10-Q/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC  20549

_______________________________

AMENDMENT NO. 1

to

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2011

OR

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

For the transition period from ____ to ____

Commission file number:   000-28238

APPLIED VISUAL SCIENCES, INC.

(Exact name of registrant as specified in its charter)

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

250 Exchange Place, Suite H, Herndon, Virginia  20170

(Address of principal executive offices and zip code)

(703) 464-5495

(Registrant’s telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes þ   No ¨

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

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

Large accelerated filer ¨   Accelerated filer ¨   Non-accelerated filer ¨   Smaller reporting company þ

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

At August 17, 2011, 85,517,211 shares of the registrant’s Common Stock, $0.001 par value, were outstanding.

EXPLANATORY NOTE

The purpose of this Amendment No. 1 to Applied Visual Sciences, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, filed with the Securities and Exchange Commission on August 18, 2011 (the “Form 10-Q”), is solely to furnish Exhibit 101 to the Form 10-Q in accordance with Rule 405 of Regulation S-T. Exhibit 101 to this report provides the consolidated financial statements and related notes from the Form 10-Q formatted in XBRL (eXtensible Business Reporting Language).

In addition to the changes above, Part II, Item 6, Exhibits is hereby amended to include certifications of the Company’s Chief Executive Officer and Chief Financial Officer as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002, as amended.  These certifications are filed or furnished, as applicable, as Exhibits 31.1, 31.2, 32.1 and 32.2 to this Amendment.

This Amendment No. 1 to the Form 10-Q speaks as of the original filing date of the Form 10-Q, does not reflect events that may have occurred subsequent to the original filing date, and does not modify or update in any way disclosures made in the original Form 10-Q.

Pursuant to Rule 406T of Regulation S-T, the interactive data files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

ITEM 6.     EXHIBITS

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

		Incorporated by Reference		Filed Herewith
Exhibit No.	Exhibit Description	Form	Filing Date
31.1	Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CEO)			ü
31.2	Certification Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (CFO)			ü
32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO)			ü
32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO)			ü
101.INS	XBRL Instance Document			ü
101.SCH	XBRL Taxonomy Extension Schema Document			ü
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document			ü
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document			ü
101.LAB	XBRL Taxonomy Extension Label Linkbase Document			ü
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document			ü

SIGNATURES

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

APPLIED VISUAL SCIENCES, INC.
By:	/s/ Michael W. Trudnak	By:	/s/ Gregory E. Hare
	Michael W. Trudnak		Gregory E. Hare
	Chief Executive Officer		Chief Financial Officer
	(Principal Executive Officer)		(Principal Financial and Accounting Officer)

Date: September 14, 2011

EX-31

Exhibit 31.1

CERTIFICATION PURSUANT TO RULE 13a-14(a) OR 15d-14(a) UNDER THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002, AS AMENDED

I, Michael W. Trudnak, certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q/A of Applied Visual Sciences, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: September 14, 2011

Signed:

/s/ Michael W. Trudnak

Name:

Michael W. Trudnak

Title:

Chairman and Chief Executive Officer

EX-31

Exhibit 31.2

CERTIFICATION PURSUANT TO RULE 13a-14(a) OR 15d-14(a) UNDER THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002, AS AMENDED

I, Gregory E. Hare, certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q/A of Applied Visual Sciences, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: September14, 2011

Signed:

/s/ Gregory E. Hare

Name:

Gregory E. Hare

Title:

Chief Financial Officer

EX-32

Exhibit 32.1

CERTIFICATION

 PURSUANT TO RULE 13a-14(b) or

RULE 15d-14(b) AND 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE

 SARBANES-OXLEY ACT OF 2002, AS AMENDED)

Pursuant to 18 U.S.C.  Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended), the undersigned officer of Applied Visual Sciences, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2011 (the “Report”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d), and the information contained in the 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: September 14, 2011

Signed:

/s/ Michael W. Trudnak

Name:

Michael W. Trudnak

Title:

Chairman and Chief Executive Officer

EX-32

Exhibit 32.2

CERTIFICATION

 PURSUANT TO RULE 13a-14(b) or

RULE 15d-14(b) AND 18 U.S.C. SECTION 1350
(AS ADOPTED PURSUANT TO SECTION 906 OF THE

 SARBANES-OXLEY ACT OF 2002, AS AMENDED)

Pursuant to 18 U.S.C.  Section 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended), the undersigned officer of Applied Visual Sciences, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2011 (the “Report”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m or 78o(d), and the information contained in the 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: September 14, 2011

Signed:

/s/ Gregory E. Hare

Name:

Gregory E. Hare

Title:

Chief Financial Officer

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CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)	Jun. 30, 2011	Dec. 31, 2010
Statement of Financial Position [Abstract]
Common shares outstanding subject to repurchase	0	282,704
Stockholder's Equity (Deficit)
Preferred stock, par value	$ 0.20	$ 0.20
Preferred stock, Authorized	1,000,000	1,000,000
Preferred stock, Issued	0	0
Preferred stock, outstanding	0	0
Common stock, par value	$ 0.001	$ 0.001
Common stock, Authorized	200,000,000	200,000,000
Common stock, Issued	85,144,060	82,212,233
Common stock, outstanding	85,144,060	82,212,233

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010	Jun. 30, 2011	Jun. 30, 2010
Income Statement [Abstract]
Net revenues	$ 6,589	$ 6,608	$ 6,589	$ 20,273
Cost of sales	0	1,008	0	14,785
Gross profit	6,589	5,600	6,589	5,488
Selling, general and administrative expense	587,277	1,091,056	1,452,270	2,516,002
Operating loss	(580,688)	(1,085,456)	(1,445,681)	(2,510,514)
Other income (expense)	202,585	(1,795,768)	1,215,508	(1,220,503)
Net loss	(378,103)	(2,881,224)	(230,173)	(3,731,017)
Net loss per common share
Basic and diluted	$ 0.00	$ (0.04)	$ 0.00	$ (0.06)
Weighted average common shares outstanding
Basic and diluted	84,986,703	65,186,830	84,286,698	63,747,597
Other comprehensive income
Comprehensive income - beginning of period	63,354	63,671	63,354	62,481
Cumulative translation adjustments	0	(317)	0	873
Comprehensive income - end of period	$ 63,354	$ 63,354	$ 63,354	$ 63,354

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Document and Entity Information (USD $)	6 Months Ended
	Jun. 30, 2011	Aug. 17, 2011
Document And Entity Information
Entity Registrant Name	Applied Visual Sciences, Inc.
Entity Central Index Key	0000873198
Document Type	10-Q
Document Period End Date	Jun. 30, 2011
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Smaller Reporting Company
Entity Public Float		$ 22,251,767
Entity Common Stock, Shares Outstanding		85,517,211
Document Fiscal Period Focus	Q2
Document Fiscal Year Focus	2011

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Fair Value Measurement

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 7 - Fair Value Measurement

The Company determines the fair value of its derivatives that are classified as liabilities, on a recurring basis using significant unobservable inputs. The fair value measurement of these liabilities is consistent with ASC 820, "Fair Value Measurements" ASC 820 did not have an impact on the consolidated financial position or results of operations; however, the required disclosure for the six months ended June 30, 2011 is as follows:

Liabilities Measured at Fair Value	Convertible Debentures, Net of Discount (1)		Embedded Conversion Feature of Debentures (2)			Total
Beginning balance as of December 31, 2010	$	1,688,205	$	2,228,431		$	3,916,636
Revaluation (gain) loss of event of default provision		-		(1,215,508	)		(1,215,508	)
Ending balance as of June 30, 2011	$	1,688,205	$	1,012,923		$	2,701,128
Total (gain) loss from revaluation of derivatives and event of default waived by holders included in earnings for the period and reported as an adjustment to interest	$	-	$	(1,215,508	)	$	(1,215,508	)

(1) The balance as of June 30, 2011 represents the outstanding convertible debentures issued November 8, 2006 and April 12, 2007.

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

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Financial Condition, Going Concern Uncertainties and Events

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 3 - Financial Condition, Going Concern Uncertainties and Events of Default

During the six-months ended June 30, 2011, Applied Visual Sciences’ revenue generating activities have not produced sufficient funds for profitable operations and we have incurred operating losses since inception. In view of these matters, realization of certain of the assets in the accompanying consolidated balance sheet is dependent upon continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing on acceptable terms, and the success of future operations. Our independent registered public accounting firm’s report on the consolidated financial statements included herein, and in our annual report on Form 10-K for the year ended December 31, 2010, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.

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

The principal amount of our outstanding Series A convertible debentures of $1,688,205 became due on July 1, 2011, and such amount was not paid. Failure to pay the principal amount of the Debentures when due constitutes an event of default under the debentures and failure to remit the principal and other amounts may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. As of the date of this report, the holders have not sought to enforce their rights under the debentures. We are in discussions with the debenture holders to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although we have not reached any agreement with the debenture holders with regard to any such repayment, repurchase or extension. Our ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance. Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures. If an event of default occurs under the debentures, the debenture holders may elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, or (b) the outstanding principal amount unpaid divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. The Company currently has insufficient funds to repay the outstanding amount in the event the debenture holders make a demand for payment.

As of June 30, 2011, we have outstanding trade and accrued payables of $1,226,777, other accrued liabilities of $513,274, and accrued salaries due to our employees and management of $5,405,201. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $90,900.

During February 2010, the Company sold securities for gross proceeds of $200,000 (or $197,000, net of commission and expenses of $3,000) to certain accredited investors at a series of closings, and issued an aggregate of 800,000 shares of common stock, and 800,000 Class Q Warrants. The Class Q Warrants are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance. Also, on February 23, 2011, the Company entered into a Securities Purchase Agreement (the “SPA”) with an institutional accredited investor for an investment up to $1,000,000. Subsequently on February 24, 2011, the Company sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance; contain piggyback registration rights, a cashless exercise provision, and certain anti-dilution and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor. The institutional investor has agreed to purchase additional shares if pre-established stock price and volume conditions are met during the seven months following the closing. The stock price and volume conditions for the first five (5) closings were not met, and there can be no assurance our shares will satisfy such conditions in connection with the two (2) remaining closings.

As of June 30, 2011, we had a cash balance of $15,670. Management believes these funds to be insufficient to fund our operations for the next twelve months absent any cash flow from operations or funds from the sale of our equity or debt securities. Currently, we are spending or incurring (and accruing) expenses of approximately $325,000 per month on operations and the continued research and development of our 3i technologies and products, including with regard to salaries and consulting fees. Management believes that we will require aggregate of approximately $3,900,000 to fund our operations for the next 12 months and to repay certain outstanding trade payables and accrued expenses. This assumes that holders of our outstanding debentures convert such debt into shares of our common stock or that we are able to extend the term of the debentures, of which there can be no assurance. In the event we are unable to extend the term of the debentures beyond their new maturity date, the debenture holders do not convert such debt or require payment of principal, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures, we shall be required to raise additional financing. Also, this assumes that we are able to continue to defer the amounts due to our employees for accrued and unpaid salaries and that we are able to continue to extend or defer payment of certain amounts due to our trade creditors, of which there can be no assurance.

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

During the six months ended June 30, 2011, although our total stockholders’ deficit decreased by $881,920 to $9,282,595, our consolidated net loss for the period was $230,173, mainly due to the change in the fair value of the derivative liability that reduced net loss by $1,215,508. Notwithstanding the foregoing discussion of management’s expectations regarding future cash flows, Applied Visual Sciences’ insolvency continues to increase the uncertainties related to its continued existence. Both management and the Board of Directors are carefully monitoring the Company’s cash flows and financial position in consideration of these increasing uncertainties and the needs of both creditors and stockholders.

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Description of Business

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 1 - Description of Business

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

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

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

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

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

· Creation of autonomous business units with defined measurable goals and objectives;

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

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

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

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

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

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

· Attract investment from investors that focus on specific industries.

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

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Acquisitions

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 4 - Acquisitions

Acquisition of Certain Assets of Difference Engines

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

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

Since the acquisition of the intellectual property, the cumulative effect on the temporary equity account for the change in the estimated redemption value of the outstanding shares held by the shareholders of Difference Engines Corporation was reduced by $1,309,496, and further reduced by $635,786 due to the sale of the Company’s stock previously held by the shareholders of Difference Engines Corporation. On June 30, 2011, prior to remeasurement, the balance of the temporary equity account for the purchase of the intellectual property owned by Difference Engines was $98,946. The lock up period expired and the shares are eligible for resale under Rule 144. The Company therefore considered ASU 2009-04 “Accounting for Redeemable Equity Instruments” and on March 31, 2011, reclassified the carrying value of the redemption, or $98,946, from temporary equity to permanent equity.

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Stockholder's Equity

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 5 - Stockholder's Equity

Issuance of Common Stock and Related Common Stock Warrants

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

On February 23, 2011, the Company entered into a Securities Purchase Agreement (the “SPA”) with an institutional accredited investor for an investment up to $1,000,000. Subsequently on February 24, 2011, the Company sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 Class CSF common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance; contain piggyback registration rights, a cashless exercise provision, and certain anti-dilution and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agent’s warrants as compensation in connection with the offering. The placement agent’s warrants are under the same terms and conditions as those issued to the institutional investor. The institutional investor has agreed to purchase additional shares if pre-established stock price and volume conditions are met during the seven months following the closing. The stock price and volume conditions for the second and third closings were not met, and there can be no assurance our shares will satisfy such conditions in connection with any subsequent closing. Common stock was increased by $600 for the par value of the shares and $135,400 to paid-in capital.

Other Common Stock Issued Including Exercises of Warrants

During April through May 2011, the Company issued to two (2) consultants an aggregate of 214,220 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $214 for the par value of the shares and paid-in capital was increased by approximately $37,361. Stock compensation expense of $37,575 was also recorded.

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

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

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

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

Other Common Stock Warrants Issued or Forfeited

During April through June 2011, the Company cancelled an aggregate of 447,652 common stock purchase warrants that expired. The fair value of the warrants on their date of issuance was $21,589.

The Company has issued warrants as compensation to its bridge note holders, placement agents and other consultants, as well as to incentivize investors in each of the Company’s private placement financings. The table below shows by category, the warrants issued and outstanding at June 30, 2011.

Common Stock Purchase Warrants	Number of Warrants Outstanding and Exercisable	Date Warrants are Exercisable	Exercise Price	Date Warrants Expire
Note and debenture holders	600,000	August 2006	$1.60	August 2011
	1,312,056	November 2006	0.25	November 2011
	1,362,057	April 2007	0.25	April 2012
	10,000	December 2007	0.70	December 2012
	18,293	February 2009	0.41	February 2014
	1,140,555	June 2009	0.25	November 2011
	1,140,554	June 2009	0.25	April 2012
	150,000	January 2010	0.25	January 2015
	78,750	September 2010	0.25	September 2015
	5,812,265
Private placement investors	864,798	July 2007	1.17	July 2012
	312,500	August 2007	0.80	December 2011
	937,500	August 2007	1.75	August 2012
	1,500,000	February 2008	0.70	February 2013
	214,285	March 2008	0.75	March 2013
	2,142,850	April 2008	0.70	April 2013
	2,682,553	Sept to December 2008	0.41	Sept to Dec 2013
	4,358,981	January to April 2009	0.41	Jan to April 2014
	1,050,000	June to July 2009	0.25	June to July 2014
	3,631,973	August 2009	0.25	July to Dec 2013
	214,285	September 2009	0.41	December 2012
	2,499,007	Oct to Dec 2009	0.25	Oct to Dec 2014
	3,299,568	March to June 2010	0.25	March to June 2015
	3,881,907	July to September 2010	0.25	July to September 2015
	5,301,345	Oct to December 2010	0.25	Oct to December 2015
	400,000	Nov to December 2010	0.50	Nov to December 2013
	800,000	February 2011	0.25	February 2014
	600,000	February 2011	0.25	February 2016
	34,691,552
Placement agents	311,760	November 2006	0.25	November 2011
	311,760	April 2007	0.25	April 2012
	47,564	July 2007	1.17	July 2012
	198,154	June 2009	0.25	November 2011
	198,154	June 2009	0.25	April 2012
	272,827	June 2009	0.45	June 2014
	108,000	July 2009	0.25	July 2014
	205,000	December 2009	0.28	December 2014
	72,000	February 2011	0.25	February 2016
	1,725,219
Consultants	60,000	February 2008	0.54	February 2013
	200,000	December 2009	0.25	December 2014
	63,000	June to August 2009	0.25	June to August 2014
	14,000	August 2010	0.25	August 2015
	14,000	September 2010	0.28	September 2015
	128,000	December 2010	0.50	December 2013
	479,000
Total Warrants Issued/Outstanding	42,708,036

As of June 30, 2011, approximately 18,521,956 of the above warrants may be exercised pursuant to the cashless exercise provisions of such warrants and, if so exercised, the shares may be subsequently resold under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Company’s common stock could cause the market price of the Company’s common stock to drop.

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Subsequent Events

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 6 - Subsequent Events

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

On July 29, 2011, the Company, in cooperation with the Aurum Institute for Health Research and the South African National Laboratory Services (“NHLS”), submitted the clinical results (processing and analysis of 985 tuberculosis sputum cases) of our fully automated Signature Mapping Tuberculosis (“TBDx™”) product, to the International Union Against Tuberculosis and Lung Disease for presentation at their 42nd Annual Union World Conference on Lung Health in October 2011.

On July 20, 2011, the Company submitted with our partner LRSI Institute of Tuberculosis & Research Development - Government of India, a final application to the Wellcome Trust for the migration, development, and clinical evaluation of Signature Mapping TBDx™ system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope. This is in response to the Wellcome Trust’s invitation after their review of our initial concept and subsequent preliminary applications.

The Company has not paid rent for the month of July and August 2011, with regard to the lease for its principal offices. Accordingly, the Company may be deemed to be in default under its lease with the landlord. We are in discussions with the landlord regarding the status of the payments due under our lease. As of the date of this report, the landlord has not sought to enforce their rights under the lease.

From August 1 - 9, 2011, employees exercised an aggregate of 140,000 stock options using outstanding accrued wages that resulted in the aggregate issuance of 140,000 shares of common stock for a reduction in accrued wages of $42,000. Common stock was increased by $140 for the par value of the shares and paid-in capital increased by $41,860.

On July 29, 2011, the Company issued 125,000 shares of common stock to a consultant as compensation for business advisory services. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $125 for the par value of the shares, $17,375 to paid-in capital, with an offset to deferred compensation for the fair value on the date of issuance of $17,500. The Company will record consulting expense over the six-month service period in accordance with ASC 505-50 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”

On July 5, 2011, the Company issued to a consultant an aggregate of 108,151 shares of common stock as compensation in lieu of cash for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $108 for the par value of the shares and paid-in capital was increased by approximately $19,565. Stock compensation expense of $19,673 was also recorded.

The Company did not make timely payment of the principal amount under its Series A Senior Convertible Debentures (the “Debentures”) due on July 1, 2011. Failure to pay the principal amount of the Debentures when due constitutes an event of default under the debentures and failure to remit the principal and other amounts may result in enforcement of the debenture holders’ rights and remedies under the debentures and applicable law. As of the date of this report, the holders have not sought to enforce their rights under the Debentures. The Company is in discussions with the debenture holders to re-negotiate the terms of the Debentures, including the repayment or repurchase of the Debentures and/or seek to extend their maturity date. The Debentures provide that any default in the payment of principal, which default is not cured within the five trading days of the receipt of notice of such default or ten trading days after the Company becomes aware of such default, will be deemed an event of default. As of the date of this report, the debenture holders have not made an election requiring immediate repayment of the mandatory amount although there can be no assurance they will not do so.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (USD $)	6 Months Ended
	Jun. 30, 2011	Jun. 30, 2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$ (230,173)	$ (3,731,017)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	48,408	63,193
Stock-based compensation expense	346,092	781,848
Fair value of warrants issued - derivative instruments	0	16,500
Revaluation of derivative instrument expense (income)	(1,215,508)	1,193,441
Gain on settlement of debt	0	(265,600)
Other noncash (stock issued in lieu of interest paid)	0	3,892
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable	69,527	(35,818)
Decrease (increase) in prepaid expenses	3,410	(28,200)
Increase in accounts payable	165,100	525,172
Increase in accrued expenses	525,625	841,280
Increase in deferred revenue	0	41,305
Net cash flows used in operating activities	(287,519)	(594,004)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of equipment	(5,970)	(42,773)
Investment in patents	(2,515)	(1,080)
Net cash flows used in investing activities	(8,485)	(43,853)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock, net	333,000	706,780
Proceeds from exercise of stock warrants	0	75,000
Proceeds from short-term convertible notes payable	0	27,138
Reduction of short-term note payable, related party	(26,200)	0
Net cash flows provided by financing activities	306,800	808,918
Effect of exchange rate changes on cash and cash equivalents	0	390
Net increase in cash and cash equivalents	10,796	171,451
Cash and cash equivalents at beginning of the period	4,874	8,707
Cash and cash equivalents at end of the period	15,670	180,158
Supplemental disclosure of cash flow information:
Remeasurement of common stock subject to repurchase	0	(59,368)
Reclassification of common stock previously subject to repurchase	98,946	2,733
Cashless exercise of common stock purchase warrants	0	16,427
Conversion of short-term convertible notes to common stock	0	50,000
Conversion of convertible debenture to common stock	0	427,500
Conversion of accounts payable and other accrued liabilities to common stock	242,650	0
Conversion of accrued wages to common stock	11,340	0
Conversion of accrued wages for exercise of employee stock options	$ 80,065	$ 0

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Basis of Presentation

6 Months Ended

Jun. 30, 2011

Notes to Financial Statements

Note 2 - Basis of Presentation

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

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

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

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

Summary of Significant Accounting Policies

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

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

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

The Company reviews the terms of convertible debt and equity securities for indications requiring bifurcation, and separate accounting, for the embedded conversion feature. Under guidelines of ASC 815-40, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” public companies that are required, or that could be required, to deliver shares of common stock as part of a physical settlement or a net-share settlement, under a freestanding financial instrument, are required to initially measure the contract at fair value (or allocate on a fair value basis if issued as part of a debt financing), and report the value in permanent equity. However, in certain circumstances (e.g. the company could not ascertain whether sufficient authorized shares exist to settle the contract), permanent equity classification should be reassessed. The classification of the contract as permanent equity should be reassessed at each balance sheet date and, if necessary, reclassified as a liability on the date of the event causing the reclassification. If a reclassification occurs from permanent equity to a liability, the fair value of the financial instrument should be removed from permanent equity as an adjustment to stockholders’ equity. Any portion of the contract that could be net-share settled as of the balance sheet date would remain classified in permanent equity. Subsequent to the initial reclassification event, changes in fair value of the instrument are charged to expense until the conditions giving rise to the reclassification are resolved. When a company has more than one contract subject to reclassification, it must determine a method of reclassification that is systematic, rational, and consistently applied. The Company adopted a reclassification policy that reclassifies contracts with the latest inception date first. To the extent that changes in fair value of equity instruments relates to financings since November 8, 2006 (the date of first closing under the debenture financing with reset provisions that made the number of potentially issuable shares indeterminable), the increase or decrease in the fair value of the warrants is charged or credited to interest expense. To the extent the equity instruments relate to other transactions (e.g. consulting expense), the increases or decreases are charged or credited based on the nature of the transaction. The number of additional shares potentially issuable under the November 8, 2006, outstanding convertible debentures and related outstanding warrants and other subsequent warrants issued was determinable as of the debentures’ final milestone reset date on May 20, 2008, and, therefore, the outstanding fair value of the warrants issued to the debenture holders, other subsequent warrants issued through May 20, 2008, and the warrants’ related beneficial conversion feature were reclassified as stockholders’ equity in accordance with currently effective generally accepted accounting principles.

Reclassifications

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

Geographic and Segment Information

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

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

The Company operates in North America, Africa, and Asia. In general, revenues are attributed to the country in which the contract originates. Revenue for the six months ended June 30, 2011, of $6,589 was from the sale of hardware and related, specifically freight, duty and taxes reimbursed by the customer for a shipment of TBDx™. Revenue for the same period ended June 30, 2010 was $20,273 from research activities of our security product/services.

	Three Months Ended June 30						Six Months Ending June 30
	2011			2010			2011			2010
Net revenues:
The Americas:
Software licenses	$	-		$	-		$	-		$	-
Research funding		-			6,608			-			20,273
Maintenance and support		-			-			-			-
Hardware and related		6,589			-			6,589			-
The Americas		6,589			6,608			6,589			20,273
United Kingdom:
Software licenses		-			-			-			-
Research funding		-			-			-			-
Maintenance and support		-			-			-			-
Hardware and related		-			-			-			-
United Kingdom		-			-			-			-
Total net revenues	$	6,589		$	6,608		$	6,589		$	20,273
Cost of sales:
The Americas:
Software licenses	$	-		$	-		$	-		$	-
Research funding		-			1,008			-			14,785
Maintenance and support		-			-			-			-
Hardware and related		-			-			-			-
The Americas		-			1,008			-			14,785
United Kingdom:
Software licenses		-			-			-			-
Research funding		-			-			-			-
Maintenance and support		-			-			-			-
Hardware and related		-			-			-			-
United Kingdom		-			-			-			-
Total cost of sales	$	-		$	1,008		$	-		$	14,785
Operating (loss):
The Americas:
Software licenses	$	(587,277	)	$	(1,090,771	)	$	(1,452,270	)	$	(2,511,494	)
Research funding		-			5,315			-			1,304
Maintenance and support		-			-			-			-
Hardware and related		6,589			-			6,589			-
The Americas		(580,688	)		(1,085,456	)		(1,445,681	)		(2,510,190	)
United Kingdom:
Software licenses		-			-			-			-
Research funding		-			-			-			-
Maintenance and support		-			-			-			(324	)
Hardware and related		-			-			-			-
United Kingdom		-			-			-			(324	)
Total operating (loss)	$	(580,688	)	$	(1,085,456	)	$	(1,445,681	)	$	(2,510,514	)
Depreciation and amortization:
The Americas:
Software licenses	$	24,257		$	35,058		$	48,408		$	62,869
Research funding		-			-			-			-
Maintenance and support		-			-			-			-
Hardware and related		-			-			-			-
The Americas		24,257			35,058			48,408			62,869
United Kingdom:
Software licenses		-			-			-			-
Research funding		-			-			-			-
Maintenance and support		-			-			-			324
Hardware and related		-			-			-			-
United Kingdom		-			-			-			324
Total depreciation and amortization	$	24,257		$	35,058		$	48,408		$	63,193
Total assets:
The Americas							$	654,685		$	962,777
United Kingdom								-			-
Total							$	654,685		$	962,777
Long-lived assets, net:
The Americas							$	612,022		$	662,764
United Kingdom								-			-
Total							$	612,022		$	662,764

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

Stock-Based Compensation

The Company has two active equity compensation plans which include the Amended and Restated 2003 Stock Incentive Plan and the 2009 Stock Compensation Plan (collectively, the “Plans”). A total of 50,000,000 shares have been reserved for issuance under these Plans in the form of stock-based awards to employees, non-employee directors and outside consultants of the Company, of which 27,863,803 shares remain available for issuance thereunder as of June 30, 2011. The grant of awards under the Plans require approval by the Compensation Committee of the Board of Directors of the Company (or the Board of Directors, in the absence of such a committee) (the “Committee”), and the Committee is authorized under the Plans to take all actions that it determines to be necessary or appropriate in connection with the administration of the Plans.

The Company adopted the provisions of ASC 718-10, “Share-Based Payment” to account for its share-based payments. ASC 718-10 requires all share-based payments to employees or to non-employee directors as compensation for service on the Board of Directors to be recognized as compensation expense in the consolidated financial statements based on the estimated fair values of such payments, and the related expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures. The Company’s estimated forfeiture rates are based on its historical experience within separate groups of employees. The fair value of each option granted was estimated on the date of grant using the Black-Scholes Merton option pricing model (Black-Scholes model). In accordance with ASC 718-10, the Company recognized total stock-based compensation expense for employees and non-employee members of the Board of Directors for the six months ended June 30, 2011 of $164,241, and $604,011 for the same period during 2010. All options granted during the six months ended June 30, 2011 were at fair value, and the related compensation expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures.

The Company accounts for stock options granted to non-employees in accordance with ASC 718-10 and ASC 505-50, “Accounting For Equity Instruments That Are Issued To Other Than Employees For Acquiring, Or In Conjunction With Selling, Goods Or Services.” ASC 505-50 establishes the measurement principles for transactions in which equity instruments are issued in exchange for the receipt of goods or services. The Company has relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied, and recognizes as an expense the estimated fair value of such options as calculated using the Black-Scholes model. The fair value is remeasured during the service period at each balance sheet date, and is amortized over the service period to vesting for each option or the term of the recipient’s contractual arrangement, whichever is shorter. The Company recognizes compensation costs, net of an estimated forfeiture rate, on a pro rata basis over the requisite service period of each vesting tranche of each award. The Company considers voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate. Total stock-based compensation expense for consultants during the six months ended June 30, 2011 and 2010 were $181,851 and $87,778, respectively. All options granted during the six months ended June 30, 2011 were at fair value, and the related compensation expense is recognized on a straight-line basis over the service period to vesting for each grant, net of estimated forfeitures.

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

Black-Scholes Model Assumptions		2011	2010
Risk-free interest rate (1)		2.27%	3.01%
Expected volatility (2)		136.7%	134.3%
Dividend yield (3)		0.0%	0.0%
Expected life (4)		6.5 years	6.5 years
(1)	The risk-free interest rate is based on US Treasury debt securities with maturities similar to the expected term of the option.
(2)	Expected volatility is based on historical volatility of the Company’s stock factoring in daily share price observations.
(3)	No cash dividends have been declared on the Company’s common stock since the Company’s inception, and the Company currently does not anticipate paying cash dividends over the expected term of the option.
(4)	The expected term of stock option awards granted is derived from historical exercise experience under the Company’s stock option plan and represents the period of time that stock option awards granted are expected to be outstanding. The expected term assumption incorporates the contractual term of an option grant, which is usually ten years, as well as the vesting period of an award, which is generally pro rata vesting over two years.

The Amended and Restated 2003 Stock Incentive Plan

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

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

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

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

The Compensation Committee did not grant any stock options under the 2003 Plan during the six months ended June 30, 2011. As of June 30, 2011, the Company has reserved under the 2003 Plan, 15,684,649 shares to be issued upon exercise of outstanding options, and 12,255,969 shares were available for future awards. Compensation expense for stock options granted is recognized over the requisite service period, which is typically the period over which the stock-based compensation awards vest. In anticipation of implementation of SFAS 123R, we accelerated the vesting of the outstanding options in December 2005, prior to adopting SFAS 123R. We applied the guidance of SAB 107 in conjunction with the adoption of SFAS 123R. This acceleration was for all employees, including the named executive officers.

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

Stock Options Exercised under the 2003 Plan

During 2011, employees exercised an aggregate of 266,882 stock options using outstanding accrued wages that resulted in the aggregate issuance of 266,882 shares of common stock for a reduction in accrued wages of $80,065. Common stock was increased by $267 for the par value of the shares and paid-in capital increased by $79,798.

Summary of stock option activity under the 2003 Plan for the six months ended June 30, 2011 issued to employees, non-employee members of the Board of Directors and consultants is as follows:

Fiscal Year and Activity	Weighted-Average Exercise Price		Number of Options
Outstanding December31, 2010	$	0.32		16,394,681
Fiscal 2011 activity
Granted
Exercised ($0.30)		0.30		(266,882	)
Cancelled(0.30)		0.30		(443,150	)
Outstanding June 30, 2011		0.32		15,684,649
Stock options available for grant				12,255,969

The following table summarizes additional information about the 2003 Plan stock options outstanding at June 30, 2011:

Issued and Outstanding				Exercisable
Type of Option and Range of Exercise Prices	Number of Options	Weighted-Average Remaining Contractual Life (Yrs)	Weighted-Average Exercise Price	Number of Options	Weighted-Average Price
Nonqualified Stock Options $0.30 (1) (5)	1,482,000	2.5	$ 0.30	1,482,000	$ 0.30
Nonqualified Stock Options $0.30 (2) (5)	44,000	3.6	0.30	44,000	0.30
Incentive Stock Options $0.15 - $4.05 (3)	802,042	4.1	0.85	802,042	0.85
Incentive Stock Options $0.15 - $0.30 (4) (5)	13,356,607	6.5	0.29	13,356,607	0.29
Total	15,684,649	6.0	$ 0.32	15,684,649	$ 0.32

(1) Initially issued to employees below fair value during the period of May 2003 through February 2004.

(2) Initially issued to directors below fair value during the period of February 2004 through September 2005.

(3) Issued to consultants at fair value.

(4) Issued to directors and employees at fair value, or above fair value for those individuals with greater than 10% beneficial ownership.

(5) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010.

The 2009 Stock Compensation Plan

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

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

Subject to the provisions of the 2009 Plan, the Compensation Committee has the power to:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The following is a summary of the number and type of awards granted to, or exercised or forfeited by, employees, non-employee members of the Board of Directors and consultant pursuant to the Company’s 2009 Stock Compensation Plan for the six months ended June 30, 2011.

Fiscal Year and Activity	Weighted-Average Grant or Exercise Price Per Share		Number of Shares
Reserved for future issuance as of December 31, 2010				15,929,563
Fiscal 2011 activity:
Common stock awards	$	0.21		321,729
Restricted stock awards		-		-
Restricted stock rights		-		-
Non-qualified stock options		-		-
Issued during 2011		0.19		321,729
Reserved for future issuance as of June 30, 2011				15,607,834
Stock options or restricted stock rights outstanding				-

Property and Equipment

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

	(Unaudited)
Asset (Useful Life)	June 30, 2011		December 31, 2010
Software (3 years)	$	84,224	$	84,224
Computer equipment (3 to 5 years)		330,961		324,991
Furniture and fixtures (7 to 10 years)		488,239		488,239
Equipment (7 to 10 years)		79,627		79,627
		983,051		977,081
Less accumulated depreciation		727,176		690,309
Equipment, net	$	255,875	$	286,772

Depreciation expense for property and equipment was $36,867 and $52,526 in the six months ended June 30, 2011 and 2010, respectively, and is reflected in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.

Goodwill and Other Intangible Assets

Intangible Assets – Intangible assets consist of acquired software and patents. Under ASC 350, “Goodwill and Other Intangible Assets,” such assets acquired including software technology is considered to have a finite life. Management has estimated the useful life to be 5 years and amortized such costs on a straight-line basis over this period. In addition, ASC 985-20, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” requires the Company to consider whether or not the software technology is impaired using a net realizable value analysis based on projected discounted cash flows. The Company prepared this analysis as of June 30, 2011, and concluded that the intangible assets are not impaired. Patent acquisition costs pertaining to the Company’s 3i technology that covers its PinPoint™ and Signature Mapping™ intellectual property (technology not acquired through acquisition), have been capitalized and are being amortized over the 20-year legal life of the patents. The Company has been granted by the United States Patent & Trademark Office (“USPTO”) five patents related to its 3i technology. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. The Company’s intangible acquired software technology was fully amortized as of December 31, 2009. Therefore, there was no amortization costs associated with acquired software during the six months ended June 30, 2011 and 2010, respectively. Amortization expense for patent acquisition costs was $11,541 and $10,667 during the six months ended June 30, 2011 and 2010, respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations. The Company anticipates incurring additional patent acquisition costs during 2011.

Excess of Purchase Price over Net Assets Acquired (Goodwill) – The Company follows the provisions of ASC 805-10, “Business Combinations” and ASC 350-10, “Goodwill and Other Intangible Assets.” These statements establish financial accounting and reporting standards for acquired goodwill. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. Effective January 1, 2002, with the adoption of ASC 350-10, goodwill must be evaluated for impairment and is no longer amortized. Excess of purchase price over net assets acquired (“goodwill”) represents the excess of acquisition purchase price over the fair value of the net assets acquired. To the extent possible, a portion of the excess purchase price is assigned to identifiable intangible assets. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2010 and the six months ended June 30, 2011, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years. Therefore, there was no amortization expense of goodwill during the six months ending June 30, 2011 or during the same period in 2010.

Impairment of Excess Purchase Price over Net Assets Acquired – The Company follows the provisions of ASC 350-10 “Goodwill and Other Intangible Assets” for the impairment of goodwill. The Company determines impairment by comparing the fair value of the goodwill, using the undiscounted cash flow method, with the carrying amount of that goodwill. Impairment is tested annually or whenever indicators of impairment arise. There was no goodwill on the consolidated balance sheet of the Company during Fiscal 2010 and the six months ended June 30, 2011, as a net realizable value analysis was made for goodwill in prior years and such asset was considered fully impaired during those prior years.

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

	Six Months Ended June 30, 2011
	Beginning Period Cost		Additions		Reductions		Net Book Value
Intangibles with finite lives:
Software technology	$	-	$	-	$	-	$	-
Patent acquisition costs		365,173		2,515		11,541		356,147
	$	365,173	$	2,515	$	11,541	$	356,147

Recently Issued Accounting Pronouncement

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

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

In May 2010, the Financial Accounting Standards Board (“FASB”) amended its authoritative guidance related to foreign currency issues that were discussed at the FASB’s Emerging Issues Task Force (“EITF”) meeting in March 2010 where the staff of the U.S. Securities and Exchange Commission (“SEC”) announced temporary guidance on certain exchange rate issues. Prompted by the use of multiple currency exchange rates in Venezuela, the use of different rates for remeasurement and translation purposes has caused reported balances for financial reporting purposes and the actual U.S. dollar denominated balances to be different. The SEC staff indicated that any differences between the amounts reported for financial reporting purposes and actual U.S. dollar denominated balances that may have existed prior to the application of highly inflationary accounting requirements on January 1, 2010 should be recognized in the income statement upon adoption, unless the issuer can document that the difference was previously recognized as a cumulative translation adjustment (“CTA”), in which case the difference should be recognized as an adjustment to CTA. The adoption of this guidance, effective June 30, 2010, did not have a material impact on the Company’s consolidated financial statements.

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

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

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

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CONDENSED CONSOLIDATED BALANCE SHEETS (USD $)	Jun. 30, 2011	Dec. 31, 2010
Current Assets
Cash and cash equivalents	$ 15,670	$ 4,874
Accounts receivable	0	69,527
Prepaid expenses	15,871	19,281
Total current assets	31,541	93,682
Equipment, net	255,875	286,772
Other Assets
Other noncurrent assets	11,122	11,122
Intangible assets, net	356,147	365,173
Total assets	654,685	756,749
Current Liabilities
Accounts payable	1,689,320	1,766,870
Other accrued liabilities	5,455,932	5,021,712
Note payable and advances, related parties	90,900	117,100
Convertible debentures	1,688,205	1,688,205
Derivative liabilities - embedded conversion feature of debentures	1,012,923	2,228,431
Total current liabilities	9,937,280	10,822,318
Common shares subject to repurchase, stated at estimated redemption value; 282,704 shares outstanding at December 31, 2010	0	98,946
Stockholder's Equity (Deficit)
Convertible preferred stock, $0.20 par value; authorized 1,000,000 shares Shares issued and outstanding at June 30, 2011 - none Shares issued and outstanding at December 31, 2010 - none	0	0
Common stock, $0.001 par value; authorized 200,000,000 shares Shares issued and outstanding at June 30, 2011 - 85,144,060 Shares issued and outstanding at December 31, 2010 - 82,212,233	85,144	82,212
Additional paid-in capital	81,352,148	80,242,987
Accumulated comprehensive income	63,354	63,354
Deficit accumulated	(90,783,241)	(90,553,068)
Total stockholder's equity (deficit)	(9,282,595)	(10,164,515)
Total liabilities and stockholder's equity (deficit)	$ 654,685	$ 756,749