhance, promote and support the fact that Imaging3 technology is the most complete and comprehensive medical diagnostic imaging solution available in the marketplace. -8- PRODUCT AND SERVICE DIFFERENTIATION The differentiating attributes of Imaging3 technology include: o The only 3D, real time medical diagnostic imaging device in the market that will produce high resolution images; o Reasonably priced; o Easy-to-install; o Vast array of features; and o Highly reliable. VALUE PROPOSITION The Company's value proposition is simple: Diagnostic imaging devices with Imaging3 technology allow healthcare providers to easily produce 3D, real time, high resolution images at a reasonable cost. POSITIONING Management believes that Imaging3 can be positioned as offering the superior solution for producing medical diagnostic images. Management believes that the Company's unique advantage is that it can offer a diagnostic imaging solution that will allow healthcare providers to view real time references for virtually any procedure. The Company plans to reposition its competitors by demonstrating that their offerings are inadequate because they: o Do not provide 3D images; o Do not provide images in real time; o Do not provide high resolution images; and o Are too costly. SALES STRATEGY After undertaking a marketing campaign, the Company intends to aggressively sell its medical diagnostic imaging devices in the United States. International sales efforts will follow after achieving market penetration in the domestic marketplace. SALES MARGIN STRUCTURE The Company's management believes that the majority of its sales will be derived from direct sales to customers, with the balance of sales derived from dealers and manufacturer's representatives. As a result, the sales margin structure must be attractive to these independent organizations. o Direct Sales - Full suggested list price; o Dealers - 30% off suggested list price; and o Manufacturer's Representatives - 10% commission. TARGET MARKET SEGMENT The Company's management has identified general medical and surgical hospitals in the United States as its primary target market segment for Imaging3 technology. According to D&B/iMarket, there are the 12,041 general medical and surgical hospitals in the United States. DISTRIBUTION CHANNELS The Company plans to sell its Imaging3 medical diagnostic imaging devices through several channels of distribution, including: -9- DIRECT SALES TO END USERS The Company's policy is to sell directly to end-users whenever possible. The Company's management expects that direct sales will occur most often with larger customers. DEALERS AND MANUFACTURER'S REPRESENTATIVES The Company has working relationships with a number of independent organizations that help distribute the Company's current product line. The Company expects to work with these independent organizations to help distribute diagnostic medical imaging devices built with Imaging3 technology. These organizations have well-established relationships with mid-size to large size customers. Many also provide specific vertical market applications. EXECUTIVE SALES Because many of Imaging3's large customers will tend to be top healthcare managers, it is important that its Company president and senior managers present its products to its large customers. FIELD SALES FORCE Management anticipates that the majority of the Company's selling efforts to large accounts will be handled internally through its field sales force. Imaging3 has chosen to use a direct sales force because its large accounts require considerable customer education and post-sales support--directly from the Company. Management believes that the Company's price points, pricing structure and profits are such that its cost of sales warrants a "person-to-person" selling strategy. DEALERS AND MANUFACTURERS' REPRESENTATIVES The Company plans to supplement its own field sales force by entering into agreements with dealers and manufacturers' representatives. Because dealers and manufacturers' representatives carry several product/service lines that are compatible with the Company's products and services, Imaging3 plans to select dealers and manufacturers representatives carrying complementary and compatible products and services, as well as dealers and manufacturers' representatives that sell dissimilar products and services yet ones that are appropriate to their customers' customer. EMPLOYEES The Company currently employs nine full-time individuals, all of who are working at the Company's offices at 3200 W. Valhalla Drive, Burbank, California 91505. Of those nine full-time employees, five are employed in administrative, marketing, and sales positions, and the remaining four are technical employees employed in research, development and production positions. The Company projects that during the next 12 months, the Company's workforce is likely to increase. To support the Company's need for technical staffing, the Company has established relationships with technical staffing organizations that continuously offer highly qualified personnel to meet the Company's needs, both locally and from out of the area. INTELLECTUAL PROPERTY MATTERS All of the Company's employees have executed agreements that impose nondisclosure obligations on the employee and in which the employee has assigned to the Company (to the extent permitted by California law) all copyrights and other inventions created by the employee during employment with the Company. The rights underlying the application for the patent of the Imaging3 technology have been assigned to the Company. The Company has in place a trade secret protection policy that the Company's management believes to be adequate to protect the Company's intellectual property and trade secrets. -10- GOVERNMENT REGULATORY APPROVAL PROCESS All the Company's products are classified as Class II (Medium Risk) devices by the FDA and clinical studies with the Company's products will be considered to be Non-Significant Risk Studies ("NSR"). Imaging3's business is governed by the FDA and all products typically require 510(k) market clearance before they can be put in commercial distribution. The Company is also regulated by the FDA's Quality Systems Regulation ("QSR"), which is similar to the ISO9000 and the European EN46000 quality control regulations. All of the Company's products currently in production or manufactured by other vendors are approved for marketing in the United States under FDA's 510(k) regulations. A 510(k) is a pre-marketing submission made to FDA to demonstrate that the device to be marketed is as safe and effective, that is, substantially equivalent ("SE"), to a legally marketed device that is not subject to pre-market approval ("PMA"). Applicants must compare their 510(k) device to one or more similar devices currently on the U.S. market and make and support their substantial equivalency claims. A legally marketed device is a device that was legally marketed prior to May 28, 1976 (pre-amendments device), or a device which has been reclassified from Class III to Class II or I, a device which has been found to be substantially equivalent to such a device through the 510(k) process, or one established through Evaluation of Automatic Class III Definition. The legally marketed device(s) to which equivalence is drawn is known as the "predicate" device(s). Applicants must submit descriptive data and when necessary, performance data to establish that their device is SE to a predicate device. The data in a 510(k) is to show comparability, that is, SE of a new device to a predicate device. Imaging3 has not sought or obtained a determination from the FDA whether a 510(K) submission is required. The FDA does not offer an opinion or determination of what submission is required. The FDA does provide a database of devices, classifications and Regulation numbers. In the Company's research of this database the Company determined several Class II devices meet the Company's criteria for submission. These devices are listed in the table below. PRODUCT CODE CLASS DESCRIPTION REGULATION ------------ ----- ----------- ---------- IZG II System, X-ray, Photofluorographic 892.1730 JAB II System, X-ray, Fluoroscopic, Non-Image-I 892.1660 JAK II System, X-ray, Tomography, Computed 892.175 This is a broad range of devices with which to compare the Company's device functionality. The FDA requires the manufacturer to submit an application, whether it is a 510(k) or PMA submission, upon receipt of the submission the FDA will respond within 30 to 45 days, with their determination of acceptance of the submission, questions and/or comments to the submission and requests for more information. All of the Company's current used rebuilt products are Class II devices, FDA approved through OEM for marketing. Once approved the FDA will not require the manufacture to resubmit an application or change the classification. They may however, request further information about the product(s), manufacturer and GMP requirements. The devices currently sold by this Company are not manufactured by this Company. OEC Medical Systems, is the original device manufacturer and responsible for the FDA submission of their original device(s). Imaging3 remanufactures OEC Medical Systems devices, thus the Company is not required to submit any FDA submission for these devices. In some instances, the Company has performed modifications to these devices to improve the devices functionality, and in these instances Imaging3 has submitted 510(k) applications. These modifications are to existing devices with existing classifications listed in the FDA database and cannot be reclassified. The FDA database listing for current products is listed below: PRODUCT CODE CLASS DESCRIPTION REGULATION ------------ ----- ----------- ---------- IZL II System, X-ray, Mobile 892.1720 As to the Company's new product and its potential for classification, the FDA requires the Company as the manufacturer to submit an application in whichever classification the Company chooses in the submission form it chooses, meaning 510(k) or PMA application. The FDA reviews the submission and determines -11- whether the application is appropriately filed and in the correct submission format. The criteria they use for determination on a 510(k) is SE, which is a comparative analysis of the manufacturers device in the submission with existing devices already approved by the FDA. This is the purpose of the FDA's Device Classification Database, giving manufactures products with approved submissions and categories of devices to compare new device submissions. A new type of device may not be found in the product classification database. If the device is a high risk device (supports or sustains human life, is of substantial importance in preventing impairment of human health, or presents a potential, unreasonable risk of illness or injury) and has been found to be not substantially equivalent ("NSE") to a Class I, II, or III [Class III requiring 510(k)], then a PMA application will be required. If the FDA determines the new device must be classified as a Class III device, the FDA may still allow the device submission to be a 510(k) submission. Class III devices, which are equivalent to devices legally marketed before May 28, 1976 may be marketed through the pre-market notification [510(k)] process until FDA has published a requirement for manufacturers of that generic type of device to submit pre-market approval data. Class III devices are usually those that support or sustain human life, are of substantial importance in preventing impairment of human health, or which present a potential, unreasonable risk of illness or injury. Examples of Class III devices which require a pre-market approval include replacement heart valves, silicone gel-filled breast implants, and implanted cerebella stimulators. The Company's new product the "Real-time 3D Imaging Device" is expected to be submitted as Product Code "IZG," Device Class II, "System, X-ray, Photofluorographic," Regulation Number 892.1730, since this is the closest device description. The FDA may at its own choosing and determination wish to reclassify this device as a Class III, which the Company believes is unlikely, since the majority of the Company's device functions are similar to existing products currently being marketed and as classified as above. If the FDA determines to classify this device as a Class III device a PMA application must be filed. The PMA application is the most stringent type of device marketing application required by FDA. The applicant must receive FDA approval of its PMA application prior to marketing the device. PMA approval is based on a determination by FDA that the PMA contains sufficient valid scientific evidence to assure that the device is safe and effective for its intended use(s). An approved PMA application is, in effect, a private license granting the applicant (or owner) permission to market the device. The PMA owner, however, can authorize use of its data by another. The PMA applicant is usually the person who owns the rights, or otherwise has authorized access, to the data and other information to be submitted in support of FDA approval. This person may be an individual, partnership, corporation, association, scientific or academic establishment, government agency or organizational unit, or other legal entity. The applicant is often the inventor/developer and ultimately the manufacturer. FDA regulations provide 180 days to review the PMA application and make a determination. In reality, the review time is normally longer. Before approving or denying a PMA application, the appropriate FDA advisory committee may review the PMA application at a public meeting and provide FDA with the committee's recommendation on whether or not FDA should approve the submission. After FDA notifies the applicant that the PMA application has been approved or denied, a notice is published on the Internet (1) announcing the data on which the decision is based, and (2) providing interested persons an opportunity to petition FDA within 30 days for reconsideration of the decision. A PMA application is a scientific, regulatory documentation to the FDA to demonstrate the safety and effectiveness of the class III device. There are administrative elements of a PMA application, but good science and scientific writing is a key to the approval of PMA application. If a PMA application lacks elements listed in the administrative checklist, FDA will refuse to accept a PMA application and will not proceed with the in-depth review of scientific and clinical data. If a PMA application lacks valid clinical information and scientific analysis based on sound scientific reasoning, it will delay FDA's review and approval. PMA applications that are incomplete, inaccurate, inconsistent, omit critical information, and poorly organized have resulted in delays in consideration of PMA applications. -12- Three categories of the PMA application are very important: TECHNICAL SECTIONS. The technical sections containing data and information should allow FDA to determine whether to approve or disapprove the application. These sections are usually divided into non-clinical laboratory studies and clinical investigations. NON-CLINICAL LABORATORY STUDIES' SECTION. Non-clinical laboratory studies' section includes information on microbiology, toxicology, immunology, biocompatibility, stress, wear, shelf life, and other laboratory or animal tests. Non-clinical studies for safety evaluation must be conducted in compliance with 21CFR Part 58 (Good Laboratory Practice for Nonclinical Laboratory Studies). CLINICAL INVESTIGATIONS SECTION. Clinical investigations section includes study protocols, safety and effectiveness data, adverse reactions and complications, device failures and replacements, patient information, patient complaints, tabulations of data from all individual subjects, results of statistical analyses, and any other information from the clinical investigations. Any investigation conducted under an Investigational Device Exemption ("IDE") must be identified as such. Imaging3, Inc. is listed with the FDA as a new device manufacturer, its Registration Number is 20300565, and its Owner Operator Number is 9023393. Though the Company does not currently manufacture new devices the FDA requires the Company's registration as a remanufacturer. Imaging3 is subject to the FDA's Radiological Health Program, under the Center for Devices Radiological Health ("CDRH") division of the FDA. The Company must be in compliance with, Good Manufactures Practices ("GMP"), Quality Control ("QC") and Medical Device Reporting ("MDR"). The FDA may from time to time, usually every 2 to 3 years, audit the Company for compliance. In these audits the FDA reviews documents, interviews management and reviews all procedures. The current GMP requirements set forth in the Quality System ("QS") regulation are promulgated under section 520 of the Federal Food, Drug and Cosmetic ("FFD&C") Act. They require that domestic or foreign manufacturers have a quality system for the design, manufacture, packaging, labeling, storage, installation, and servicing of finished medical devices intended for commercial distribution in the United States. The regulation requires that various specifications and controls be established for devices; that devices be designed under a quality system to meet these specifications; that devices be manufactured under a quality system; that finished devices meet these specifications; that devices be correctly installed, checked and serviced; that quality data be analyzed to identify and correct quality problems; and that complaints be processed. Thus, the QS regulation helps assure that medical devices are safe and effective for their intended use. The FDA monitors device problem data and inspects the operations and records of device developers and manufacturers to determine compliance with the GMP requirements in the QS regulation. The MDR regulation provides a mechanism for FDA and manufacturers to identify and monitor significant adverse events involving medical devices. The goals of the regulation are to detect and correct problems in a timely manner. Although the requirements of the regulation can be enforced through legal sanctions authorized by the FFD&C Act, FDA relies on the goodwill and cooperation of all affected groups to accomplish the objectives of the regulation. The statutory authority for the MDR regulation is section 519(a) of the FFD&C Act as amended by the Safe Medical Devices Act ("SMDA") of 1990. The SMDA requires user facilities to report: o Device-related deaths to the FDA and the device manufacturer; o Device-related serious injuries to the manufacturer, or to FDA if the manufacturer is not known; and o Submit to FDA on an annual basis a summary of all reports submitted during that period. When a problem arises with a product regulated by FDA, the Agency can take a number of actions to protect the public health. Initially, the agency works with the manufacturer to correct the problem voluntarily. If that fails, legal remedies include asking the manufacturer to recall a product, having federal marshals seize products if a voluntary recall is not done, and detaining imports at the port of entry until problems are corrected. If warranted, FDA can -13- ask the courts to issue injunctions or prosecute those that deliberately violate the law. When warranted, criminal penalties including prison sentences are sought. Once on the market, there are post-market surveillance controls with which a manufacturer must comply. These requirements include the Quality Systems (also known as Good Manufacturing Practices), and Medical Device Reporting regulations. The QS regulation is a quality assurance requirement that covers the design, packaging, labeling and manufacturing of a medical device. The MDR regulation is an adverse event reporting program. The Company is also required to report under the MDR requirements, which are for injuries and deaths, of which the Company has had none since its registration. For all devices manufactured or remanufactured by the Company, the FDA may request updated information regarding any device with a previously approved 510(k) or PMA submission. If any substantial changes are made to existing approved devices the FDA may require a 510(k) supplement submission, which, in most cases, does not require the manufacture to delay production or marketing of the modified device. As with all applications, this determination lies entirely with the FDA. Imaging3's last audit with the FDA was in 2000 and the Company expects a new audit to take place shortly after its new device is submitted in a 510(k) application. In an audit performed by the FDA, the Company's records for service and repair, quality control, device labeling and serial number tracking are reviewed. If the FDA finds issues of non- compliance they issue a letter requesting correction, giving the Company 30 days to correct the non-compliance. Extensions can be requested to reply, but most issues if any can be handled in a 30-day period. Since the Company's registration with the FDA in 1995, it has had only one audit. The Company did not receive any notice or correspondence of non-compliance due to that audit. The Company received only a one suggestion regarding its record keeping process, which addressed preventive maintenance forms being included in all customer files, for which the Company provides service. Imaging3, to its knowledge, has been in good standing with the FDA, receiving no actions or correspondence. The Company is also licensed with the State of California as a Device Manufacturer, license number 63620. Both require annual renewal registration updates, listing any new products being manufactured or marketed. The State of California currently follows the FDA standards and requirements. The Company has had no instances of non-compliance with either the FDA or the state of California. The consequences of non-compliance range from, letter stating non-compliance and a period to cure, suspension of manufacturing and distribution to fines and suspension of operations. Imaging3 estimates it will obtain FDA approval this year, although there is no assurance that this approval will be granted when expected. This estimate for FDA approval is based on Mr. Janes' past experience with 510(k) submissions. All of the Company's marketing efforts for the new device must start from the date the FDA approves the device to be marketed. Since the Company is already registered with the FDA as a new device manufacturer and has been through an audit performed by the FDA, the FDA is already familiar with the Company and its processes. The FDA may wish to obtain updated information about the Company and may require more time to process this 510 (k) submission than estimated. In two other 510(k) submissions by Mr. Janes, the process lasted approximately 120 days, however, these systems were not as complex. Management believes Mr. Janes' familiarity with the process and experience with 510(k) submissions will help the Company to stay within its estimate. With Mr. Janes, the Company does not have to seek help in this process, through consultants as most companies must, which add to the expense and delays in this process. Management believes that having a person in-house having the experience with the process, understanding 510(k) submissions, direct access to all engineering and proprietary knowledge is a distinct advantage and should allow the Company complete the process within the estimated time. -14- To enter the European market, the Company's products as well as its quality assurance systems will have to be approved and certified by an authorized certifying body such as Technischer Uberwachungsverein; English translation: Technical Inspection Association ("TUV"), Underwriters Laboratories ("UL") or British Standards Institute ("BSI"). In the future, the Company may plan to go through this process as a part of its overall enhancement of the quality systems. TUV, UL and BSI are all standards testing companies assisting manufactures to comply with published standards, regulatory standards and laws necessary for marketing devices throughout the world and the United States. These three companies provide the UL and CE (the European equivalent of the UL mark in the United States) marks, demonstrating compliance with the standards and laws. TUV is a Nationally Recognized Testing Laboratory ("NRTL") and Safety Checklist Contractors ("SCC") certified, providing a full suite of services, including CE Marking assistance, electromagnetic compatibility ("EMC"), electrical & mechanical testing, and many additional global conformity assessment services that help companies gain product compliance to enter individual country markets. UL is an independent, not-for-profit product-safety testing and certification organization. They test products for public safety for more than a century. Since their founding in 1894, they have held the undisputed reputation as a leader in product- safety testing and certification within the United States. Management believes that building on their household name in the United States, that UL is becoming one of the most recognized, reputable conformity assessment providers in the world. Today, their services extend to helping companies achieve global acceptance, whether for an electrical device, a programmable system, or an organization's quality process. BSI, exists to help industry develop new and better products and to make sure that products meet current and future laws and regulations. It tests products from medical devices to fire extinguishers to lamps for football stadium against published standards. Far East, Middle East, Eastern European, and Latin American markets have different regulatory requirements. The Company intends to comply with applicable requirements if and when it decides to enter those markets. OTHER GOVERNMENT REGULATIONS The delivery of health care services has become one of the most highly regulated of professional and business endeavors in the United States. Both the federal government and individual state governments are responsible for overseeing the activities of individuals and businesses engaged in the delivery of health care services. Federal law and regulations are based primarily upon the Medicare and Medicaid programs. Each of these programs is financed, at least in part, with federal funds. State jurisdiction is based upon the state's interest in regulating the quality of health care in the state, regardless of the source of payment. The Company believes that it is materially complying with applicable laws, however, the Company has not received or applied for a legal opinion from counsel or from any federal or state judicial or regulatory authority. Additionally, many aspects of the Company's business have not been the subject of state or federal regulatory interpretation. The laws applicable to the Company are subject to evolving interpretations. If the Company's operations are reviewed by a government authority, it may receive a determination that could be adverse to the Company. Furthermore, laws that are applicable to the Company may be amended in a manner that could adversely affect the Company. Only a very small portion of the Company's revenues come through this system. All of the Company's revenues are obtained from sales and service to vendees who pay the Company directly. The Company is not subject to Medicare, Medicaid, or any other federally funded health care program. ITEM 2. PROPERTIES The Company currently maintains its administrative offices and production facility at 3200 W. Valhalla Drive, Burbank, California 91505. This facility contains 10,600 square feet of space, and the Company currently pays rent at a rate of $1.05 per square foot, gross. -15- ITEM 3. LEGAL PROCEEDINGS The Company may be involved in legal actions and claims arising in the ordinary course of business, from time to time, none of which at this time is considered to be material to the Company's business or financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS COMMON STOCK The Company's common stock trades on the OTC Bulletin Board Market under the symbol "IMGG." The range of high and low bid quotations for each fiscal quarter within the last two fiscal years was as follows: YEAR ENDED DECEMBER 31, 2008 HIGH LOW -------------------------------------- ------- ------- First Quarter ended March 31, 2008 $0.12 $0.12 Second Quarter ended June 30, 2008 $0.12 $0.10 Third Quarter ended September 30, 2008 $0.078 $0.078 Fourth Quarter ended December 31, 2008 $0.069 $0.055 YEAR ENDED DECEMBER 31, 2007 HIGH LOW -------------------------------------- ------- ------- First Quarter ended March 31, 2007 $0.13 $0.12 Second Quarter ended June 30, 2007 $0.11 $0.1075 Third Quarter ended September 30, 2007 $0.13 $0.135 Fourth Quarter ended December 31, 2007 $0.1225 $0.12 -------------------------------------- The above quotations reflect inter-dealer prices, without retail markup, mark-down, or commission and may not necessarily represent actual transactions. As of February 28, 2009, there were approximately 649 record holders of the Company's common stock, not including shares held in "street name" in brokerage accounts which is unknown. As of February 28, 2009, there were approximately 257,474,052 shares of common stock outstanding on record. DIVIDENDS The Company has not declared or paid any cash dividends on its common stock and does not anticipate paying dividends for the foreseeable future. EQUITY COMPENSATION PLAN INFORMATION The Company has not yet, but may in the future, establish a management stock option plan pursuant to which stock options may be authorized and granted to the executive officers, directors, employees and key consultants of the Company. In the event the Company establishes the stock option plan, the Company expects to authorize approximately 16,000,000 shares or more for future issuance. -16- WARRANTS As of December 31, 2008, the Company had no warrants outstanding. ITEM 6. SELECTED FINANCIAL DATA. Not applicable. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION CAUTIONARY STATEMENTS This Form 10-K contains financial projections and other "forward-looking statements," as that term is used in federal securities laws, about Imaging3 Inc.'s ("Imaging3," "we," "us," or the "Company") financial condition, results of operations and business. These statements include, among others: statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Form 10-K. You can find many of these statements by looking for words such as "believes," "expects," "anticipates," "estimates," or similar expressions used in this Form 10-K. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause the Company's actual results to be materially different from any future results expressed or implied by the Company in those statements. The most important facts that could prevent the Company from achieving its stated goals include, but are not limited to, the following: (a) volatility or decline of the Company's stock price; (b) potential fluctuation in quarterly results; (c) failure of the Company to earn revenues or profits; (d) inadequate capital to continue the business and barriers to raising the additional capital or to obtaining the financing needed to implement its business plans; (e) failure to commercialize the Company's technology or to make sales; (f) changes in demand for the Company's products and services; (g) rapid and significant changes in markets; (h) litigation with or legal claims and allegations by outside parties; (i) insufficient revenues to cover operating costs; (j) failure to obtain FDA approval for the Company's new medical scanning device, which is still in its prototype stage. There is no assurance that we will be profitable. We may not be able to develop, manage or market our products and services successfully. We may not be able to attract or retain qualified executives and technology personnel. We may not be able to obtain customers for our products or services. Our products and services may become obsolete. Government regulation may hinder our business. Additional dilution in outstanding stock ownership may be incurred due to the issuance of more shares, warrants and stock options, or the exercise of outstanding warrants and stock options. -17- Because the statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the forward-looking statements. The Company cautions you not to place undue reliance on the statements, which speak only as of the date of this Form 10-K. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that the Company or persons acting on its behalf may issue. The Company does not undertake any obligation to review or confirm analysts' expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events. The following discussion should be read in conjunction with our condensed consolidated financial statements and notes to those statements. In addition to historical information, the following discussion and other parts of this quarterly report contain forward-looking information that involves risks and uncertainties. CURRENT OVERVIEW Our efforts have been to market our refurbished equipment. The sales and revenues from service and parts are either from extended warranty purchases at the time of purchase of the refurbished equipment, or service contracts and time and material revenue realized upon warranty expiration, the majority of which is realized one year from equipment purchase as warranties expire. Our sales effort through direct mail, broadcast facsimile and broadcast email to thousands of potential customers throughout the United States generates leads of potential customers desiring to purchase equipment either immediately or in the course of one year. This lead generation through direct mail and broadcast facsimiles and email will continue on a quarterly basis with the goal of increasing the total number of our leads for our sales staff. Management expects that the marketing program will also eventually help stabilize the amount of refurbished equipment sold on a monthly basis, since the carry-over of leads not looking for immediate purchase will overlap with the immediate sales leads. The greater the number of leads generated, whether immediate or long term, the greater the opportunity to eventually create a consistent number of sales. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We monitor our estimates on an on-going basis for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate. We have identified the policies below as critical to our business operations and the understanding of our results of operations. REVENUE RECOGNITION. We recognize revenue in accordance with the Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" ("SAB 104"). We recognize revenue upon shipment, provided that evidence of an arrangement exists, title, and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured. We record revenue net of estimated product returns, which is based upon our return policy, sales agreements, management estimates of potential future product returns related to current period revenue, current economic trends, changes in customer composition and historical experience. We accrue for warranty costs, sales returns, and other allowances based on our experience. Generally, we extend credit to our customers and do not require collateral. We perform ongoing credit evaluations of our customers and historic credit losses have been within our expectations. We do not ship a product until we have either a purchase agreement or rental agreement signed by the customer with a payment arrangement. This is a critical policy, because we want our accounting to show only sales that are "final" with a payment arrangement. We do not make consignment sales or inventory sales -18- subject to a "buy back" or return arrangement from customers. PROVISION FOR SALES RETURNS, ALLOWANCES AND BAD DEBTS. The Company maintains a provision for sales allowances, returns and bad debts. Sales returns and allowances result from equipment damaged in delivery or customer dissatisfaction, as provided by agreement. The provision is provided for by reducing gross revenue by a portion of the amount invoiced during the relevant period. The amount of the reduction is estimated based on historical experience. RESERVE FOR OBSOLETE/EXCESS INVENTORY. Inventories are stated at the lower of cost or market. We regularly review our inventories and, when required, will record a provision for excess and obsolete inventory based on factors that may impact the realizable value of our inventory including, but not limited to, technological changes, market demand, regulatory requirements and significant changes in our cost structure. If ultimate usage varies significantly from expected usage, or other factors arise that are significantly different than those anticipated by management, inventory write-downs or increases in reserves may be required. The fire in 2002 incinerated our inventory, so we have not had to deal with significant amounts of obsolete inventory since that time. Our procedure is now to maintain only limited inventory, based on our experience in service and repair, necessary for current service and repair contracts or orders anticipated within the following 60 days. We have supply relationships with long term suppliers to provide additional parts on an as needed, prompt basis for the vast majority of repair and service parts, so obsolescence is no longer a factor in our business. We have not recorded any material amounts as charges to obsolescence since the fire in 2002 destroyed our warehouse. Rental income is recognized when earned and expenses are recognized when incurred. The rental periods vary based on customer's needs ranging from five days to six months. An operating lease agreement is utilized. The rental revenues were insignificant in the twelve month period ended December 31, 2008. Written rental agreements are used in all instances. OTHER ACCOUNTING FACTORS The effects of inflation have not had a material impact on our operation, nor are they expected to in the immediate future. Although we are unaware of any major seasonal aspect that would have a material effect on the financial condition or results of operation, the first quarter of each fiscal year is always a financial concern due to slow collections after the holidays. The deposits that are shown in the financials are for pending sales of existing products and not any new patented product. These are deposits received from our customers for sales of equipment and services and are only removed as deposits upon completion of the sale. If for whatever reason a customer order is cancelled the deposit would be returned as stated in the terms of sale, minus a restocking fee. No depositor is a related party of any officer or employee of Imaging3, Inc. Our terms of deposit typically are 50% down with the balance of the sale price due upon delivery. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2008 AS COMPARED TO THE YEAR ENDED DECEMBER 31, 2007. We had revenues for the year ended December 31, 2007 of $1,323,773 as compared to $1,755,754 for the year ended December 31, 2008, which represented a 32% increase. The increase in sales was attributed directly to an increase in equipment sales for this period. For the year ended December 31, 2008, our remanufactured equipment sales were $1,116,000 as compared to $782,585 for the year ended December 31, 2007, representing an increase in equipment sales of $333,415 or 42%. Our service and parts sales for the year ended December 31, 2007 were $186,050 as compared to $153,087 for the year ended December 31, 2008, which is a decrease of $32,963 or 21%. -19- Our rental revenue has been a little more than 1% of our total revenue in the past two years and is recognized over the term of the lease agreement. Rental revenues are only deemed earned as collected. In February 2002, a fire destroyed our manufacturing facility and headquarters building along with our entire inventory, all office equipment and internal infrastructure. Rebuilding the Company's inventory and entire infrastructure continues to this day. The amount of insurance received from this fire was approximately $2,400,000, which was inadequate to replace inventory and rebuild the necessary assets and infrastructure required to be rebuilt over eight years of prior business. Several employees were let go and offices in San Diego, Arizona, Washington and Florida were closed, which lowered administrative expenses but negatively impacted revenue and income as well. Although the Company has made significant strides, it continues on the path of rebuilding. Our cost of revenue was $910,125 for the year ended December 31, 2007 as compared to $662,232 for the year ended December 31, 2008, a decrease of $247,893 or 37%. This decrease resulted directly from decreased costs for equipment, parts, sales and services. The Company's gross profit margin for the year ended December 31, 2007 was $413,649 as compared to $1,093,521 for the year ended December 31, 2008, a 164% increase, giving the Company a strong gross profit margin for the year. This is due to increased revenue and decreased costs in 2008. The Company's total operating expenses decreased from $2,465,299 for the year ended December 31, 2007 to approximately $2,278,720 for the year ended December 31, 2008, a decrease of 8% due to decreased general and administrative expenses. Outside consulting expenses decreased by $121,780. Overall professional fees have decreased by $119,516 or 21% due in part to a decrease in outside consulting fees. Auto expense increased in part and was caused primarily by the increased impact affected by the overall gasoline price increases for the year. Travel and entertainment expenses decreased by $12,871 which was caused primarily by a late surge in December 2008 sales as well as late expenses resulting from the RSNA annual convention in Chicago, Illinois. The taxes account was impacted by other taxes that decreased by $12,371 as evidenced by decreased sales to clients in the State of California, which reduced taxes owed to the State Board of Equalization and to the County of Los Angeles. The net overall increase of $1,548 in utilities to the Burbank Department of Water and Power was as a result of satisfying most of the debt owed to the City, which mistakenly read only one meter rather than two meters. Once the City realized its mistake, it quickly assessed the Company the difference for the period and arranged a workout with an advance for payment of the difference. Our net loss for the fiscal year ending December 31, 2007 was $2,061,255 as compared to $906,929 for the fiscal year ending December 31, 2008. This improvement was as a direct result from increased revenues and controlled expenses for the year. At December 31, 2008 the Company had a balance due to the Chief Executive Officer of the Company amounting to $784,210 for the amount borrowed by the Company. This amount is due on demand, secured and interest free. The Company filed its tax return for 2000 as an S Corporation and changed its status to a C Corporation effective August 1, 2001. The Company accounts for income taxes under Statements of Financial Accounting Standards No. 109 (SFAS 109). Under SFAS 109, deferred income taxes are reported using the liability method. Deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. We have recorded insignificant liabilities of $800 per year for income taxes due to adjustments as a result of the conversion from an S corporation to a corporation for tax purposes. The provision for income taxes was recorded for the state minimum tax of $800 imposed on corporations. (See Note 7 in financial statements for year ended December 31, 2008.) We expect the trend of operating losses by the Company to continue into the future at the current or greater rate as we spend money on product development and marketing. There is no assurance we can achieve significant profitable sales to overcome losses. We do not expect litigation against us to expand as evidenced by the significant drop in activity in this area and do not believe it is an increasing trend. In fact, in 2007, we had only one new litigation case as in 2006, so our feeling is that the trend is away from increasing litigation, although we can give no assurances in relation to future litigation. We experienced a very destructive fire in 2002 that destroyed our facilities and inventory. Due to the loss of records, inventory, facilities, assets and revenues and the disruption to our business and cash flow in the fire in 2002, several lawsuits resulted creating additional legal expenses (refer to "Legal Proceedings" and Note 12 in the accompanying December 31, 2008 financial statements for further detail). Many of these lawsuits were for equipment orders -20- that could not be filled or serviced to the customer's satisfaction and vendor payables. The interruption in business, the destruction of our inventory and operations, legal expenses and the expenses incurred to rebuild, were sought through litigation with Tower Engineering as described in Note 12 in the accompanying December 31, 2008 financial statements. This claim, however, lost in a Motion for Summary Judgment and allowance was made for it in 2005. Further, the Arbitrator in the Tower matter ruled against us by awarding Tower a judgment for $79,394.93. Cases settled during 2005, 2006 and 2007 are as previously mentioned in this report. In 2008, the Company spent and recorded $15,861 for research and development of its patented technology, which includes software design, mechanical design and the manufacturing of the prototype. Costs for individuals employed by Imaging3 are absorbed in normal operating expenses and are not separated at this time for simplicity. LIQUIDITY AND CAPITAL RESOURCES Our total current assets increased from $244,050 as of December 31, 2007 to $487,484 as of December 31, 2008, a difference of $243,434 or 100%. Inventory for the year ended December 31, 2007 was $163,753 and increased to $328,740 for year ended December 31, 2008. This is due in large part to the increase in inventory during this period and the manner in which inventory is valued. Our total current liabilities decreased from $3,711,359 as of December 31, 2007 to $3,465,597 as of December 31, 2008. This decrease is due in large part to payment of settled accrued litigation expense as well as the liquidation of accounts payables. During the year ended December 31, 2007, the Company used $1,192,683 of cash for operating activities, as compared to $1,557,399 during the year ended December 31, 2008. Cash provided by financing activities during the year ended December 31, 2007 was $1,169,624, as compared to $1,651,544 during the year ended December 31, 2008. GOING CONCERN QUALIFICATION The Company has incurred significant losses from operations, and such losses are expected to continue. The Company's auditors have included a "Going Concern Qualification" in their report for the year ended December 31, 2008. In addition, the Company has limited working capital. The foregoing raises substantial doubt about the Company's ability to continue as a going concern. Management's plans include seeking additional capital and/or debt financing. There is no guarantee that additional capital and/or debt financing will be available when and to the extent required, or that if available, it will be on terms acceptable to the Company. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The "Going Concern Qualification" may make it substantially more difficult to raise capital. OFF-BALANCE SHEET ARRANGEMENTS None. -21-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA OF IMAGING3, INC. IMAGING3, INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS CONTENTS Report of Independent Registered Public Accounting Firm .................................................... 23 Balance Sheets as of December 31, 2008 and 2007............................................................. 24 Statement of Operations for the years ended December 31, 2008 and 2007...................................... 25 Statement of Changes in Stockholders' Deficit for the years ended December 31, 2008 and 2007................ 26 Statement of Cash Flows for the years ended December 31, 2008 and 2007 ..................................... 27 Notes to Financial Statements .............................................................................. 28-36
-22- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders Imaging3, Inc. We have audited the accompanying balance sheets of Imaging3, Inc. as of December 31, 2008 and 2007, the related statements of operations, stockholders' equity, and cash flows for the two year period ended December 31, 2008. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Imaging3, Inc. as of December 31, 2008 and 2007 and the results of its operations and its cash flows for the two year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. The Company's financial statements are prepared using the generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has deficit accumulated at December 31, 2008 of $10,687,106 including a net loss of $906,928 for the year ended December 31, 2008. These factors as discussed in Note 10 to the financial statements, raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 10. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Kabani & Company, Inc. CERTIFIED PUBLIC ACCOUNTANTS Los Angeles, California February 24, 2009 -23-
IMAGING3, INC. BALANCE SHEETS DECEMBER 31, ASSETS 2008 2007 ----------------- ---------------- CURRENT ASSETS: Cash and cash equivalents $ 73,447 $ 2,293 Accounts receivable, net 64,149 57,380 Inventory, net 328,740 163,753 Prepaid expenses 21,148 20,624 ----------------- ---------------- Total current assets 487,484 244,051 PROPERTY AND EQUIPMENT, NET 23,755 18,673 OTHER ASSETS 31,024 31,024 ----------------- ---------------- $ 542,263 293,747 ================= ================ LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable $ 175,329 213,953 Accrued expenses 2,270,638 2,723,064 Deferred revenue 119,052 106,705 Equipment deposits 116,368 275,900 Due to an officer 784,210 391,738 ----------------- ---------------- Total current liabilities 3,465,597 3,711,359 STOCKHOLDERS' DEFICIT: Common stock, no par value; authorized shares 500,000,000; 249,924,052 issued and outstanding 7,763,772 6,381,316 Accumulated deficit (10,687,106) (9,780,178) ----------------- ---------------- Total stockholders' deficit (2,923,334) (3,417,612) ----------------- ---------------- $ 542,263 293,747 ================= ================ The accompanying notes form an integral part of these audited financial statements
-24-
IMAGING3, INC. STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007 2008 2007 ------------------ ------------------- NET REVENUES $ 1,755,754 $ 1,323,773 COST OF GOODS SOLD 662,232 910,125 ------------------ ------------------- GROSS PROFIT 1,093,521 413,648 OPERATING EXPENSES General and administrative expenses 2,278,720 2,465,299 ------------------ ------------------- Total operating expense 2,278,720 2,465,299 ------------------ ------------------- LOSS FROM OPERATIONS (1,185,199) (2,051,651) OTHER INCOME (EXPENSE): Interest expense (51,790) (70,857) Other income 330,860 103,316 Legal settlement - (41,263) ------------------ ------------------- Total other income (expense) 279,070 (8,804) ------------------ ------------------- LOSS BEFORE INCOME TAX (906,128) (2,060,455) PROVISION FOR INCOME TAXES 800 800 ------------------ ------------------- NET LOSS $ (906,928) $ (2,061,255) ================== =================== BASIC AND DILUTED NET LOSS PER SHARE $ (0.00) $ (0.01) ================== =================== *BASIC AND DILUTED WEIGHTED AVERAGE COMMON STOCK OUTSTANDING 243,552,012 211,921,567 ================== =================== *Weighted average number of shares used to compute basic and diluted loss per share for the years ended December 31, 2008 & 2007 are the same since the effect of dilutive securities is anti-dilutive. The accompanying notes form an integral part of these audited financial statements
-25-
STATEMENT OF STOCKHOLDERS' DEFICIT FOR THE YEARS ENDED DECEMBER, 2008 AND 2007 COMMON STOCK UNAMORTIZED TOTAL NUMBER OF SUBSCRIPTION CONSULTING ACCUMULATED STOCKHOLDERS' SHARES AMOUNT RECEIVABLES FEES DEFICIT DEFICIT ----------------- ------------ --------------- ----------------- ---------------- Balance on January 1, 2007 204,109,521 $ 4,845,682 $ (82,043) $ - $ (7,718,923) $ (2,955,284) Common stock issued for cash 18,250,659 1,113,240 - - - 1,113,240 Common stock issued for consulting services 1,245,655 201,761 - (201,761) - - Common stock issued for services 956,250 146,800 - - - 146,800 Common stock issued for R&D 1,000,000 120,000 - - - 120,000 Subscription receivables - - 82,043 - - 82,043 Amortization of prepaid consulting fees - - - 183,011 - 183,011 Fund raising cost - (46,168) - - - (46,168) - Net loss for December 31, 2007 - - - - (2,061,255) (2,061,255) ----------------- ------------ --------------- --------------- ----------------- ---------------- Balance on December 31, 2007 225,562,085 6,381,316 - (18,750) (9,780,178) $ (3,417,611) Common stock issued for cash 22,943,634 1,259,072 1,259,072 Common stock issued for services 1,418,333 123,383 18,750 142,134 Net loss for December 31, 2008 ($906,928) (906,929) ----------------- ------------ --------------- --------------- ----------------- ---------------- Balance on December 31, 2008 249,924,052 $ 7,763,771 $ - $ - $ (10,687,106) $ (2,923,334) ================= ============ =============== =============== ================= ================
-26-
IMAGING3, INC. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007 2008 2007 --------------------- ---------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (906,928) $ (2,061,255) Adjustments to reconcile net loss to net cash used in operating activities: Bad debt expense 15,000 Depreciation and amortization 17,910 15,227 Common stock issued for services and R&D 142,133 449,812 (Increase) / decrease in current assets: Accounts receivable (21,769) 18,976 Inventory (164,987) 340,510 Prepaid expenses and other assets (524) 501 Increase / (decrease) in current liabilities: Accounts payable (38,624) (539,836) Accrued expenses (452,425) 584,203 Deferred revenue 12,347 7,905 Equipment deposits (159,532) (8,725) --------------------- ---------------------- Net cash used in operating activities (1,557,398) (1,192,683) --------------------- ---------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of plant, property, and equipment (22,992) - CASH FLOWS FROM FINANCING ACTIVITIES: Receipts from/(payments to) officer 392,472 20,509 Proceeds from subscription receivable - 82,043 Proceeds from issuance of common stock 1,259,072 1,067,072 --------------------- ---------------------- Net cash provided by financing activities 1,651,544 1,169,624 --------------------- ---------------------- NET INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS 71,154 (23,059) CASH & CASH EQUIVALENTS, BEGINNING BALANCE 2,293 25,352 --------------------- ---------------------- CASH & CASH EQUIVALENTS, ENDING BALANCE $ 73,447 $ 2,293 ===================== ====================== The accompanying notes form an integral part of these audited financial statements
-27- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 1. ORGANIZATION AND DESCRIPTION OF BUSINESS Imaging3, Inc. (the "Company") is a California corporation, incorporated on October 29, 1993 as Imaging Services, Inc. The Company filed a certificate of amendment of articles of incorporation to change its name to Imaging3, Inc. on August 20, 2002. The Company's primary business is production and sale of medical equipment, parts and services to hospitals, surgery centers, research labs, physician offices and veterinarians. Equipment sales include new c-arms, c-arms tables, remanufactured c-arms, used c-arm and surgical tables. Part sales comprise of new or renewed replacement parts for c-arms. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows: USE OF ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers all liquid investments with a maturity of three months or less from the date of purchase that are readily convertible into cash to be cash equivalents. The Company maintains its cash in bank deposit accounts that may exceed federally insured limits. The Company has not experienced any losses in such accounts. ACCOUNTS RECEIVABLE The Company's customer base consists of a geographically dispersed customer base. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis. INVENTORIES Inventories, comprising of finished goods and parts are stated at the lower of cost (first-in, first-out method) or market. Management compares the cost of inventories with the market value and allowance is made for writing down the inventories to their market value, if lower. DUE TO OFFICER At December 31, 2008 and 2007, the Company had balances due to the Chief Executive Officer of the Company of $784,210 and $391,738 for amounts borrowed during the years. The amount is due on demand, interest free and secured by the assets of the Company. -28- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 PROPERTY & EQUIPMENT Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to expenses as incurred and additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives of three to eight years. IMPAIRMENT OF LONG-LIVED ASSETS The Company applies the provisions of Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS No. 144"), issued by the Financial Accounting Standards Board ("FASB"). FAS No. 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value. The Company tests long-lived assets, including property, plant and equipment and intangible assets subject to periodic amortization, for recoverability at least annually or more frequently upon the occurrence of an event or when circumstances indicate that the net carrying amount is greater than its fair value. Assets are grouped and evaluated at the lowest level for their identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to the future estimated cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows as the rate the Company utilizes to evaluate potential investments. The Company estimates fair value based on the information available in making whatever estimates, judgments and projections are considered necessary. There was no impairment of long-lived assets in the year ended December 31, 2008. EQUIPMENT DEPOSITS Equipment deposits represent amounts received from customers against future sales of goods since the Company recognizes revenue upon shipment of goods. These deposits are applied to the invoices when the equipment is shipped to the customers. The balances at December 31, 2008 and 2007 were $116,368 and $275,900, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of financial accounting standard No. 107, Disclosures about fair value of financial instruments, requires that the Company disclose estimated fair values of financial instruments. The carrying amounts reported in the statements of financial position for current assets and current liabilities qualifying, as financial instruments are a reasonable estimate of fair value. The carrying amounts related to cash equivalents, accounts receivable, other current assets and accounts payable approximate fair value due to the relatively short maturity of such instruments. The fair value of long-term debt is estimated by discounting the future cash flows of each instrument at rates currently available to the Company for similar debt instruments of comparable maturities. The Company's financial instruments primarily consist of cash and cash equivalents, accounts receivable, advances to employees, accounts payable, equipment deposits, and related party advances and borrowings. As of the balance sheet dates, the estimated fair values of the financial instruments were not materially different from their carrying values as presented on the balance sheet. This is attributed to the short maturities of the instruments and that interest rates on the borrowings approximate those that would have been available for loans of similar remaining maturity and risk profile at respective balance sheet dates. -29- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 REVENUE RECOGNITION The Company recognizes its revenue in accordance with the Securities and Exchange Commissions ("SEC") Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial Statements" ("SAB 104"). SAB 104 revises or rescinds portions of the interpretative guidance included in Topic 13 of the codification of staff accounting bulletins in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. Revenue is recognized upon shipment, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured. Revenue is recorded net of estimated product returns, which is based upon the Company's return policy, sales agreements, management estimates of potential future product returns related to current period revenue, current economic trends, changes in customer composition and historical experience. The Company accrues for warranty costs, sales returns, and other allowances based on its experience. Generally, the Company extends credit to its customers and does not require collateral. The Company performs ongoing credit evaluations of its customers and historic credit losses have been within management's expectations. ADVERTISING COSTS The Company expenses the cost of advertising as incurred or, as appropriate, the first time the advertising takes place. Advertising costs for the years ended December 31, 2008 and 2007 were $207,745 and $114,369 respectively. STOCK-BASED COMPENSATION In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 123 prescribes accounting and reporting standards for all stock-based compensation plans, including employee stock options, restricted stock, employee stock purchase plans and stock appreciation rights. SFAS No. 123 requires compensation expense to be recorded (i) using the new fair value method or (ii) using the existing accounting rules prescribed by Accounting Principles Board Opinion No. 25, "Accounting for stock issued to employees" (APB 25) and related interpretations with pro forma disclosure of what net income and earnings per share would have been had the Company adopted the new fair value method. The Company uses the intrinsic value method prescribed by APB 25 and has opted for the disclosure provisions of SFAS No.123. INCOME TAXES The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109 (SFAS 109). Under SFAS 109, deferred income taxes are reported using the liability method. Deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. BASIC AND DILUTED NET LOSS PER SHARE Net loss per share is calculated in accordance with the Statement of financial accounting standards No. 128 (SFAS No. 128), "Earnings per share." SFAS No. 128 superseded Accounting Principles Board Opinion No.15 (APB 15). Net loss per share for all periods presented has been restated to reflect the adoption of SFAS No. 128. Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. -30- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 SEGMENT REPORTING Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosure About Segments of an Enterprise and Related Information" requires use of the "management approach" model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company. SFAS 131 has no effect on the Company's financial statements as substantially all of the Company's operations are conducted in one industry segment. RECENT PRONOUNCEMENTS In December 2007, the FASB issued SFAS No. 141 (Revised 2007), "Business Combinations." The objective of this statement is to significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of SFAS No. 141R to have a material impact on the Company's financial statements. In December 2007, FASB issued FASB Statement No. 160, "Noncontrolling Interests in Consolidated Financial Statements--an amendment of ARB No. 51." This Statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding non-controlling interest in one or more subsidiaries or that deconsolidate a subsidiary. Not-for-profit organizations should continue to apply the guidance in Accounting Research Bulletin No. 51, "Consolidated Financial Statements," before the amendments made by this Statement, and any other applicable standards, until the Board issues interpretative guidance. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, January 1, 2009, for entities with calendar year-ends). Earlier adoption is prohibited. The effective date of this Statement is the same as that of the related Statement 141(R). This Statement shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. This statement has no effect on the financial statements as the Company does not have any outstanding non-controlling interest. In March 2008, the FASB issued FASB Statement No. 161, "Disclosures about Derivative Instruments and Hedging Activities." The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The new standard also improves transparency about the location and amounts of derivative instruments in an entity's financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. FASB Statement No. 161 achieves these improvements by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity's liquidity by requiring disclosure of derivative features that are credit risk-related. Finally, it requires cross-referencing within footnotes to enable financial statement users to locate important. Based on current conditions, the Company does not expect the adoption of SFAS 161 to have a significant impact on its results of operations or financial position. -31- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 3. ACCOUNTS RECEIVABLE All accounts receivable are trade related. These receivables are current and management believes are collectible except for which a reserve has been provided. The balance of accounts receivable as of December 31, 2008 and 2007 were $64,149 and $57,380. The reserve amount for uncollectible accounts was $1,375 as of December 31, 2008 and 2007, respectively. 4. INVENTORIES Inventory comprised of the following: December December 31, 2008 31, 2007 ------------ ------------- Parts inventory $ 22,082 $ 30,951 Finished goods 306,658 132,802 ------------ ------------- Total $ 328,740 $ 163,753 ============ ============= 5. PROPERTIES AND EQUIPMENT Net property and equipment were as follows: December 31, 2008 December 31, 2007 ------------------- ------------------ Furniture and office equipment $ 78,695 $ 55,704 Tools and Shop equipment 54,183 54,183 Vehicles 105,871 105,871 ------------------- ------------------ 238,749 215,757 Less Accumulated depreciation (214,995) (197,084) ------------------- ------------------ Total $ 23,754 $ 18,673 =================== ================== Depreciation expenses were $17,910 and $15,227 for the year ended December 31, 2008 and 2007, respectively. 6. ACCRUED EXPENSES Accrued expenses consisted of the following : December 31, 2008 December 31, 2007 ------------------- ------------------ Accrued wages $ 30,352 $ 194,103 Accrued legal fees 416,620 404,927 Accrued Ongoing Litigation 1,807,165 2,109,806 Other accrued expenses 16,501 14,228 ------------------- ------------------ Total $ 2,270,638 $ 2,723,064 =================== ================== 7. INCOME TAXES The Company changed to C-corporation in July 2001. No provision was made for Federal income tax for the year ended December 31, 2006 and 2005, since the Company had significant net operating loss. As of December 31, 2008, the Company incurred net operating losses for tax purposes of approximately $9,903,000. The net operating loss carry forwards may be used to reduce taxable income through the year 2028. The availability of the Company's net operating loss carry forwards are subject to limitation if there is a 50% or more positive change in -32- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 the ownership of the Company's stock. The provision for income taxes consists of the state minimum tax imposed on corporations. Temporary differences that give rise to deferred tax assets and liabilities at December 31, 2008 and 2007, comprised of depreciation and amortization, entertainment, bad debt expense, and net operating loss carry forward. The gross deferred tax asset balance as of December 31, 2008 was approximately $3,981,000. A 100% valuation allowance has been established against the deferred tax assets, as the utilization of the loss carry forwards cannot reasonably be assured. The components of the net deferred tax asset are summarized below: DECEMBER 31, 2008 DECEMBER 31, 2007 ----------------- ----------------- Deferred tax assets Net operating losses $ 3,981,000 $ 3,623,000 Less: valuation allowance (3,981,000) (3,623,000) ----------------- ----------------- $ - $ - ================= ================= The following is a reconciliation of the provision for income taxes at the U.S. federal income tax rate to the income taxes reflected in the Statement of Operations: DECEMBER 31, 2008 DECEMBER 31, 2007 ----------------- ----------------- Tax expense (credit) at statutory rate-federal (34)% (34)% State tax expense net of federal tax (6) (6) Changes in valuation allowance 40 40 ----------------- ----------------- Tax expense at actual rate $ - $ - ================= ================= Income tax expense consisted of the following: 2008 2007 ------------ ------------ Current tax expense: $ - $ - Federal State 800 800 ------------ ------------ Total Current $ 800 $ 800 Deferred tax credit: $ 306,000 $ 735,000 Federal State 51,000 122,000 ------------ ------------ Total deferred $ 357,000 $ 857,000 Less: valuation allowance (357,000) (857,000) ------------ ------------ Net Deferred tax credit - - ------------ ------------ Tax expense $ 800 $ 800 ============ ============ 8. STOCKHOLDERS' EQUITY COMMON STOCK During the year ended December 31, 2008, the Company issued 22,943,634 shares of common stock for cash amounting $1,376,618. During the year ended December 31, 2008 the Company issued 1,418,333 shares of common stock for consulting services. The expenses amounted to $123,383. -33- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 During the year ended December 31, 2007, the Company issued 18,250,659 shares of common stock for cash amounting to $1,067,072. During the year ended December 31, 2007 the Company issued 1,245,655 shares of common stock for consulting services. The expenses amounted to $201,761. During the year ended December 31, 2007 the Company incurred fund raising cost of $46,168. The fund raising cost represented the referral fees payable to finders for introducing purchasers of the Company's common stock and was booked against additional paid in capital received from cash received from issuance of common stock. 9. SUPPLEMENTAL DISCLOSURE OF CASH FLOWS The Company prepares its statements of cash flows using the indirect method as defined under the Financial Accounting Standard No. 95. The Company paid income taxes of $800 and interest of $51,790 during the year 2008. The Company paid income taxes of $800 and interest of $74,660 during the year 2007. 10. GOING CONCERN The Company's financial statements are prepared using the generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. In the years ended December 31, 2007 and 2008, the Company had incurred losses of $2,061,255 and $909,929, respectively. The Company has accumulated deficit of $10,687,106 on December 31, 2008. In addition, the Company had negative cash flow from operating activities amounting $1,557,399 during the year ended December 31, 2008. The continuing losses have adversely affected the liquidity of the Company. In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company's ability to raise additional capital, obtain financing and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Management has taken the following steps to revise its operating and financial requirements, which it believes are sufficient to provide the Company with the ability to continue as a going concern. Management devoted considerable effort during the years ended December 31, 2007 and 2008, toward (i) obtaining additional equity financing and in that regard, the Company is in the process of offering to sell more shares at $.04 per share in private placements to accredited investors, (ii) controlling of salaries and general and administrative expenses, (iii) management of accounts payable, (iv) evaluation of its distribution and marketing methods, and (v) increasing marketing and sales. In order to control general and administrative expenses, the Company has established internal financial controls in all areas, specifically in hiring and overhead cost. The Company has also established a hiring policy under which the Company will refrain from hiring additional employees unless approved by the CEO and CFO. Accounts payable are reviewed and approved or challenged on a daily basis and the sales staff is questioned as to the validity of any expense on a monthly basis. Senior management reviews the annual budget to ascertain and question any variance from plan, on a quarterly basis, and to anticipate and make adjustments as may be feasible. 11. COMMITTMENTS The Company has a facility lease agreement effective October 1, 2004 for five years with an option to extend for a 60 month period. Future minimum lease commitments, excluding property taxes and insurance, payable at December 31, 2009 are approximately as follows: -34- IMAGING3, INC. Notes to Financial Statements December 31, 2008 and 2007 2009 90,630 ----------------- $ 90,630 Rent expenses for leased facility were $120,840 and $120,840 for year ended December 31, 2007 and 2008, respectively. It is anticipated that the company will exercise its options under the renewal lease agreement during the third quarter of 2009. 12. CONTINGENCIES & LITIGATION Partly in connection with a fire at the Company's facility on or about February 19, 2002, in which the Company's manufacturing, warehouse, and office facilities were substantially destroyed, the Company became engaged in litigation in several courts, all of which have reached judgment or been settled or dismissed except for Tenaya Surgical Center LLC vs. Imaging3, Inc., Clark County (Las Vegas) District Court case # A516984. The judgments and settlements are reflected in the liability section of the Company's balance sheet and total $1,807,165. The following is a summary of those settlements and judgments: CASE NAME SETTLEMENT/JUDGMENT AMOUNT --------- -------------------------- Tower Engineering $79,395 Dan Asbille 26,443 Arkansas Medical Imaging LLC 33,650 Covington Anesthesia Assoc 11,127 DeLage Landen 9,000 DLW 41,500 Dove 24,473 Fairfield Pain Management Center 92,400 Medison 804,587 Modern Printing 16,000 North Surgery 35,758 Peach Tree Clinic 14,364 Skagit County 22,299 Stonebridge Leasing 25,698 Surgery Center LLC 71,000 Tenaya Surgical 50,000 Veterinary Management Services 382,900 Wayne LeBleu & Assoc 5,441 Ambulatory Surgery Centers 36,000 --------------------------- Total: $1,807,165 13. OTHER INCOME Since 2003, the Company has continuously accrued interest and penalties on disputed payroll tax of $103,622. On September 24, 2008, the lien was released for the full satisfaction of federal payroll taxes. As a result, a total of $170,372 which included payroll tax, interest, and penalties has been recorded as other income on the Company's financial statements as of December 31, 2008. The Company also recorded $156,977 as gain on litigation settlement which was attributed as part of the settlement and payment pertaining to Tom's River Surgery Center and Medstone during the first nine month period for the year ended December 31, 2008. -35- 14. RELATED PARTY TRANSACTION The Company has a consulting agreement with the Chief Executive Officer of the Company under which he receives compensation of $12,000 per month. The Chief Executive Officer provides management, administrative, marketing, and financial services to the Company pursuant to the consulting agreement which is terminable on 30 days notice by either party. The consulting agreement commenced on January 1, 2002 and will continue until such time as the Company terminates the agreement or the Chief Executive Officer resigns. The accrued compensation has been included in due to officers. During the normal course of business, the Chief Executive Officer advanced funds to the Company. These advances are recorded as due to officer. The balance of due to officer amounts to $784,210 and $391,738 as of December 31, 2008 and 2007, respectively. 15. SUBSEQUENT EVENTS From January to February 2009, the Company through a private placement issued 7,550,007 shares of common stock for cash of $302,000. -36- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ITEM 9A(T). CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by Imaging3 is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. The Company's Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining controls and procedures for the Company. Management has evaluated the effectiveness of the Company's disclosure controls and procedures as of December 31, 2008 (under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer) pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. As part of such evaluation, management considered the matters discussed below relating to internal control over financial reporting. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures are effective. The term "internal control over financial reporting" is defined as a process designed by, or under the supervision of, the registrant's principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: o pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant; o provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant; and o provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant's assets that could have a material effect on the financial statements. MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes of accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. Furthermore, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to change in conditions, or the degree of compliance with the policies or procedures may deteriorate. -37- Under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of its control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in internal control-integrated framework. Based on this evaluation, the Company's Chairman, Chief Executive Officer, and Acting Chief Financial Officer have concluded that the disclosure controls and procedures are effective. AUDITOR'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING There have been no changes in the Company's internal control over financial reporting that occurred during the Company's fiscal year that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Prior to the fourth quarter, Imaging3 completed procedures to achieve Sarbanes-Oxley 404 compliance, which were tested during and since the fourth quarter. INHERENT LIMITATIONS ON EFFECTIVENESS OF CONTROLS The Company's management does not expect that its disclosure controls or its internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. ITEM 9B. OTHER INFORMATION None. -38- PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE The following table lists the executive officers and directors of the Company as of February 28, 2009: NAME AGE POSITION ------------------- --- -------------------------------------- Dean Janes 43 Chairman of the Board of Directors and Chief Executive Officer Xavier Aguilera (1) 60 Executive Vice President, Chief Financial Officer, Corporate Secretary and Director Christopher Sohn 48 President and Chief Operating Officer ----------------------------------- (1) Member of Audit Committee. DEAN JANES has been the Chairman and Chief Executive Officer of the Company since its inception in October 1993. Mr. Janes founded Imaging Services, Inc. in October of 1993 which changed its name to Imaging3, Inc. in 2002. Mr. Janes was the President and Chief Executive Officer of Imaging Services, Inc. from 1993 to 2001, his responsibilities included business development and overseeing operations, sales and marketing, operations and finance. In 2001 Mr. Janes brought Mr. Christopher Sohn on as President and Chief Operating Officer with Mr. Janes taking the position of Chairman and Chief Executive Officer, his duties remain the same with the exception of directly overseeing operations and finance. Prior to founding the Company, Mr. Janes worked for COHR, Center for Health Resources, from 1992 to 1993 as a Senior Field Service Engineer; his job responsibilities included technical support for junior engineers and business development of service contracts and revenues for all makes of medical imaging equipment. From 1991 to 1992, Mr. Janes worked for Toshiba American Medical Corporation; his job title was National Technical Support Engineer. His primary responsibilities were to assist Service Engineers throughout the United States with problems and design errors with Cath Labs and Angio Suites being a conduit to Japan and the Service Engineers in the United States. From 1990 to 1991, Mr. Janes worked for OEC Medical Systems, Inc. as a Senior Field Service Engineer; his responsibilities were to maintain, repair and install c-arms and Urology systems in the Southern California area. From 1988 to 1990 Mr. Janes worked for Kaiser Medical Physics as an in-house X-ray Service Engineer for Kaiser Harbor City Hospital; his responsibilities were to maintain and repair medical imaging equipment within the hospital and three outlying clinics. Mr. Janes also served in the United States Army Reserves as a Biomedical engineer; his service was from 1983 to 1991, with a tour in the first Gulf War from December of 1990 to April of 1991. He majored in Bio-Medical Electronic Engineering at the University of Colorado Technical Institute (1984-1988). Mr. Janes is the principal inventor of Imaging3 real-time 3D medical diagnostic imaging technology. Mr. Janes is a member of MENSA. Dean Janes and Michele Janes are husband and wife. XAVIER AGUILERA has been the Executive Vice President, Chief Financial Officer and Corporate Secretary of the Company since 1999. Mr. Aguilera's responsibilities include managing the Company's finances, accounting, taxes, credit facilities and interfacing and developing new relationships with banks and other financial institutions. Prior to working for the Company, Mr. Aguilera was self-employed as a consultant for Xavier Aguilera & Associates from 1997 to 1999. His responsibilities were to manage and open primary healthcare facilities throughout Southern California. He provided property management, estate planning, credit facility and Import/Export consulting for several businesses in Southern California. From 1995 to 1997, Mr. Aguilera was the Chief Administrative Officer for East Los Angeles Doctors Hospital; his responsibilities were to manage administrative personnel within the hospital, manage public relations, business development and JCAHO compliance. From 1992 to 1995, Mr. Aguilera was the Chief Executive Officer for El Centro Human Services Corporation; his responsibilities were to develop and implement a community based mental health facility consisting of eight satellite centers. He managed a $9.4 million budget and a full time staff of 240 employees. From 1990 to 1992, Mr. Aguilera was a Deputy Director/Administrator for Northeast Community Clinic; his responsibilities were to implement and administer the clinics health -39- programs and oversee operations. From 1988 to 1990, Mr. Aguilera was self employed as a consultant for finance, management and international finance. He provided these services to banks as well as businesses throughout Southern California. From 1987 to 1988, Mr. Aguilera was Vice President of International Banking Marketing for California Commerce Bank; his responsibilities were to manage and administer a $14 million portfolio, develop new business in the Southern California with Hispanic Businesses and develop business relationships with Northern Mexico businesses and banks. From 1981 to 1987, Mr. Aguilera was an Assistant General Manager/Deputy Director for Banco Nacional de Mexico, (BANAMEX). He was responsible for $60 million in new deposits as well as new business development and management of commercial and personal lending departments. He holds a bachelor degree in business from California State University at Northridge (1983) and a Certificate of Medical Management from the University of California at Los Angeles (1995). CHRISTOPHER SOHN has been the President and Chief Operating Officer of the Company since 2001. As a Chief Operating Officer for Imaging3, Mr. Sohn's responsibilities include developing international sales, marketing and resourcing network, organizing and strategizing with manufacturing companies and researching new sources of products from developing countries for import into the United States, overseeing of business operations and human resources. Prior to working for the Company, Mr. Sohn was President and Chief Executive Officer of DMI, Inc. from 1994 to 2000. As Chief Executive Officer for an international trading company of diagnostic medical imaging system, Mr. Sohn's main responsibility was to develop business relationships and dealer networks in Central and South American markets, connecting this with the needs of Asian medical equipment manufactures as well as manufactures in the United States and North America. Mr. Sohn has also organized and participated in more than a dozen medical exhibitions during this period including the Hospitalar (Brazil 1995-2000), and RSNA during the same period. From 2000 to 2001, Mr. Sohn was Chief Executive Officer of ISOL America, Inc.; his responsibilities included starting up an overseas headquarters for the parent company ISOL Korea in the United States as well as setting up a distribution and dealer network in the United States, Central and South America for ISOL's products, which included MRI, Magnetic Resonance Imaging and Bone Desitometry Systems. Mr. Sohn also assisted in the Company's efforts to achieve FDA and UL approval of its products as well as researching manufacturing partners for the assembly and manufacture of ISOL products within the United States. Mr. Sohn majored in biochemistry and computer science at the University of California at Los Angeles (1978-1982). LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS Under California Corporation Law, the Company's directors will have no personal liability to the Company or its stockholders for monetary damages incurred as the result of the breach or alleged breach by a director of his "duty of care." This provision does not apply to the directors' (i) acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) acts or omissions that a director believes to be contrary to the best interests of the corporation or its shareholders or that involve the absence of good faith on the part of the director, (iii) approval of any transaction from which a director derives an improper personal benefit, (iv) acts or omissions that show a reckless disregard for the director's duty to the corporation or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the corporation or its shareholders, (v) acts or omissions that constituted an unexcused pattern of inattention that amounts to an abdication of the director's duty to the corporation or its shareholders, or (vi) approval of an unlawful dividend, distribution, stock repurchase or redemption. This provision would generally absolve directors of personal liability for negligence in the performance of duties, including gross negligence. The California Corporations Code grants corporations the right to indemnify their directors, officers, employees and agents in accordance with applicable law. The Company's Bylaws provide for indemnification of such persons to the full extent allowable under applicable law. These provisions will not alter the liability of the directors under federal securities laws. The Company intends to enter into agreements to indemnify its directors and officers, in addition to the indemnification provided for in the Company's Bylaws. These agreements, among other things, indemnify our directors and officers for certain expenses (including attorneys' fees), judgments, fines, and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising out of such person's services as a director or officer of the Company, any subsidiary of the -40- Company or any other company or enterprise to which the person provides services at the request of the Company. The Company believes that these provisions and agreements are necessary to attract and retain qualified directors and officers. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers or persons controlling the Company pursuant to the foregoing provisions, the Company has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Act and is therefore unenforceable. BOARD COMMITTEES The Board of Directors has appointed an Audit Committee. As of February 28, 2009, the sole member of the Audit Committee is Xavier Aguilera, who may not be considered to be independent as defined in Rule 4200 of the National Association of Securities Dealers' listing standards. The Board of Directors has adopted a written charter of the Audit Committee. The Audit Committee is authorized by the Board of Directors to review, with the Company's independent accountants, the annual financial statements of the Company prior to publication, and to review the work of, and approve non-audit services performed by, such independent accountants. The Audit Committee will make annual recommendations to the Board for the appointment of independent public accountants for the ensuing year. The Audit Committee will also review the effectiveness of the financial and accounting functions and the organization, operations and management of the Company. The Audit Committee was formed on August 31, 2003. The Audit Committee held one meeting during fiscal year ended December 31, 2008. The Company established a Compensation Committee on August 31, 2003, which consists of one director, Dean Janes. The Compensation Committee is responsible for reviewing general policy matters relating to compensation and benefits of directors and officers, determining the total compensation of our officers and directors. The Board of Directors does not have a nominating committee. Therefore, the selection of persons or election to the Board of Directors was neither independently made nor negotiated at arm's length. REPORT OF THE AUDIT COMMITTEE The Company's Audit Committee has reviewed and discussed the Company's audited financial statements for the fiscal year ended December 31, 2008 with senior management. The Audit Committee has reviewed and discussed with management the Company's audited financial statements. The Audit Committee has also discussed with Kabani & Company, Inc., Certified Public Accountants ("KC"), the Company's independent auditors, the matters required to be discussed by the statement on Auditing Standards No. 61 (Communication with Audit Committees) and received the written disclosures and the letter from KC required by Independence Standards Board Standard No. 1 (Independence Discussion with Audit Committees). The Audit Committee has discussed with KC the independence of KC as auditors of the Company. Finally, the Audit Committee has considered whether the independent auditors provision of non-audit services to the Company is compatible with the auditors' independence. Based on the foregoing, the Company's Audit Committee has recommended to the Board of Directors that the audited financial statements of the Company be included in the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2008 for filing with the United States Securities and Exchange Commission ("SEC"). The Audit Committee also approved KC's engagement to prepare the Company's consolidated tax returns for its fiscal year ending December 31, 2008. The Company's Audit Committee did not submit a formal report regarding its findings. AUDIT COMMITTEE XAVIER AGUILERA Notwithstanding anything to the contrary set forth in any of the Company's previous or future filings under the Securities Act of 1933, as amended (the "Securities Act"), or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that might incorporate this report in future filings with the Securities and Exchange Commission, in whole or in part, the foregoing report shall not be deemed to be incorporated by reference into any such filing. -41- CODE OF CONDUCT The Company has adopted a Code of Conduct that applies to all of its directors, officers and employees. The text of the Code of Conduct has been posted on the Company's Internet website and can be viewed at www.imaging3.com. Any waiver of the provisions of the Code of Conduct for executive officers and directors may be made only by the Audit Committee when formed or the full Board of Directors and, in the case of a waiver for members of the Audit Committee, by the Board of Directors. Any such waivers will be promptly disclosed to the Company's shareholders. COMPLIANCE WITH SECTION 16(A) OF EXCHANGE ACT Section 16(a) of the Exchange Act requires the Company's officers and directors, and certain persons who own more than 10% of a registered class of the Company's equity securities (collectively, "Reporting Persons"), to file reports of ownership and changes in ownership ("Section 16 Reports") with the Securities and Exchange Commission (the "SEC"). Reporting Persons are required by the SEC to furnish the Company with copies of all Section 16 Reports they file. Based solely on its review of the copies of such Section 16 Reports received by it, or written representations received from certain Reporting Persons, all Section 16(a) filing requirements applicable to the Company's Reporting Persons during and with respect to the fiscal year ended December 31, 2008 have been complied with on a timely basis, except that Dean Janes may have been late on one or more of his Form 4 filings. ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE OFFICER COMPENSATION The following table sets forth the total compensation paid in all forms to the executive officers and directors of the Company during the periods indicated: SUMMARY COMPENSATION TABLE ---------------------- ------- ---------- -------- --------- ------------- -------------- --------------- ----------- NON-EQUITY NON-QUALIFIED NAME AND INCENTIVE DEFERRED PRINCIPAL POSITION OPTION PLAN COMPENSATION ALL OTHER (1) YEAR SALARY BONUS AWARDS COMPENSATION EARNINGS COMPENSATION TOTAL ---------------------- ------- ---------- -------- --------- ------------- -------------- --------------- ----------- Dean Janes, 2008 $144,000 0 0 0 0 0 $144,000 Chief Executive Officer Christopher Sohn, 2008 $110,000 0 0 0 0 0 $110,000 President and Chief Operating Officer Xavier Aguilera, 2008 $ 95,000 0 0 0 0 0 $ 95,000 Chief Financial Officer/Treasurer, Executive Vice President, and Corporate Secretary Michele Janes, 2008 $ 35,000 0 0 0 0 0 $ 35,000 Vice President of Administration Officers as a Group 2008 $340,000 0 0 0 0 0 $340,000 ------------------------- (1) All officers serve at will without employment contracts except that Dean Janes is employed under a Consulting Agreement under which the Company pays Mr. Janes $12,000 per month until either party terminates the Agreement on 30 days written notice.
-42- EMPLOYMENT AGREEMENTS The Company has not entered into any employment agreements with its executive officers to date. The Company may enter into employment agreements with them in the future. Dean Janes, the Company's Chief Executive Officer, is engaged pursuant to a consulting agreement. See "Certain Relationships and Transactions - Item 13." OUTSTANDING EQUITY AWARDS None of the Company's executive officers received any equity awards during the year ended December 31, 2008. DIRECTOR COMPENSATION None of the Company's directors received any compensation for their respective services rendered to the Company during the year ended December 31, 2008. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth the names of our executive officers and directors and all persons known by us to beneficially own 5% or more of the issued and outstanding common stock of Imaging3 at February 28, 2009. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage of ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or become exercisable within 60 days of February 28, 2009 are deemed outstanding even if they have not actually been exercised. Those shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. The percentage ownership of each beneficial owner is based on 257,474,052 outstanding shares of common stock. Except as otherwise listed below, the address of each person is c/o Imaging3, Inc., 3200 W. Valhalla Drive, Burbank, California 91505. Except as indicated, each person listed below has sole voting and investment power with respect to the shares set forth opposite such person's name.
NUMBER OF SHARES BENEFICIALLY NAME, TITLE AND ADDRESS OWNED (1) PERCENTAGE OWNERSHIP ----------------------- ----------------------------- -------------------- Dean Janes (includes shares owned by wife, Michele Janes) Chairman and Chief Executive Officer 62,516,328 24.20% Christopher Sohn President and Chief Operating Officer 23,000,000 1.59% Xavier Aguilera Director, Chief Financial Officer/Treasurer, Executive Vice President, and Secretary 200,000 0.08% All current Executive Officers as a Group 85,716,328 25.87% ------------------------------------- (1) Except as pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned. The total number of issued and outstanding shares and the total number of shares owned by each person does not include unexercised warrants and stock options, and is calculated as of February 28, 2009.
-43- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Mr. Janes, the Company, and UBS Financial Services entered into an arrangement pursuant to which Mr. Janes has agreed to invest in the Company, using the proceeds from the sale by Mr. Janes of a portion of his existing shares in the open market. Effective March 23, 2009 and applicable retroactively to February 4, 2008, Mr. Janes has modified his program with Imaging3, Inc. and UBS Financial Services. Under the modification, Mr. Janes will not have the right to purchase any shares of the common stock of the Company from the proceeds of his sales of stock in the open market through UBS Financial Services. To date, Mr. Janes has sold a total of 3,875,983 shares of his common stock in the Company in the open market through UBS Financial Services since February 4, 2008, resulting in net proceeds to Mr. Janes of approximately $375,000. Since February 4, 2008, Mr. Janes has loaned all of those proceeds to the Company without interest, payable to Mr. Janes on demand. In the original program, Mr. Janes had the right to convert those advances into shares of the Company's common stock, at an aggregate conversion price approximately equal to the net proceeds from his stock sales, although no such conversions had yet been made. Under the modified program, Mr. Janes will not have the right to convert any of the advances into shares of common stock. Instead, Mr. Janes has agreed to modify his demand notes into long-term noninterest bearing loans payable in full by the company on or before December 31, 2012. Mr. Janes, Chief Executive Officer, a Director and principal shareholder of the Company, loaned the Company $250,000 on August 24, 2004, evidenced by a note due on demand bearing 6% interest and secured by a pledge agreement. As of December 31, 2008, the Company has repaid $185,790 of the principal amount of the loan to Mr. Janes. Mr. Janes has waived the 6% interest due to him under this loan. Mr. Janes loaned an additional $375,000 to the Company on April 24, 2005, evidenced by a note due on demand bearing no interest and secured by a Pledge Agreement. The Company and Mr. Janes treat this note as a revolving loan. Mr. Janes is employed pursuant to a consulting agreement for $12,000 per month plus expenses. The Agreement is terminable by either party on 30 days written notice. The Company owes Mr. Janes $24,000 under the consulting agreement for the year ended December 31, 2008. Dean Janes and Michele Janes are husband and wife. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Kabani & Company, Inc., Certified Public Accountants ("KC") is the Company's principal auditing accountant firm. KC has also provided other non-audit services to the Company. The Audit Committee approved the engagement of KC before KC rendered audit and non-audit services to the Company. Each year the independent auditor's retention to audit our financial statements, including the associated fee, is approved by the Board before the filing of the previous year's Annual Report on Form 10-K. KC FEES 2008 2007 ------------------------ Audit Fees(1) $48,000 $ 26,700 Audit Related Fees -0- Tax Fees(2) All Other Fees -0- -0- ------------------------ $48,000 $ 26,700 ======================== ----------------------------------- (1) Audit Fees consist of fees for the audit of our financial statements and review of the financial statements included in our quarterly reports. (2) Tax fees consist of fees for the preparation of original federal and state income tax returns and fees for miscellaneous tax consulting services. -44- PRE-APPROVAL POLICIES AND PROCEDURES OF AUDIT AND NON-AUDIT SERVICES OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Audit Committee's policy is to pre-approve, typically at the beginning of our fiscal year, all audit and non-audit services, other than de minimis non-audit services, to be provided by an independent registered public accounting firm. These services may include, among others, audit services, audit-related services, tax services and other services and such services are generally subject to a specific budget. The independent registered public accounting firm and management are required to periodically report to the full Board regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. As part of the Board's review, the Board will evaluate other known potential engagements of the independent auditor, including the scope of work proposed to be performed and the proposed fees, and approve or reject each service, taking into account whether the services are permissible under applicable law and the possible impact of each non-audit service on the independent auditor's independence from management. At Audit Committee meetings throughout the year, the auditor and management may present subsequent services for approval. Typically, these would be services such as due diligence for an acquisition, that would not have been known at the beginning of the year. The Audit Committee has considered the provision of non-audit services provided by our independent registered public accounting firm to be compatible with maintaining their independence. The Audit Committee will continue to approve all audit and permissible non-audit services provided by our independent registered public accounting firm. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Exhibits EXHIBIT DESCRIPTION ------- ------------------------------------------------------------------------------------------ 3.1 Articles of Incorporation (1) 3.2 Articles of Amendment dated October 25, 2001, June 24, 2002, and August 13, 2002(1) 3.3 Bylaws (1) 3.4 Certificate of Amendment dated September 30, 2003(2) 3.5 Certificate of Amendment dated October 25, 2001(3) 3.6 Certificate of Amendment June 24, 2002(3) 3.7 Certificate of Amendment August 13, 2002(3) 10.1 Patent No. 6,754,297(3) 10.2 Consulting Agreement(3) 10.3 Assignment(3) 10.6 Commercial Promissory Note dated August 4, 2004(4) 10.7 Security Agreement(4) 10.8 Commercial Promissory Note dated April 24, 2005(5) 10.9 IR Commercial Real Estate Association Standard Industrial/Commercial Single-Tenant Lease - Net, dated June 21, 2004 by and between Four T's, Bryan Tashjian, Ed Jr. Tashjan, Bruce Tashjan, Greg Tashjan and Dean Janes DBA Imaging Services, Inc.(6) 31.1 Section 302 Certification of Chief Executive Officer 31.2 Section 302 Certification of Chief Financial Officer 32.1 Section 906 Certification of Chief Executive Officer 32.2 Section 906 Certification of Chief Financial Officer ---------------------- (1) Incorporated by reference to the Form 10SB/A Registration Statement filed with the Securities and Exchange Commissioner on December 9, 2002. (2) Incorporated by reference to Amendment No. 2 to Form SB-2 Registration Statement filed with the Securities and Exchange Commission on October 6, 2004. (3) Incorporated by reference to Amendment No. 3 to Form SB-2 Registration Statement filed with the Securities and Exchange Commission on October 21, 2004. (4) Incorporated by reference to Amendment No. 5 to Form SB-2 Registration Statement filed with the Securities and Exchange Commission on April 18, 2005. (5) Incorporated by reference to Amendment No. 6 to Form SB-2 Registration Statement filed with the Securities and Exchange Commission on July 7, 2005. (6) Incorporated by reference to Amendment No. 8 to Form SB-2 Registration Statement filed with the Securities and Exchange Commission on September 9, 2005.
-45- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 27, 2009 IMAGING3, INC. By: /s/ Dean Janes -------------------------------------- Dean Janes, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Dean Janes Dated: March 27, 2009 ------------------------------------------------ Dean Janes, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) By: /s/ Xavier Aguilera Dated: March 27, 2009 -------------------------------------------------- Xavier Aguilera, Chief Financial Officer/Treasurer, Executive Vice President, Corporate Secretary and Director (Principal Financial/Accounting Officer) By: /s/ Christopher Sohn Dated: March 27, 2009 ------------------------------------------------------ Christopher Sohn, President and Chief Operating Officer -46-