UNITED STATES
SECURITIES AND EXCHANGE COMMISSION               WASHINGTON, DC  20549                FORM 10-K  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934   X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2010   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________  Commission File No. 000-28238                 APPLIED VISUAL SCIENCES, INC. (Exact Name of Registrant As Specified In Its Charter)    Delaware54-1521616(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)  Registrants Telephone Number, Including Area Code: (703) 464-5495  Securities registered pursuant to Section 12(b) of the Act:None  Securities registered pursuant to Section 12(g) of the Act:Common Stock, $.001 par value per share   Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ___ No ü  Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ___ No ü  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ü    No ___  Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ___ No __  Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]   Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.  Large Accelerated Filer [  ]    Accelerated Filer [  ] Non-Accelerated Filer [  ] Smaller Reporting Company [ü]  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes __ No ü  The aggregate market value of the voting common equity held by non-affiliates based upon the average of bid and asked prices for the Common Stock on June 30, 2010, the last business day of the registrants most recently completed second fiscal quarter as quoted on the OTC Bulletin Board was approximately $22,251,767.  The number of shares outstanding of the registrants common stock, as of March 30, 2011, was 84,763,958.                  DOCUMENTS INCORPORATED BY REFERENCE None.       2  NOTE REGARDING FORWARD-LOOKING STATEMENTS  Our disclosure and analysis in this Report contains forward-looking statements which provide our current expectations or forecasts of future events.  Forward-looking statements in this Report include, without limitation: information concerning possible or assumed future results of operations, trends in financial results and business plans, including those related to earnings, earnings growth, revenue and revenue growth; statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues; statements about expected future sales trends for our products; statements about our future capital requirements and the sufficiency of our cash, cash equivalents, and available bank borrowings to meet these requirements; information about the anticipated release dates of new products; other statements about our plans, objectives, expectations and intentions; and other statements that are not historical fact.  Forward-looking statements generally can be identified by the use of forward-looking terminology such as believes, expects, may, will, intends, plans, should, seeks, pro forma, anticipates, estimates, continues, or other variations thereof (including their use in the negative), or by discussions of strategies, plans or intentions.  Such statements include but are not limited to statements under Part I, Item 1A - Risk Factors, Part II, Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations, Part I, Item 1  Business and elsewhere in this Report.  A number of factors could cause results to differ materially from those anticipated by such forward-looking statements, including those discussed under Part I, Item 1A - Risk Factors and Item 1 - Business of this Report. The absence of these words does not necessarily mean that a statement is not forward-looking.  Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements.  Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including factors described in Part I, Item 1A - RiskFactorsof this Report.  You should carefully consider the factors described in Part I, Item 1A - Risk Factors in evaluating our forward-looking statements.  You should not unduly rely on these forward-looking statements, which speak only as of the date of this Report.  We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this Report, or to reflect the occurrence of unanticipated events.  You should, however, review the factors and risks we describe in the reports we file from time to time with the Securities and Exchange Commission (SEC).                   3  APPLIED VISUAL SCIENCES, INC. TABLE OF CONTENTS PART I 6 ITEM 1.     BUSINESS 6 ITEM 1A.  RISK FACTORS 33 ITEM 1B.  UNRESOLVED STAFF COMMENTS 47 ITEM 2.     PROPERTIES 47 ITEM 3.     LEGAL PROCEEDINGS 47 PART II 47 ITEM 5.     MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES47 ITEM 6.     SELECTED FINANCIAL DATA 50 ITEM 7.     MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 50 ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 70 ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 71 ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 71 ITEM 9A.  CONTROLS AND PROCEDURES 71 ITEM 9B.  OTHER INFORMATION 72 PART III 72 ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 72 ITEM 11.   EXECUTIVE COMPENSATION 78 ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 93 ITEM 14.   PRINCIPAL ACCOUNTiNG FEES AND SERVICES 94 PART IV 95 ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 96 SIGNATURES 99 CONSOLIDATED FINANCIAL STATEMENTS 100 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 101   4  CONSOLIDATED BALANCE SHEETS 102 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) 103 CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (DEFICIT) AND COMPREHENSIVE INCOME (LOSS) 104 CONSOLIDATED STATEMENTS OF CASH FLOWS 106 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 107 NOTE 1.    Basis of Presentation and Going Concern Considerations 107 NOTE 2.    Significant Accounting Policies 109 NOTE 3.    Other Accrued Liabilities 117 NOTE 4.    Financing Arrangements 117 NOTE 5.    Fair Value Measurement 124 NOTE 6.    Stockholders Equity (Deficit) 125 NOTE 7.    Acquisitions 137 NOTE 8.    Goodwill and Intangible Assets 138 NOTE 9.    Income Taxes 139 NOTE 10.  Commitments and Contingencies 139 NOTE 11.  Employment Agreements With Executive officers 140 NOTE 12.  Related Party Transactions 142 NOTE 13.  Operating Leases 143 NOTE 14.  Subsequent Events 143                         5  PART I        ITEM 1.     BUSINESS OVERVIEW  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 (3iTM”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists diagnostic imaging tools. Product development in these areas is ongoing, and while there can be no assurance, we believe that the technology should produce results equal to or greater than those currently achieved in baggage scanning.  On July 19, 2010 we announced that we had expanded ours organizational structure to better reflect our business operations and to provide an enhanced operational structure to capitalize on domestic and international business and joint product development opportunities.  We changed our name to Applied Visual Sciences, Inc. (APVS) and our common stock began to be quoted on the OTC Bulletin Board under symbol APVS. APVS serves as the holding company and IT development organization for the group.  The Company has achieved certain significant corporate life cycle milestones that necessitated a more diverse corporate structure.  The purpose of the structure is to segregate distinct business operations into separate corporate entities, all under a single umbrella organization. Our two wholly-owned operating subsidiaries are: Guardian Technologies International, Inc. - the homeland security/defense technology entity, and Signature Mapping Medical Sciences, Inc. - the healthcare technology entity.  APVS will maintain ownership of all existing and in-process patents, as well as any future patentable technology developed by its research and development staffs, or developed as a tangential application of its core patented technologies.  Our subsidiaries will be the business operations focused on new product development, marketing, and sales for their respective markets. By structuring in this manner, as a means to conduct business, we expect to realize the following benefits: · Creation of autonomous business units with defined measurable goals and objects; · Alignment of risk characteristics to the specific product, line of business or foreign market; · Provide a level of legal risk insulation to the core assets, the patents & intellectual property; · Flexibility to maximize tax benefits, both domestic & foreign activities; · Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships; · Facilitate the potential spin-off of one of the subsidiary entities; · Facilitate the potential sale of part of the company; and, · Attract investment from investors that focus on specific industries.  Aviation/Homeland Security Technology Solution - PinPointTM  Through our wholly-owned subsidiary, Guardian Technologies, we market our PinPointTM product, which is “intelligent imaging informatics” (3iTM) technology for the detection of guns, explosives, and other threat items contained in baggage in the airport environment or for building security applications.  PinPointTM can identify threat items, notify screeners of the existence of threat items, and speed the security process by eliminating unnecessary baggage checks, provide the screener with an instantaneous second opinion, and reduce processing time spent on false positives (baggage selected for security review that contains no threat items).  We propose to market and will seek to license the PinPointTM product primarily to the United States Transportation Services Administration (TSA) for   6  use in airports, the Federal Protection Services for use in federal buildings and to foreign governments and airport authorities. It is also our intent to distribute the product through various distribution methods.  The extended beta version working model of PinPointTM has been tested successfully at live carry-on baggage checkpoints in three international airports. Integration within currently deployed manufacturers’ scanning equipment is a requisite to anticipated sales, and is considered a development risk. PinPointTM is available for sale to customers; however no sales are anticipated until we are able to seamlessly integrate with the manufacturers’ scanning equipment either directly or through a device that is Digital Imaging and Communications in Security (“DICOS”) compliant that has been approved by the DHS and TSA  Currently, there are limited standards within the aviation security marketplace for the testing and validation of software technology solutions.  To date, the marketplace has placed a premium on the newest innovations in hardware technology and has failed to grasp how a threat detection software solution can succeed.  A major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) is expected to open a path to both increasing the interoperability of security equipment as well as providing a mechanism to use third party threat detection software as part of the screening solution.  This enabling initiative is the Digital Imaging and Communications in Security (DICOS) standard, similar to the Digital Imaging and Communications in Medicine (DICOM) standard.  With a defined standard for the output of each screening device, complimentary automated threat detection software can be appended to any x-ray equipment.  The schedule for publication of this standard is being driven by the expected purchase by DHS/TSA of new security screening equipment for over 400 US airports.  Applied Visual Sciences, Inc. personnel are participating in, and co-chair, the Checked and Checkpoint Digital Radiography working group, one of the three NEMA working groups drafting the DICOS standards.  Management believes that international market acceptance of PinPointTM as a viable threat detection solution will not only enhance our ability to sell worldwide, but it will open additional opportunities for the development of PinPointTM as the “intelligent image” analysis solution for areas such as military target acquisition, satellite remote sensing, and additional opportunities within aviation security such as whole-body scanners and cargo scanning.  Additionally, we will seek support of the U.S. Congress and the equipment manufacturers through lobbying and other efforts.  We remain focused on the ongoing development of PinPointTM, particularly with respect to field test results as well as the promotion of DICOS as the medium for deployment.  This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country. Market acceptance is a key to our future success.  Recent Developments - PinPointTM  The Company was granted by the United States Patent & Trademark Office (“USPTO”) a patent underlying our PinPointTM technology.  The patent, for the “System and Method for Identifying Objects of Interest in Image Data.” was granted on February 24, 2009, Patent No. US 7,496,218.  Applied Visual Sciences, Inc. continued to perform research and development activities in accordance with the terms of its February 17, 2009 extension for two years of the Cooperative Research and Development Agreement (CRDA) with the Transportation Security Administration (TSA) that was initially signed on August 18, 2006, and previously renewed on August 8, 2007 and February 12, 2008, with the United States Department of Homeland Security Science and Technology Directorate, for testing and validation of the PinPointTM product capabilities at the Transportation Security Labs (TSL). The project began on September 5, 2006 for explosive image collection, which is being followed by refinement of the development and testing of PinPointTM.  While TSA certification is not absolutely essential to the acceptance of Applied Visual Sciences, Inc.’s PinPointTM product, we believe that having TSA certification and a business relationship with the TSA is important to our strategic growth plans, as the relationship represents an important opportunity to obtain contracts for the licensing of our baggage scanning applications and for future aviation and transportation security applications and solutions that we develop or enhance.  Healthcare Signature MappingTM Solution  In an effort to expand upon the use of our core technology 3iTM “intelligent imaging informatics,” we are migrating and adopting our threat detection algorithms and quantitative imaging capabilities for use in the imaging field of diagnostic radiology and pathology.  The technology is called Signature MappingTM.Our Signature MappingTM platform technology represents the technological basis upon which we expect all diagnostic radiology and pathology applications will be developed. Any Signature MappingTM product introduced in the United States may be subject to Food and Drug Administration (FDA) review and approval, including with regard to its safety and effectiveness before we may begin marketing and selling any such product in the U.S. Such approval may require us to obtain extensive data from clinical studies to demonstrate such safety or effectiveness.  There may be similar regulatory requirements in foreign countries in which we seek to market and sell our healthcare CAD products.   7   Similar to a persons fingerprint, tissues have a unique structure. Each structure creates a unique pattern or “signature” that can be extracted from an image to differentiate, locate, identify, and classify by using our Signature MappingTM technology.  Signature MappingTM is expected to further help radiologists by visualizing the various structures within a particular tissue so they can be examined and quantified. This capability is expected to provide a next-generation image analysis, clarification, visualization and Signature MappedTM “tissue characterization and detection.  Management believes that it will add significant clinical value to a wide range of difficult to detect diseases in diagnostic radiology, by distinguishing and characterizing different tissue types in images regardless of the modality that generated the image.  Based on its ability to perform “tissue characterization”, Signature MappingTM is expected to be capable of being used to analyze images generated across all imaging modalities without the need for new image capture hardware costs.  It will serve instead as a software-based, multi-modality approach to image analysis combined with Signature Mapping’sTM unique “tissue characterization” and detection. As a result, Signature MappingTM is expected to be able to differentiate the contrast resolution between different tissue types, even when the material or tissue in the image is very diffuse or obscured by other objects, such as is the case where diseased lung tissue is located behind a rib in an x-ray chest examination. It is capable of displaying these signatures in a way that empowers radiologists to make a more informed and confident diagnosis, even for hard to distinguish structures such as masses in dense breast tissue.  Signature MappingTM appears to provide advantages for providing the knowledge for automatic detection.  The development of a “tissue characterization” and detection model employs the use of supervised machine learning and contextual image analysis to analyze and classify the features associated with the newly created “signatures.”  The fusion of these three technologies is known as Applied Visual Sciences, Inc.’s Intelligent Imaging Informatics 3iTM. Unlike other pattern recognition methodologies, the 3iTM solution can reveal and differentiate inherent structures for all materials in an image regardless of the imaging modality used to create the image; location within the image: shape or texture, and object orientation even if obscured by its relationship to other materials.  Clinical Experience and Medical Accomplishments While Signature MappingTM is expected to be capable of use in a wide range of medical image analysis applications, our initial application product development efforts are focused in four areas: · detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system; · breast cancer detection using x-ray mammography, MRI and ultrasound; · neurological imaging analysis through the detection and quantification of acute intracranial hemorrhage using non-contrast CT, normal pressure hydrocephalus, · multiple sclerosis using MRI; and · chest radiography targeted at tuberculosis and silicosis detection using digital x-ray.  Our research to-date includes five programs and studies conducted under the direction of the Image Processing and Informatics Laboratory at the University of Southern California (USC) using clinical data and images provided by: the Image Processing and Informatics Laboratory at USC, Howard University, and the South Florida Clinical Mammography Data Base.  In addition, our research includes a program and study for the detection of TB in stained sputum slides through a photo microscopy system at the National Health Laboratories of South Africa.  In the future, we expect to compete with existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health and manufacturers of dipstick or biomarker manufacturers, including SPAN Diagnostics Ltd., India,  Yayasan Hati Sehat (YHS), Indonesia and Wiener Laboratorios, Argentina.  We may also partner with one or more of these existing CAD manufacturers, or an emerging company with new technology for the CAD arena.  Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (“OEM”), or system integrators.  Although there is no current computer-aided-detection for TB sputum microscopy analysis, which can be identified as competition to Signature MappingTM, there are substitute technologies, which in the long run could compete for sputum specimen analysis.  The dipstick or biomarker approach could be considered a future competitor to Signature MappingTM. Ultimately, competition with our approach will be driven by its cost per procedure, ease-of-use, sensitivity and specificity, and the ability to be used by non-trained or lightly trained personnel in the point of care environment. These emerging tests are Polymerase Chain Reaction, TB Breathalyzer, Q-Beta Replicase Assay, Transcription-Medicated Amplification, Ligase Chain Reaction, Strand Displacement Amplification, Nucleic Acid Sequence-Based Amplification and Branched DNA and Cepheid Systems GeneXpert® System.  Recent Developments - Signature MappingTM   8   On December 28, 2010, submitted with our partner LRSI Institute of Tuberculosis & Research Development - Government of India, a preliminary application to the Wellcome Trust for the migration, development, and clinical evaluation of Signature Mapping TBDxTM system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope.  This is in response to the Wellcome Trust’s invitation after the review of our concept application.  On December 6, 2010, delivered our first fully automated Signature Mapping TBDxTM system to the South African National Health Laboratory Services (the "NHLS"), resulting in net revenue of $90,225.  On December 1, 2010, the Company and our South African partner, The Aurum Institute for Health Research, presented the TBDxTM fully automated system and the initial clinical findings from the first 496 of the 2500 cases analyzed to the senior management and physicians from the South African National Laboratory Services (“NHLS”). The initial results persuasively emphasizes the use of TBDxTM as a front end screening diagnostic system with the use of its decision support capabilities aiding the laboratory technologist in a decision support capacity. As a result, a decision was taken to revise the clinical protocol and add to the clinical study the combined performance of the TBDxTM system and the laboratory technologist.It was determined that this is a ‘real-world’ performance evaluation in which to conduct the study. As an additional outcome of the meeting, based on the strength of clinical findings and TBDxTM demonstration, the CEO of the National Health Laboratory Services together with their TB Program Director, agreed to conduct the next phase of the TBDxTM evaluation, the Demonstration Project. This is to be conducted at the Braamfontein Hospital in Johannesburg, South Africa under laboratory production conditions and acceptable clinical protocol. To perform the evaluation and testing, the NHLS was provided a quotation for three TBDxTM fully automated systems.  On November 29, 2010, the company installed its fully automated slide management and detection system in the NHLS National TB Reference Laboratory. The TBDx system is comprised of an auto-slide loader, bar code reader and 4 magazines with 200 slide capacity, upgraded BX41 fluorescence microscope, and Signature Mapping computer aided detection software and high resolution workstation with image processing and TB decision support capabilities.  On July 9, 2010, the Company and LRS Institute of Tuberculosis & Research Development, an agency under Indian Governments Ministry of Health and Family Welfare, jointly submitted to the Wellcome Trust a proposal for the migration, development, and clinical evaluation of Signature Mapping system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope. Subsequently, on October 22, 2010, we were notified by the Wellcome Trust that our Concept Application was accepted and at the request of the Wellcome Trust, the Company and LRS Institute of Tuberculosis & Research Development, an agency under Indian Governments Ministry of Health and Family Welfare, jointly submitted to the Wellcome Trust the Affordable Healthcare In India Translation Award Preliminary Application for the migration, development, and clinical evaluation of Signature MappingTM TBDxTM system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope. If the proposal is accepted, it is anticipated that the proposal will be funded and commencement of the project will begin the 3rd Quarter of 2011 with a twelve month projected completion. As reported by the World Health Organization, Country Office of India, Core Programme Centers Communicable Disease and Disease Surveillance, March 25, 2009, India maintains more than 12,000 certified governmental TB facilities throughout their entire health care system.  India is the highest TB burden country accounting for one fifth of global incidence (i.e. nearly 2 million new cases each year), and approximately 330,000 deaths annually. It is estimated that the social and economic burden to patients and their families from TB in India is in excess of $3.3 billion dollars annually. (See RNTCP Sensitization First Edition 10th Nov 06. TRC, Socio-Economic Impact of TB on Patients and Family in India, Int J Tub Lung Dis 1999).  On October 21, 2010, the Company started Phase II of the fully automated hardware-software tuberculosis detection system Signature Mapping TBDxTM (“SM TBDxTM”).  The clinical trial is in collaboration with The Aurum Institute for Health Research, The London School of Hygiene and Tropical Medicine, The South African National Health Laboratory Services, Medicine in Need, and George Washington University Medicine.  The SM TBDxTM clinical trial is being performed at Applied Visual Sciences’ facility, and conducted under independent observer validation with George Washington University Medicine. The scope of the clinical trial is to validate the new integrated technology, and includes comparative data from:  1. Human expert readers under research conditions, 2. Human laboratory technologists reading under routine conditions, 3. Cultured results, which is considered the gold standard, and 4. SM TBDxTM at World Health Organization accepted guidelines on specificity and sensitivity.  On May 27, 2010, the testing of the fully automated tuberculosis detection system, Signature Mapping TBDxTM (“SM TBDxTM”), at the South African National Health Laboratories (NHLS) successfully validated the integrated performance of each hardware component of the automated slide management system. The integrated hardware-software tuberculosis (TB) detection solution accurately identified 100% of the TB slides processed during an abbreviated trial.  As a result, the scope of the clinical trial   9  protocols were expanded to further demonstrate the new integrated technology, and include comparative data from human expert readers under research conditions, human laboratory technologists reading under routine conditions, and culture (considered the gold standard).  On May 25, 2010, the Company and Rodash 136 (Pty) Ltd, of South Africa, executed a Preferred International Distributor Agreement for Rodash to promote the licensing and distribution of Applied Visual Sciences’ PinPointTM suite of software. Rodash will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the end of the then-current period. The Company appointed Rodash as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of PinPointTM products.  On May 25, 2010, the Company and Romador 168 (Pty) Ltd, of South Africa, executed a Preferred International Distributor Agreement for Romador to promote the licensing and distribution of Applied Visual Sciences’ Signature MappingTM suite of software. Romador will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the then-current period. The Company appointed Romador as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of Signature MappingTM products.  On April 19, 2010, the Company received an order from IDECO Group Limited, in South Africa, for three fully automated Signature Mapping Tuberculosis Diagnostic (“TBDxTM”) systems. Shipment of the three systems is for the clinical evaluation of the TBDxTM fully automated detection system that took place in May 2010 with the South African National Health Laboratory Services (the "NHLS"), and subsequent evaluation that will take place in the United States, which is to be conducted under independent observer validation. At the end of the clinical evaluations, the three TBDx systems will be assigned to the NHLS laboratories involved in ongoing tuberculosis research.  We continue the development of our automated TB sputum detection product, TBDxTM in collaboration with the Aurum Institute for Health Research (“Aurum”), in South Africa.  On October 17, 2008, we completed the development of a functional prototype of the automated TB software.  The prototype demonstrated our ability to collect sputum slide images, present those images within a viewer system, analyze in real time the images captured, and to automatically detect and quantify tuberculosis bacteria at relatively high rates of accuracy and low false positives. In February 2009, we installed the alpha prototype Signature MappingTM TBDxTM software in a “retrofit configuration” for evaluation by the National Health Laboratories (HLS) in South Africa.  The configuration included an Olympus fluorescent microscope, a 1.2 megapixel camera and a HP desktop computer configured to Applied Visual, Inc.s hardware specifications.  The evaluation included the data collection and evaluation to determine optimal performance configuration and possible impacts to different microscope and digital camera specifications and sputum slide quality.  A number of workflow considerations were evaluated to optimize detection and workflow integration for a particular laboratory setting.  The technical team was trained to detect and evaluate auramine stained tuberculosis specimens on various sputum slide levels of quality.  We identified additional business revenue opportunities and extended applications for Signature MappingTM in the tuberculosis program.  These include: training, slide quality management, overall quality management and tuberculosis vs. bacterium species analysis in culturing, using the Zeal-Nielsen staining process.  Additionally, our technical team collected a significant quantity of clinical data, customer insight and feedback from key HLS personnel on the optimal workflow for both the retrofit and “black box” requirements.  The TBDxTM application wrapper was stress-tested in a clinical application oriented environment.  On March 24, 2009, the Company signed a Memorandum of Understanding (“MOU”) with Aurum Innova (Pty) Limited (“Innova”) and the National Health Laboratory Services of South Africa (“NHLS”).  The purpose of the agreement is for the parties to jointly undertake activities for the completion of our Signature MappingTM Tuberculosis (“TBDx”) product for deployment in the NHLS laboratories.  The parties are required to collaborate to enhance TBDxTM’s overall performance, customize its use for application in the National Health Laboratory Services tuberculosis diagnosis and quality management program, and clinically evaluate, measure, and test TBDx performance.  The collaboration includes conducting the clinical evaluation at selected NHLS laboratories that conduct sputum slide tuberculosis analysis and diagnosis.  In February 2009, the Company in conjunction with our partner the Aurum Institute established a Scientific Advisory Board in South Africa, and its members include Dr. Gavin J. Churchyard, founder and CEO of Aurum Institute for Health Research, Dr. David Clark, President of the Aurum Institute for Health Research, Dr. Gerrit Coetzee, Head of the National Tuberculosis Reference Laboratory of the National Health Laboratory Services, Dr. Bernard Fourie, Chief Scientific Officer with the Medicine in Need Inc organization, Mr. Stan Harvey, Acting Executive Regional Manager of the National Health Laboratory Services, and Dr. Natalie Beylis, Director of Laboratory Tuberculosis Services at the National Health Laboratory Services Braamfontein Hospital.  The responsibilities of the Scientific Advisory Board include the identification of product specifications for our Signature MappingTM Tuberculosis (“TBDxTM”) product, and determination of how the technology will be implemented in South Africa.  The Scientific Advisory Board met in May 2009,   10  and agreed on the requirements for TBDx application and detection performance, and overall customer requirements.  The establishment of the Scientific Advisory Board led to the memorandum of understanding between Applied Visual Sciences, Inc., Aurum, and NHLS, discussed above.  The Company was granted by the United States Patent & Trademark Office (USPTO) a patent underlying our Signature MappingTM technology.  The patent, for the “System and Method for Identifying Objects of Interest in Image Data.” was granted on February 17, 2009, Patent No. US 7,492,937.  On February 4, 2009, the Company signed a Master Development Agreement with Aurum Innova (Pty), Ltd., a company related to the Aurum Institute for Health Research. In February 2009, we installed an alpha product of Signature MappingTM tuberculosis (“TBDx”) software in a “retrofit configuration” for an evaluation by the National Health Laboratories (NHLS) in South Africa. This agreement extends the Companys contractual relationship with Aurum that was first established with the signing of a Memorandum of Understanding on July 25, 2008.  The new agreement provides for the joint development of products and services aimed at the screening, early detection and staging of diseases including TB, silicosis, and malaria.  Each product will be the subject of a separate project specifications and the MDA included project specifications for our joint development of an automated TB sputum detection product.  Aurum has agreed to clinically evaluate the products, and the parties agreed to jointly market and sell, initially in South Africa but eventually in sub-Saharan Africa, the jointly developed products, including our Signature MappingTM TBDxTM product, through third parties and/or through Aurum.  The Company agreed to pay Aurum a royalty on a product by products basis, based on the net revenue received by us through our distributors, and to be delineated by the parties.  Also, the Company agreed to pay Aurum a commission with regard to sales of the products by Aurum.  Further, Aurum has agreed to use every reasonable effort to raise funding to complete the development of a product following completion of the initial proof of concept.  Any intellectual property jointly developed by us and Aurum will be jointly owned.  The agreement may be terminated on one years prior written notice by either party, automatically terminates upon completion of project specifications and if no products are being marketed under the agreement, or for cause.  The agreement also contains certain confidentiality and indemnification provisions.  In August 2009, the Companys Software Quality Assurance Team completed all unit, component, integration, and systems testing of our Signature MappingTM Tuberculosis (“TBDxTM”) product.  The completion of the internal testing is the final preparation for the October 2009 clinical trials in South Africa, to evaluate, measurement, and testing of TBDxs performance in automating and improving the diagnostic capabilities and management of routine sputum microscopy.  Financial Condition, Going Concern Uncertainties and Events of Default  During the year ended December 31, 2010, 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, 2009, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern.  Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.  During the period of June through August 2009, at a series of closings, Applied Visual Sciences, Inc. issued six-month convertible promissory notes to a total of 12 accredited investors in the aggregate principal amount of $725,000. The six-month notes accrued interest at a rate of 10% per annum. The notes were convertible, at the holders option, into shares of common stock at a conversion price of $0.25 per share. If converted, each holder is entitled to receive Class M common stock purchase warrants for the right to purchase an equal number of shares and they are exercisable at a price of $0.25 per share, contain certain anti-dilution and other customary provisions, and expire sixty (60) months from the date the warrants were issued. On December 31, 2009, we had an aggregate principal amount outstanding of $675,000 from eleven (11) note holders.  During the year ended December 31, 2010, all note holders converted an aggregate principal amount of $675,000 and $71,999 of accrued interest into an aggregate of 2,987,995 shares of common stock, and 2,987,995 Class M Warrants.  The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and we were considered in default for nonpayment of principal and unpaid interest and late fees.  The holders though had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, we entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, we agreed with two debenture holders: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately   11  $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) we issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that we may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures. During the year ended December 31, 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock.  As of December 31, 2010, we have outstanding trade and accrued payables of $1,347,819, other accrued liabilities of $454,648, and accrued salaries due to our employees and management of $4,986,115. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $117,100.  From March through September 2010, we sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 4,424,000 shares of common stock and 4,424,000 Class N Warrants for gross proceeds of $1,106,000 (or $1,022,280, net of commission and expenses of $83,720). The Class N 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 five years after the date of issuance.  During November through December 2010, we sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 400,000 shares of common stock and 400,000 Class P Warrants for gross proceeds of $100,000 (or $93,000, net of commission and other expenses of $7,000). The Class P Warrants are exercisable at a price of $0.50 per share; contain piggyback registration rights, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance.  As of December 31, 2010, we had a cash balance of $4,874.  Subsequently and through April 5, 2011, we received $350,000 (or $338,000, net of commissions and expenses of $12,000) from the issuance and sale of common stock and warrants in a private offering.  Included in the subsequent closings is $150,000 under a February 23, 2011, Securities Purchase Agreement executed by the Company with an institutional accredited investor for up to $1,000,000, under certain stock price and volume conditions. Management believes these funds to be insufficient to fund our operations, absent any cash flow from operations or funds from the sale of our equity or debt securities. We are currently 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.  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 and the convertible note, the debenture and convertible note holder do not convert such debt or require payment of principal and interest, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures (excluding convertible notes), 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 Applied Visual Sciences limited revenues to date, we have 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.  The proceeds from our financings are insufficient to fund our operations, pay our trade payables, repay our unconverted debentures, or accrued and unpaid wages to our employees.  Therefore, the debentures holders, our employees or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations.  Also, in the event we are unable to pay our employees, we may suffer employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of our stock, we may have limited or no access to the capital markets.  Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.  During Fiscal 2010, our total stockholders deficit decreased by $2,529,598 to $10,164,515 and our consolidated net loss was $3,650,231 for the year ended December 31, 2010. 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   12  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.  RECENT DEVELOPMENTS  Seaside 88, L.P. Financing  On February 24, 2011, we held the first closing of a private placement of securities pursuant to the terms of a Securities Purchase Agreement, dated February 23, 2011, between the Company and Seaside 88, L.P. (Seaside).  At such first closing, we sold to Seaside an aggregate of 600,000 shares of common stock and 600,000 common stock purchase warrants for gross proceeds to us of $150,000.  The warrants are exercisable at a price of $0.25 per share for a period of five years from the date of issuance, contain a cashless exercise provision, certain anti-dilution provisions, and other customary provisions.  In addition, under the Agreement, Seaside has agreed to provide additional financing to us by purchasing shares of our common stock at seven subsequent closings and in the following amounts: at a second closing to be held one month following the first closing, an amount of shares equal to forty percent (40%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing; at a third closing to be held one month following the second closing, an amount of shares equal to thirty percent (30%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing; at a fourth closing to be held one month following the third closing, an amount of shares equal to twenty percent (20%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing; at each of four additional subsequent closings to be held one month following the immediately preceding closing, an amount of shares equal to ten percent (10%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding the subsequent closing.  Seaside has agreed to purchase our shares at each subsequent closing for a price per share equal to the lower of an amount equal to: (a) 60% of the volume weighted average of actual trading prices of the shares for the ten (10) consecutive trading days immediately prior to a date of the applicable closing and (b) 64% of the volume weighted average of actual trading prices of the shares for the trading day immediately prior to the applicable closing date.  If, under this calculation, the price of a share at a subsequent closing does not exceed a floor price of $0.25, Seaside will not be obligated to purchase our shares at that closing.  The failure to hold a closing will not impact the holding of the subsequent closings. Also, Seaside will not be obligated to purchase shares at a closing if such purchase would cause Seaside to beneficially own in excess of 9.99% of our shares.  A second closing was not held during March 2010 due to our common stock not meeting the volume and floor requirements, described above.  We have agreed to pay the fees of Seasides counsel with regard to the first closing in the amount of $25,000, $5,000 of which was paid at the first closing and $5,000 will be paid at each of the first four subsequent closings.  We have also agreed to pay the fees of Seasides counsel for each subsequent closing in the amount of $2,500.  We granted to Seaside a piggy back registration right with regard to the shares issued in the financing, including the shares underlying the Warrants.  The agreement contains representations and warranties of us and Seaside, certain indemnification provisions and customary conditions to each closing.  We may terminate the Agreement on ten days prior written notice to Seaside.  Seaside may terminate the Agreement at any time prior to a subsequent financing upon written notice to us if we consummate a reverse stock split or a subsequent financing to which Seaside is not a party.  Midtown Partners & Co., LLC (Midtown), acted as placement agent for the offering.  Under the terms of a Non-Circumvention and Compensation Agreement, dated January 12, 2011, between the Company and Midtown, in connection with the offering, we agreed to pay or issue to Midtown at a closing a placement fee equal to 6% of the proceeds received by us at the closing and placement agents warrants equal to 6% of the shares sold at the closing (including the shares underlying the Warrants).  At the first closing, we paid or issued the following compensation to Midtown for its services as placement agent in connection with the offering: (i) a placement fee in the amount $9,000 and (iii) placement agents warrants to purchase an aggregate of 72,000 shares.  The placement agents warrants are exercisable at a price of $0.25 per share for a period of five years from the date of issuance, contain a cashless exercise provision and are substantially identical to the warrants issued to Seaside in the placement.  Convertible Debenture Restructuring  On October 15, 2010, we entered into an Amendment and Waiver Agreement (Amendment and Waiver Agreement) with the two holders of the Companys outstanding Series A 10% Senior Convertible Debentures due November 8, 2008 (the Debentures) in the aggregate principal amount of $1,688,205 which were issued in a private placement that closed in November 2006 and April 2007 to amend certain terms of the Debentures, related securities purchase agreement and other agreements pursuant to which the Debentures and Series D Common Stock Purchase Warrants of the Company were sold to certain purchasers (the Debenture transaction documents).  Under the terms of the Amendment and Waiver Agreement: (i) the Holders agreed to extend the maturity date of the Debentures to June 30, 2011; (ii) the Holders agreed that, in lieu of, and in exchange for, the payment in cash of accrued interest, late fees, liquidated   13  damages, certain penalty interest and the payment of certain mandatory default amounts in excess of the principal amount due to the Holders as of the date of the Amendment and Waiver Agreement (Interest and Default Amounts), the Company would issue to the Holders an aggregate of 2,552,653 shares of the Companys common stock; (iii) the Holders agreed that the Debentures, as amended, will not bear interest during the period from July 1, 2010 through the maturity date; (iv) the Holders agreed to waive all claims with regard to the payment of the Interest and Default Amounts, to waive prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the Debenture transaction documents and to release the Company from any claims with respect to the Interest and Default Amounts and prior Defaults; (v) he conversion price of the Debentures was set at $0.25 to reflect adjustments that had previously occurred to the conversion price pursuant to the price reset and anti-dilution provisions of the Debentures; (vi) each Holder agreed to terminate the Holders registration rights agreement with the Company pursuant to which the Company had undertaken to register and maintain the registration for resale under the Securities Act of 1933, as amended (the Securities Act), of the shares underlying the Debentures and Series D Common Stock Warrants held by the Holder.  In addition, the Holders agreed to certain conforming amendments to the default provisions of the Debentures, including to: (a) provide that only a default in the payment of principal or liquidated damages when due under the particular Debenture (and not any outstanding Debenture) will trigger an event of default, and (b) delete the default provision for a failure to maintain a registration statement to cover the resale of the shares underlying the Debentures and Series D Warrants.  The Holders agreed, commencing March 3, 2011, that we may force a conversion of the Debentures in accordance with the following: (i) if the variable weighted average price for our common stock (VWAP) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for our common stock during such period equals or exceeds $50,000, we may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; (ii) if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, we  may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; (iii) if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, we may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.  A forced conversion may only be effected once every 90 days and our ability to force any such conversion is subject to certain equity conditions which, as amended by the Amendment and Waiver Agreement, include that: (i) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a Holder to utilize the registration statement to resell its shares or the shares issuable upon conversion may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered an opinion of its outside counsel that such resale may legally be made, (ii) we have honored all conversions and redemptions of a Debenture by the Holder, (iii) we have paid all liquidated damages and other amounts due to the Holder, (iv) our stock is traded on the OTC Bulletin Board or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of common stock to cover the issuance of the shares upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holders 4.99% or 9.99% ownership restriction cap under the Debentures, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control may occur and the transaction has not been consummated, and (ix) the Holder is not in possession of material non-public information regarding us. The Amendment Agreement contained certain representations and warranties of the parties and certain conditions to closing.  Certain Recent Financings  On December 16, 2010, we agreed to convert a $50,000 outstanding convertible promissory note for 200,000 shares of common stock, and 200,000 Class M common stock purchase warrants. The conversion price of the note was $0.25. The note holder also converted a total of $7,630 accrued and unpaid interest for an aggregate of 30,520 shares of common stock, and 30,520 Class M common stock purchase warrants. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance.  During November through December 2010, we sold to accredited investors an aggregate of 400,000 shares of common stock and 400,000 Class P Warrants for gross proceeds of $100,000 ($93,000, net of commissions and expenses in the amount of $7,000). The warrants are exercisable at a price of $0.50 per shares; contain piggyback registration rights, and certain anti-dilution and other customary provisions. The warrants expire thirty-sixty (36) months from the date of issuance.  On October 26, 2010, in accordance with an outstanding capital raise, four executives and a consultant and director converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation into an aggregate of $1,267,706, for a total of 5,070,825 shares of common stock, and an aggregate of 5,070,825 Class N Common Stock Purchase Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire sixty (60) months from the date of issuance.   14   On October 18, 2010, the two outstanding debenture holders converted $638,163 of accrued and unpaid interest for 2,552,653 shares of common stock. The conversion price of the interest was $0.25, which was based on the conversion rate per the debenture agreement.  Acquisition of Certain Assets of Difference Engines  On October 23, 2003, we entered into an agreement with Difference Engines Corporation (Difference Engines), a Maryland corporation, pursuant to which we 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, we 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 our 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.  During the year ended December 31, 2010, the temporary equity account was increased and the permanent equity account decreased by $59,368 for the change in the estimated redemption value of the outstanding shares currently held by the shareholders of Difference Engines Corporation, and reducedby $2,733 for the reclassification of common shares previously subject to repurchase. During the year ended December 31, 2009, the temporary equity account was decreased and the permanent equity account increased by $12,090 for the change in the estimated redemption value of the outstanding shares currently held by the shareholders of Difference Engines Corporation.  Since the acquisition of the intellectual property and through December 31, 2010, 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 is a reduction of $1,309,496, and due to the sale of the Companys stock previously held by the shareholders of Difference Engines Corporation is a reduction of $635,786. Therefore, the balance of the temporary equity account for the purchase of the intellectual property owned by Difference Engines as of the consolidated balance sheet date is $98,946.  Our Business  Introduction  Applied Visual Sciences is a technology company that designs and develops imaging informatics solutions for delivery to its target markets through its 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.  On July 19, 2010 the Company announced that it expanded its organizational structure to better reflect its business operations and to provide an enhanced operational structure to capitalize on international business and joint product development opportunities.  Guardian Technologies International, Inc. (GDTI) changed its name to Applied Visual Sciences, Inc. (APVS)and traded on the Over-the-Counter Bulletin Board under symbol APVS. APVS is the parent company, and serve 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.   Applied Visual Sciences, Inc. two wholly-owned 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.   15  By structuring in this manner, as a means to conduct business, we expect to realize the following benefits: · Creation of autonomous business units with defined measurable goals and objects; · Alignment of risk characteristics to the specific product, line of business or foreign market; · Provide a level of legal risk insulation to the core assets, the patents & intellectual property; · Flexibility to maximize tax benefits, both domestic & foreign activities; · Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships; · Facilitate the potential spin-off of one of the subsidiary entities; · Facilitate the potential sale of part of the company; and, · Attract investment from investors that focus on specific industries.  Each of our wholly-owned subsidiaries target markets share certain common characteristics: · Each is large, growing, and underserved. · Each requires the ability to derive intelligent, timely, and useful informational value from digital images. · Each faces significant current and ongoing problems related to exponential image data volume growth versus decreasing information quality. · Each requires new approaches to its challenges, as previous solutions have become less effective. · Each requires sophisticated solutions that build on a common platform that can be easily customized. · Most importantly, Applied Visual Sciences, Inc.s core competencies and newly developed techniques apply across all of the market problems we are addressing.  Currently, we are focused on providing technology solutions and services in two primary markets, healthcare and aviation/homeland security.  However, as we develop new or enhanced solutions 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.  Our Business Strategy  Our strategic vision is to position our core technology as the de facto standard for digital image analysis, knowledge extraction, and detection.  Our strategy is based upon the following principal objectives: · Maintain product development and sales/marketing focus on large, underserved, and rapidly growing markets with a demonstrated need for intelligent imaging informatics. · Leverage Applied Visual Sciences, Inc.s technology, experienced management team, research and development infrastructure. · Focus our talents on solving highly challenging information problems associated with digital imaging analysis. · Establish an international market presence through the development of a significant OEM/Reseller network. · Build and maintain a strong balance sheet to ensure the availability of capital for product development, acquisitions, and growth. · Seek to broaden our investment appeal to large institutions.  To achieve our strategic vision, we are aware of the need to exercise the financial and operational discipline necessary to achieve the proper blend of resources, products and strategic partnerships.  These efforts can accelerate our ability to develop, deploy and service a broad range of intelligent imaging informatics solutions directly to our target markets and indirectly through OEM/value added reseller (VAR) partners.  During 2010, we continued implementing changes across the spectrum of our business. We refined our marketing strategy and enhanced our PinPointTM and Signature MappingTM product offerings.  Our Strategic Achievements During 2010  In line with our strategic plan, during fiscal 2010, we accomplished the following:  PinPointTM:  In security, our focus in 2010 was primarily on shifting the existing security paradigm from a proprietary hardware focus to a more integrated solution incorporating PinPoint software.  In addition, we believe we established Applied Visual Sciences, Inc. as an expert in security.  We have effectively staked our position by demonstrating a definitive understanding of the complexities and risks of   16  security, while offering the fundamental missing element that bridges the security gap  the identification of threats by the use of automated detection software that is consistent versus the current ineffective methodology.  Our achievements were: · Completed and approved by all stake-holders on September 21, 2010, NEMAs Digital Communication in Security (DICOS) standards initiative funded by the TSA and the Department of Homeland Security, the committee is tasked with developing digital imaging and communications standards that can be used, in future government procurements, to enable networking between scanning systems and standardization of the imaging output from the hardware so third-party software and components, like PinPoint, can more easily be developed, tested and deployed.  This standard will enhance security screening and threat assessment processes across multiple vendor platforms at all critical infrastructure locations (airports, buildings, mass transit, ports, rail, and nuclear power plants) and other venues where large numbers of people congregate. As co-chair of the DICOS working committee, Applied Visual Sciences, Inc. led the drafting of the proposed standards which, will impact acceptance of third-party software on scanners used by TSA and DHS. · Throughout the year, the company submitted to various departments within the Department of Homeland Security proposals for PinPoint and expects to receive responses in 2011. · On May 25, 2010, the Company and Rodash 136 (Pty) Ltd, of South Africa, executed a Preferred International Distributor Agreement for Rodash to promote the licensing and distribution of Applied Visual Sciences’ PinPointTM suite of software. Rodash will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the end of the then-current period. The Company appointed Rodash as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of PinPointTM products in such geographic areas.  Signature MappingTM:  In healthcare, our focus in 2010 was dedicated on the development of an integrated solution for the detection of tuberculosis.   Applied Visual Sciences, Inc. undertook measures to meet objectives that many established, world-renowned individuals and companies have failed to achieve.  Our achievements:  · On April 19, 2010, the Company received an order from IDECO Group Limited, in South Africa, for three fully automated Signature Mapping Tuberculosis Diagnostic (TBDxTM”) systems. Shipment of the three systems is for the clinical evaluation of the TBDxTM fully automated detection system that took place in May 2010 with the South African National Health Laboratory Services (the "NHLS"), and subsequent evaluation that will take place in the United States, which is to be conducted under independent observer validation. At the end of the clinical evaluations, the three TBDx systems will be assigned to the NHLS laboratories involved in ongoing tuberculosis research. · On May 25, 2010, the Company and Romador 168 (Pty) Ltd, of South Africa, executed a Preferred International Distributor Agreement for Romador to promote the licensing and distribution of Applied Visual Sciences Signature MappingTM suite of software. Romador will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the then-current period. The Company appointed Romador as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of Signature MappingTM products. · On May 27, 2010, the testing of the fully automated tuberculosis detection system, Signature Mapping TBDxTM (“SM TBDxTM”), at the South African National Health Laboratories (NHLS) successfully validated the integrated performance of each hardware component of the automated slide management system. The integrated hardware-software tuberculosis (TB) detection solution accurately identified 100% of the TB slides processed during an abbreviated trial.  As a result, the scope of the clinical trial protocols were expanded to further demonstrate the new integrated technology, and include comparative data from human expert readers under research conditions, human laboratory technologists reading under routine conditions, and culture (considered the gold standard).   17  · July 9, 2010, we submitted a concept application to the Wellcome Trust, along with the LRS Institute of Tuberculosis & Research Development, an agency under Indian Governments Ministry of Health and Family Welfare, for the application for the migration, development, and clinical evaluation of Signature Mapping TBDxTM system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope.  The submission was in response to a request from the Indian government. · On November 29, 2010, the company installed its fully automated slide management and detection system in the NHLS National TB Reference Laboratory. The TBDx system is comprised of an auto-slide loader, bar code reader and 4 magazines with 200 slide capacity, upgraded BX41 fluorescence microscope, and Signature Mapping computer aided detection software and high resolution workstation with image processing and TB decision support capabilities.  · On December 1, 2010, the Company and our South African partner, The Aurum Institute for Health Research, presented the TBDxTM fully automated system and the initial clinical findings from the first 496 of the 2500 cases analyzed to the senior management and physicians from the South African National Laboratory Services (“NHLS”). The initial results persuasively emphasizes the use of TBDxTM as a front end screening diagnostic system with the use of its decision support capabilities aiding the laboratory technologist in a decision support capacity. As a result, a decision was taken to revise the clinical protocol and add to the clinical study the combined performance of the TBDxTM system and the laboratory technologist.It was determined that this is a ‘real-world’ performance evaluation in which to conduct the study. As an additional outcome of the meeting, based on the strength of clinical findings and TBDxTM demonstration, the CEO of the National Health Laboratory Services together with their TB Program Director, agreed to conduct the next phase of the TBDxTM evaluation, the Demonstration Project. This is to be conducted at the Braamfontein Hospital in Johannesburg, South Africa under laboratory production conditions and acceptable clinical protocol. To perform the evaluation and testing, the NHLS was provided a quotation for three TBDxTM fully automated systems.  · On December 6, 2010, delivered our first one fully automated Signature Mapping TBDxTM system to the South African National Health Laboratory Services (the "NHLS"), resulting in net revenue of $90,225.  · On December 28, 2010, submitted with our partner LRSI Institute of TB & RD - Government of India, a preliminary application to the Wellcome Trust for the migration, development, and clinical evaluation of Signature Mapping TBDxTM system for Automatic Detection of AFB using Ziehl-Neelsen Stain and Bright Field Microscope.  This is in response to the Wellcome Trusts invitation after the review of our concept application.  Other activities: · Received net proceeds of approximately $1,115,280 from certain private offerings of our securities, $262,500 from the exercise of warrants, and $37,350 from the exercise of stock options, · Converted all outstanding short-term notes in the principal amount of $675,000 and $71,999 of related interest, debenture holders converted $427,500 of outstanding principal amount, converted $147,441 of outstanding accounts payable, and our four executives and a consultant/director converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation in an aggregate of $1,267,706, · On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. The agreement resulted in (i) an extension of the maturity date to June 30, 2011, (ii) $1,688,205 of outstanding principal amount of will not bear interest from July 1, 2010 through the new maturity date, (iii) converted $638,163 of unpaid regular interest for an aggregate of 2,552,653 shares of common stock, (iv) waived all defaults and released the Company from unpaid additional interest and late fees of $773,314, and default amounts of $2,541,739, (v) terminated the registration rights provision of the debentures, and (vi) the Company may force a conversion of the debentures under certain equity price and volume conditions, · On October 19, 2010, the United States Patent & Trademark Office (USPTO) issued to the Company Patent No. US 7,817,833, titled System and Method for Identifying a Feature of Interest in Hyperspectral Data, which is related to our underlying intelligent imaging informatics (3iTM) technology for our security product.  This third patent issued to the Company extends our existing patent protection into image analysis domain where multiple images or pictures are created and utilized for automated computer analysis and assessment.  The patented process is capable of detecting objects of interests with a high degree of confidence; does not rely only on prior knowledge of an objects shape, volume, texture or density to be effective; and is most powerful where the presence of disease or threat objects must be distinguished from healthy tissue or non-threat objects that are similar in color, brightness, and texture,   18  · On November 23, 2010, The United States Patent & Trademark Office (USPTO) issued to the Company Patent No. US 7,840,048, titled “System and Method for Determining Whether There is an Anomaly in Date,” which is related to our underlying “intelligent imaging informatics” (3iTM) technology for our security product. Management believes that our future growth will be based upon a continued concentration on the core aspects of our business:  targeted sales/marketing activities with broader geographic coverage and product offerings, expanded international OEM/VAR relationships, product innovations designed to enhance knowledge extraction and anomaly detection within the digital imaging arena, exceptional professional services and expanded strategic partnerships that complement our internal efforts.  Vital to our business strategy are partnerships that contribute to our product innovation efforts or expand the distribution of our products. Our goal is to have partners in certain target markets, primarily the international markets, focused on distributing and servicing our PinPointTM and Signature MappingTM software products as they become commercially viable. In addition, we propose to develop and leverage additional technology partnerships to expand our product offerings or enhance our existing products to appeal to a specific market.  OUR PRODUCTS  Our Core Technology - 3iTM Engine  We are a technology company that designs and develops imaging informatics solutions for delivery to our target markets through our subsidiaries Guardian Technologies International, Inc. for aviation/homeland security and Signature Mapping Medical Sciences, Inc., for healthcare. We utilize 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 (3iTM”) 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.  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 businesses.  Further, we may form wholly-owned subsidiaries to operate within defined vertical markets.  Our Principal Products  Our principal products are Aviation/Homeland Security Technology (PinPointTM) and Healthcare (Signature MappingTM) solutions:  Aviation/Homeland Security Technology Solution - PinpointTM  Combining proprietary technology platforms in imaging and knowledge extraction, we have developed an “intelligent imaging informatics” software solution, PinPointTM, that can identify threat items; notify screeners of the existence of threat items; and speed the security process by eliminating unnecessary baggage checks, provide the screener with an instantaneous second opinion, and reduce processing time spent on false positives (baggage selected for security review that contains no threat items).  Our objective is to become the leading provider of contraband detection systems worldwide and to extend our technology expertise to address broader applications for detection. Specific elements of our growth strategy are to enhance our technological leadership, expand our sales and marketing organization, leverage our detection technology expertise to enter new markets for detection, and selectively pursue strategic relationships and acquisitions.   19   In summary, the principal features of our PinPointTM product are as follows: · Intelligent imaging informatics technology for the detection of guns, explosives, and other threat items at airport baggage areas. · Operates on multiple platforms, contains an application interface for ease of use and connectivity, and is hardware agnostic. · We have 11 pending patent applications (U.S. and foreign) and one U.S. provisional patent application covering the implementation of our core 3iTM technology. · Independently tested to high levels of reliability.  Outperformed current technologies by increasing detection rates and lowering false positives (current performance data based on reports by industry experts). · Multi-process application built on a foundation of algorithms, image filters, statistics, and physics.  We believe PinPointTM is reaching technological feasibility as certain high-risk development issues are being addressed for the integration with manufacturers’ scanning equipment.  A major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) is expected to open a path to increase the interoperability of security equipment and provide a mechanism to use third party threat detection software as part of the screening solution.  This enabling initiative is the Digital Imaging and Communications in Security (DICOS) standard, similar to the Digital Imaging and Communications in Medicine (DICOM) standard.  With a defined standard for the output of each screening device, complimentary automated threat detection software can be appended to any x-ray equipment.  The schedule for publication of this standard is being driven by the expected purchase by DHS/TSA of new security screening equipment for over 400 US airports.  Applied Visual Sciences, Inc. personnel are participating in one of the three NEMA working groups drafting the DICOS standards.  The intelligent imaging informatics engine, which serves as the foundation for the PinPointTM product, adapts readily to the analysis and detection of objects of interest across divergent digital sources:  still images, video, and hyper-spectral images.  The 3iTM technology platform can be deployed across many automated detection applications:  cargo scanning, body scanning, military target acquisition, healthcare disease detection and anomaly identification, and to perform satellite remote sensing ground surveys.  Our research and development activities to adapt our 3iTM technology to many of these detection applications have already commenced.  Most of the fundamental ground truths associated with baggage scanning hold true for body scanning; the hardware technology for body scanning is advancing as the baggage scanners and their potential physical impact on humans.  Our research and development work has also included, on a preliminary basis, the development of 3iTM technology for deployment in the hyper-spectral environment.  One such use within the hyper-spectral environment would be a military use for target acquisition.  We are also pursuing an additional market opportunity using our 3iTM platform technology, adding to our detection family of products.  PinPoint nSightTM (nSight) provides visualization enhancements that allow bomb technicians and investigators to assess the presence of explosives more rapidly and accurately using single-energy x-ray scanners.  The technology adds textural and color components to such images, helping bomb investigation technicians to detect threats that would otherwise be unseen by the human eye. In May 2006, we entered into a Distribution Agreement with Logos Imaging LLC, a manufacturer of portable bomb scanning equipment, with regard to the distribution of PinPoint nSightTM.  During fiscal 2007, we sold to Logos 10 licenses for our threat assessment software technology for bomb detection scanners, PinPoint nSightTM.  We are also continuing to develop other distributor relationships in an effort to increase market penetration of our PinPoint nSight TM product.  Healthcare - Signature MappingTM Solution  In an effort to expand upon the use of our core technology 3iTM “intelligent imaging informatics,” we have migrated and adopting our threat detection algorithms and quantitative imaging capabilities for use in the imaging field of diagnostic radiology and pathology.  The technology is called Signature MappingTM.Our Signature MappingTM platform technology represents the technological basis upon which we expect all diagnostic radiology and pathology applications will be developed. Any Signature MappingTM product introduced in the United States may be subject to Food and Drug Administration (“FDA”) review and approval, including with regard to its safety and effectiveness before we may begin marketing and selling any such product in the U.S. Such approval may require us to obtain extensive data from clinical studies to demonstrate such safety or effectiveness.  There may be similar regulatory requirements in foreign countries in which we seek to market and sell our healthcare CAD products.  The challenge for modern radiology is to improve the quality of clinical care while simultaneously reducing costs and improving patient outcomes.  To accomplish this goal, radiology has greatly expanded its use of various imaging modalities to include Nuclear Medicine, Ultrasound, Computer Tomography (CT), Magnetic Resonance Imaging (MRI), Positron Emission Tomography, and Digital Radiography (X-ray).  While significant improvements in diagnostic radiology have occurred using these imaging modalities, the same degree of technological advancements has not been available to help radiologists to accurately interpret and quantify the rapidly   20  expanding number and diversity of imaging cases generated each day; and coupled with the level of difficulty in reading the image, radiologists are also prone to interpretation subjectivities, and misreads given the enormous patient loads and time constraints radiologists face each day. Studies and other literature indicate that radiologists are about 80% accurate at best in reading screening x-ray breast examinations - 75% accurate for women in their 40s. Certain studies have found that lesions are simply not detected 10 to 15% of the time. (See Milano C (1999). Subjectivity Challenges Breast Cancer Exams and Diagnosis.)  Such knowledge has resulted in a tendency towards additional procedures, such as biopsies which sometimes prove unnecessary. While traditional computer aided detection (CAD) assists radiologists by marking anomalies without providing additional visualization or analytical tools, CAD applications have certain characteristics that limit their capabilities. CAD results are associated with high false positive rates. The pattern recognition algorithms employed by CAD restrict their functionality to searching for a specific disease within a specific imaging modality. Applied Visual Sciences, Inc. is developing a new approach for radiographic image analysis based on our platform technology, Signature MappingTM.  It is the first image-analysis-based technology that we believe will be capable of “characterizing tissues” across a broad range of digital imaging modalities. The software has been designed to work seamlessly with Digital Imaging and Communication in Medicine (DICOM) images generated from any existing imaging modality.  It can be integrated into a Picture Archiving & Communication System (PACS) network, a stand-alone digital imaging modality, a diagnostic workstation or a clinical review workstation. Similar to a person’s fingerprint, each tissue has a unique structure. Each structure creates a unique pattern or “signature” that can be extracted from an image to differentiate, locate, identify, and classify by using our Signature MappingTM technology.  Signature MappingTM is expected to further help radiologists by visualizing the various structures within a particular tissueso they can be examined and quantified. This capability is expected to provide a next-generation image analysis, clarification, visualization and Signature Mapped TM “tissue characterization” and detection.  Management believes that it will add significant clinical value to a wide range of difficult to detect diseases in diagnostic radiology by distinguishing and characterizing different tissue types in images regardless of the modality that generated the image. Based on its unique properties, Signature MappingTM is expected to be capable of being used to analyze images generated across all imaging modalities without the need for new image capture hardware costs.  It will serve as a software-based, multi-modality approach to image analysis when combined with Signature Mapping’sTM unique” tissue characterization” and detection. As a result, Signature MappingTM is expected to differentiate the contrast resolution between different tissue types, even when the material or tissue in the image is very diffuse or obscured by other objects, such as is the case where diseased lung tissue is located behind a rib in an x-ray chest examination. It is capable of displaying these signatures in a way that empowers radiologists to make a more informed and confident diagnosis, even for hard to distinguish structures such as masses in dense breast tissue.  Signature MappingTM appears to provide advantages for providing the knowledge for automatic detection.  The development of a “tissue characterization” and detection model employs the use of supervised machine learning and contextual image analysis to analyze and classify the features associated with the newly created “signatures.”  The fusion of these three technologies is known as Applied Visual Sciences, Inc.’s Intelligent Imaging Informatics 3iTM. Unlike other pattern recognition methodologies, the 3iTM solution can reveal and differentiate inherent structures for all materials in an image regardless of the imaging modality used to create the image, the location within the image, the shape or texture, and the object orientation even if obscured by its relationship to other materials.  Clinical Experience and Medical Accomplishments While Signature MappingTM is expected to be capable of use in a wide range of medical image analysis applications, our initial application product development efforts are focused in four areas: · detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system; · breast cancer detection using x-ray mammography, MRI and ultrasound; · neurological imaging analysis through the detection and quantification of acute intracranial hemorrhage using non-contrast CT, normal pressure hydrocephalus, and multiple sclerosis using MRI; and · chest radiography targeted at tuberculosis and silicosis detection using digital x-ray.  In July 2007, we entered into an agreement with the Medical Imaging Informatics (MI2) at the Keck School of Medicine, University of Southern California to conduct a multiple-phase process to clinically evaluate, and give feedback on potential enhancements to, our 3iTM “intelligent imaging analysis” solutions as applied to medical radiology imaging.  Our 3iTM product segments clarifies, distinguishes and identifies organic objects even when masked by one or more other objects of similar density and chemical composition.  This is an expected product extension of our 3iTM-based computer-aided detection technology in adapting scientific principles employed for explosives detection to medical image analysis.  We continued our collaboration relationship with a new agreement dated July 19,   21  2007 for a one year term, to include clinical studies for our Signature MappingTM product.  The first half of the collaboration focused on image-based visualization and CAD solutions for the detection of breast cancer on mammograms, and the second half of the collaboration will be for the detection of small acute intracranial hemorrhage (AIH) on CT.  Our research to-date includes five programs and studies conducted under the direction of the Image Processing and Informatics Laboratory at the University of Southern California (USC) using clinical data and images provided by: the Image Processing and Informatics Laboratory at USC, Howard University, and the South Florida Clinical Mammography Data Base.  In addition a program and study was conducted for the detection of TB in stained sputum slides through a photo microscopy system at the National Health Laboratories of South Africa.  Tuberculosis  The Disease  The World Health Organization (WHO) has declared tuberculosis a global health emergency. The WHO has estimated that 2 billion of the world's population is infected with the tuberculosis bacteria. Furthermore, WHO statistics indicate that in 2006 approximately 9.2 million people developed tuberculosis and 1.5 million people died from the disease, mostly in underdeveloped countries. (See Global Tuberculosis Control - surveillance, planning and financing, WHO Report 2008.)  Tuberculosis  Sputum Microscopy  Commercial interest in TB diagnostics has been limited by a lack of detailed information on the size and characteristics of the TB diagnostic market.  An international network of contacts and investigators has for the first time, yielded a strategic overview of the current global market for TB diagnostics, encompassing testing for active disease caused by TB, as well as detecting latent infection, monitoring response to treatment, and drug-susceptibility testing (DST).  This information has been compiled and published by the World Health Organization (WHO). This analysis indicates that annually over US$1 billion is spent worldwide on TB diagnostics, a figure over twice as large as the current market for TB drugs.  One-third (US $326 million) of this money is spent outside of the established market economies (EME), where 73% of TB diagnostic testing takes place.  Lower labor costs primarily account for the lower cost per test performed in developing countries. (See A Large, Untapped Global Market Exists for Improved TB Tests, WHO Report October 25, 2006.)  According to WHO published reports from 2005, sputum smear microscopy (83 million annual cases) and chest radiography (47 million annual x-rays) for active disease are by far the most common tests performed in middle-income and low-income countries. These tests eclipse the use of higher performance more complex and expensive tests, such as culture and nucleic acid testing (NAT).  Skin testing with purified protein derivative (PPD) is the highest volume TB diagnostic test used in the EME (40 million annual tests), where it makes up half the total market, reflecting the importance of detection of latent infection in those countries.  (See Global Tuberculosis Control - surveillance, planning and financing, WHO Report 2005.)  Depending on where you are in the world, the range of TB diagnostic tools may vary.  The highest priority for TB control in high burden settings is detection of active TB cases excreting large numbers of infectious bacteria in such settings, sputum smear microscopy is predominate diagnostic test in use. (See Diagnostic for Tuberculosis Global Demand and Market Potential Report, WHO on behalf of the Special Program for Research and Training in Tropical Diseases 2006.)  Diagnosis of active TB by identification of tubercle bacilli in sputum smears use a light microscope for Ziehl-Neelsen stained specimens or under a fluorescence microscope for rhodamine/auramine stained sputa.  There is scientific consensus that fluorescence microscopy is superior for the identification of tubercle bacilli.  Lung Disease Detection  Tuberculosis  Tuberculosis detection and treatment in developing countries is hampered by a shortage of radiologist and technologists available to interpret and administer chest x-rays.  Typically, a long lag time exists between the time chest x-rays are administered and when an accurate diagnosis can be made and communicated to the patient.  Patients sputum samples are also used to detect tuberculosis.  Sputum sample analysis is a highly laboratory intensive and tedious, time-consuming process requiring highly trained laboratory technologists.  Any diagnostic lag time between conducting a patients chest x-ray and sputum sample laboratory tests delays interpretation, diagnosis and drug therapy. In some cases the patients are difficult to re-contact and may never receive drug treatment. These delays mean the infected patients are likely to infect others in their immediate surrounding.  Clinical Value of Signature MappingTM  In connection with the development of our TBDx product, we have partnered with the Aurum Institute for Health Research (“Aurum Institute”).  The Aurum Institute, headquartered in Johannesburg, South Africa, is an internationally recognized medical   22  research organization, a world leader in research and treatment involving tuberculosis, HIV/AIDS, malaria and other infectious diseases.  Under the collaborative partnership, Applied Visual Sciences, Inc. and the Aurum Institutes scientists are expected to collaborate to perfect the use of Signature MappingTM imaging technology to automatically detect, identify and quantify the bacteria that causes tuberculosis. Automation of these processes with Applied Visual Sciences, Inc.'s technology is expected to reduce labor costs, provide more timely diagnosis and delivery of therapeutic treatments, eliminate human errors and sharply improve detection rates and accuracy of diagnosis.  The Aurum Institute has also partnered with Applied Visual to expand its activities within the mining industry to include detection of silicosis. Silicosis is a form of lung disease resulting from occupational exposure to silica dust over a period of years. Silicosis causes slowly progressive fibrosis of the lungs, impairment of lung function and a tendency to tuberculosis of the lungs. In early internal tests, Signature MappingTM has been shown to be capable of detecting silicosis.  The use of Signature MappingTM to detect and monitor tuberculosis (“TB”) changes over a given treatment period using radiographic chest x-rays was also studied. In early internal tests, Signature MappingTM proved to be successful in detecting lung area, quantifying normal lung volumes, and reporting lung volume changes over time during drug treatment therapies.  Our efforts are focused on the development of a technology platform for diagnostic radiology and developed for specific diagnostic modalities and targeted applications based upon our Signature MappingTM technology that we expect to be able to market and sell to the medical industry in the U.S. and overseas. We have made technical progress in the development of Signature MappingTM.  However, certain of the products we may develop will require us to obtain FDA approval for such product to enable us to sell such product in the U.S., or satisfy any comparable regulatory approval requirements overseas.  Further, our ability to develop any such product will depend, in part, on our ability to raise additional financing to continue such development or obtain applicable grant funding.  There can be no assurance we will be able to raise such additional financing or funding to continue our development efforts.  Breast Cancer  The Disease  Breast cancer is the most commonly diagnosed cancer and the second leading cause of cancer deaths among women in the US.  Although the overall morbidity rate of breast cancer is lower among African American Women (AAW) than Caucasian Women, the morbidity rate among AAW younger than 50 years old is higher than Caucasian Women and has resulted in substantially higher mortality rates (31/100,000 vs. 27/100,000). The table below shows annual demographics for breast cancer statistics in the U.S.  Breast imaging proceduresAbout 35 million screening examsBiopsy proceduresAbout 1.5 million biopsies conducted12% of biopsies are positive168,000 detected cancersMortality rateAbout 40,950 womenBiopsy per procedure cost$1,000 - $3,000 dollarsAnnual gross national biopsy cost$1.5 -  $4.5 billion dollarsA 10% reduction in biopsies would save approximately$150 - $500 million dollars Source: Breast Cancer Fund, The Demographics of Breast Cancer in the U.S. 2003.  Detection  Early detection is a critical factor for controlling survival. Early detection provides increased therapeutic options and improved probability of survival. Mammography is a reliable and cost-effective screening technology. When properly conducted, mammography has been estimated to reduce breast cancer mortality by 20-30%.  Currently, ductal carcinoma-in-situ (DCIS) represents 25%-30% of all reported breast cancers.  Approximately 95% of all DCIS are diagnosed because radiologists identify them in mammograms. However, reading mammograms is difficult and prone to misinterpretation, subjectivity, and misreads.  Studies have found that screening x-ray exams are about 80% accurate at best and that lesions are simply not detected 10% to 15% of the time. The National Cancer Institute reported that 25% of breast tumors are missed in women in their forties. (See Liu B, Z. M., Document J (2005, "Utilizing data grid architecture for the backup and recovery of clinical image data." Comput Med Imaging Graph. 29(2-3): 95-102, and National Cancer Institute, "Cancer in African American Women.")  Dense breasts pose a greater challenge to cancer detection using mammograms, especially early-stage breast cancers. Approximately 25% of women have dense breasts; thus a large number of mammograms, especially in AAW, are more difficult to   23  clinically interpret. The risk of breast cancer associated with the highest category of density is estimated to be two to six times greater than for women with the lowest category of breast density.  Clinical Value of Signature MappingTM  On the basis of our initial studies, the signatures of malignant tumors in mammograms exhibit significant differences when compared with cysts, benign lesions, or dense breast tissue after being processed with Signature MappingTM.  Measurable differences exist among different breast structures in both the spatial and frequency domains.  Signatures of different tissues vary in their entropy, linearity, boundary gradients, and homogeneity. As a result, the internal structure of masses in dense breast tissue can be characterized and identified and displayed radiographically to the clinician. Signature MappingTM is expected to visually display levels within the tumor and distortions in the breast geometry outside the tumor.  The effectiveness of these algorithms was evaluated through a pilot study conducted with the Norris Cancer Center at the University of Southern California. The study consisted of two sets of mammographic cases, a training set and a testing set.  Both sets contained 40 normal and 40 confirmed solid cancer masses and were matched for levels of interpretation difficulty and patient age, variations in breast density, and types of tumors. Applied Visual used the training set for the development of its algorithms and for training the participating radiologists in the study.  The test set was used in the pilot study to gain clinical feedback and determine the effectiveness of the radiologist’s interpretations using Signature MappingTM. Preliminary clinical results based on the visual performance of five highly-skilled and experienced mammographers using the mammography-specific Signature MappingTM process demonstrated improved accuracy and ease of use in the study.  Clustered micro-calcifications may be the only visually detectable manifestation of early breast cancer. Mammography is very responsive to the presence of micro-calcifications, however, the specificity of mammography remains low.  Benign calcifications cannot always be distinguished from those indicating malignancy resulting in a large population of women who do not have cancer, but are subjected to biopsy.  Using Signature MappingTM we expect that the miniscule structures within micro-calcifications can be characterized and their potential for pathology identified by the radiologists.  While carcinomas are rarely found in cysts, they are difficult to accurately diagnose through the use of mammography because they cannot be distinguished from other well circumscribed solid masses unless they display several characteristic patterns of calcification. Applied Visual is optimizing Signature MappingTM for the accurate characterization of cysts as part of ongoing development that includes an early-onset cancer detection model.  Traumatic Brain Injury The Disease Traumatic Brain Injury (TBI) and acute stroke are two patient populations extremely likely to present in emergency room settings. Each requires immediate, accurate determination of the presence of bleeding for treatment and optimal outcome. However, detection and diagnosis of acute intracranial bleeding can be extremely challenging for the emergency room physician. In the U.S., traumatic brain injury is the major cause of death in children, and stroke is the third leading cause of death in the adult population.  The following are pertinent statistics.  Traumatic Brain InjuryStrokeIncidence - Hemorrhagic
Incidence - Ischemic
Total1,500,000112,500
637,500
750,000Deaths50,000160,000Long Term Disabilities90,000295,000Economic Impact$56.3 Billion annually$62.7 Billion annually Source: Center for Integration of Medicine and Innovative Technology.  Detection  For acute stroke patients, non-contrast head CT scanning is mandatory for rapidly distinguishing ischemic from hemorrhagic infarction and for defining the anatomical distribution of the stroke.  Patients with acute ischemic stroke may be triaged to receive   24  thrombolytic therapy to break the clot, while patients with hemorrhagic stroke follow a different diagnostic and therapeutic pathway.  CT scans also may rule out other life-threatening processes such as hematoma, neoplasm and abscesses. For patients with TBI, with or without a fracture, the most critical factor is determining if a brain injury is present.  CT scan is used most often to evaluate acute head injuries; a major indicator of brain injury is the presence of intracranial bleeding.  CT is useful for identifying injuries to the brain itself and to determine the presence, location and severity of bleeding. Data collected from the research company IMV indicates that in 2006, about 62 million CT procedures was conducted in the United States, and estimated that between 38 and 50 percent of those studies were conducted to image the brain. (See Health Imaging News Report, November 7, 2006.) Clinical Value of Signature MappingTM  We have developed multiple solutions for the analysis and “tissue characterization” of the brain, including the detection of 5% or less intracranial hemorrhages, the detection and quantification of multiple sclerosis lesions, and the measurement of normal pressure hydrocephalus.  The most extensive work has been focused in the area of Traumatic Brain Injury with a special emphasis on accurately segmenting and detecting intracranial bleeding using axial Computer Tomography (CT) slices. Under our test conditions, Signature MappingTM has been demonstrated in all cases to be an accurate and sensitive tool for the detection of acute intracranial bleeds. It has also demonstrated an ability to differentiate between small intracranial bleeds that are less than 5% subdural hematoma from difficult to discern bone hardening artifacts typical in most CT scans. In early study results of ER physicians, general radiologists and neuro-radiologists, Signature MappingTM improved the performance of all three groups, and more importantly, elevated the detection performance level of the emergency room physicians to those equaling the neuro-radiologists. Results of the multiple sclerosis study found that Signature MappingTM algorithms are capable of accurately detecting lesions and, importantly, providing accurate automated measurements of the size and overall lesion volumes. Compared to clinical observers, Signature MappingTM proved to be a more sensitive tool for detecting lesions that were considered marginal or undetectable and provided extremely accurate measurements while reducing the radiologist analysis time to just seconds.  Normal Pressure Hydrocephalus (NPH) was also analyzed by IPI. The challenge facing the radiologist is determination of whether the pressure changes in the ventricles are caused by the normal course of aging or as a result of an anomaly. Signature MappingTM detected and quantified the ventricles and cranial spinal fluid visualized from the MRI images. IPI reviewed the results of utilizing Signature MappingTM and determined that the results accurately detected cerebral spinal fluid, provided a methodology for segmenting the ventricles, and determined and quantified ventricular size and volume.  MARKETS AND COMPETITION  Aviation Security Screening Products  Market  Initially, management has focused its principal development and marketing efforts for its PinPointTM product on the market for airport baggage screening technology solutions. However, as discussed further below, and although there can be no assurance, management believes that its PinPointTM solution is also capable of being adapted for use in the people portal and cargo screening markets.  The following discussion focuses on the market for baggage screening solutions; however, we have also provided an overview of the potential market for people portal and cargo screening technology solutions, potential future markets for our PinPointTM product.  Baggage Screening Market  Security oversight of airports in the United States is overseen by the Transportation Safety Administration (“TSA”) with an annual operating budget in excess of $5 billion.  TSA has the responsibility for over 480 U.S. airports with a combined inventory of baggage scanning equipment (checked baggage area and the carry-on baggage area) in excess of 6,000 scanners.  While exact statistics on the number of scanners deployed in the rest of the world are not readily available, management estimates that the market is four times greater than the U.S.  In addition to baggage scanners, airports worldwide are faced with replacing or supplementing existing metal detectors for passenger processing.  Since the events of September 11, 2001, there has been a growth surge in the baggage screening industry.  In the decade leading up to 9/11, the U.S. market for baggage screening products and services maintained a steady $400-$600 million per year.  Since 9/11 the industry has reinvented itself almost from the ground up.  The growth in the marketplace for baggage screening products and services arises as a result of the TSAs need to position itself to accommodate the forecasted growth in demand from 2 billion baggage screening   25  transactions in 2001, to 7.3 billion in 2006 and 17.6 billion in 2010. See Homeland Security Research Corporation (HSRC) report, 2003-2010 Luggage and Large Parcel Screening Market Report.  Technology is expected to convert the marketplace from a largely services (labor-driven) environment to technology intensive.  The current baggage screening technology is a stopgap measure rather than a delivering solution.  The fused technologies "checkpoint of the future" will dominate the market.  It will provide multi-threat screening (next generation bombs weapons and weapons of mass destruction). Sectors such as aviation, maritime and mass transit, public gathering sites and government and private sector sensitive sites is expected to spend an accumulated $60 billion on hand-held baggage screening equipment, service and infrastructure during the 2003-2010 period (compared to an accumulated $7 billion during the 1994-2001 period). See Homeland Security Research Corporation (HSRC) report, 2003-2010 Luggage and Large Parcel Screening Market Report.  Currently, there are limited standards within the aviation security marketplace for the testing and validation of software technology solutions.  To date the marketplace has placed a premium on the newest innovations in hardware technology and has failed to grasp how a threat detection software solution can succeed.  A major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) is expected to open a path to both increase the interoperability of security equipment as well as provide a mechanism to use third party threat detection software as part of the screening solution.  This enabling initiative is the Digital Imaging and Communications in Security (DICOS) standard, similar to the Digital Imaging and Communications in Medicine (DICOM) standard.  With a defined standard for the output of each screening device, complimentary automated threat detection software can be appended to any x-ray equipment.  The schedule for publication of this standard is being driven by the expected purchase by DHS/TSA of new security screening equipment for over 400 US airports.  Applied Visual Sciences, Inc. is a co-chair of one of the three NEMA working groups drafting the standard.  As highlighted below, in a recent NEMA article, DICOS - Homeland Security Spending Keeps on Growing - Published by, U.S. government expenditure for security solutions is expected to increase.  Management believes that Applied Visual Sciences, Inc. is positioned to be a third-party solution provider leveraging the standard output of all future security equipment procured by the US Government.  NEMA stated Global homeland security spending has received a major boost in light of recent international terrorist events, as countries look at new ways to thwart terrorists and secure borders. Spending in the industry is expected to triple to $178 billion by 2015.  Security-related spending will include more sophisticated information technology and the protection of other vulnerable terrorist targets.  With the initial focus on airport security, NEMA has stepped up its outreach to DHS and TSA. Currently developing DICOS, the new NEMA standard will capture scans of checked baggage so that scans can be read by threat detection software. The new standard is expected to facilitate interoperability of security-imaging equipment. With DHS/TSA expected to purchase new equipment for over 400 U.S. airports, NEMA members have joined with DHS to develop the standard.  With Phase 1 of DICOS expected to be completed this year, NEMA has begun looking at other modalities. The security industry is looking at border, rail, seaport, industrial and nuclear plant security.  Management believes that international market acceptance of PinPointTM as a viable threat detection solution will not only enhance our ability to sell worldwide, but it will open additional opportunities for the development of PinPointTM as the “intelligent image” analysis solution for areas such as military target acquisition, satellite remote sensing, and additional opportunities within aviation security such as people portals and cargo scanning.  Additionally, we will seek support of the U.S. Congress and the equipment manufacturers through lobbying and other efforts.  We remain focused on the ongoing development of PinPointTM, particularly with respect to field test results.  This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country. Market acceptance is a key to our future success.  Information regarding the amount of the TSAs annual budget allocated for the purchase of software solutions that are able to detect threat items at U.S. airports and other similar facilities, such as PinPointTM, is not readily discernible from publicly available information or independent research reports. However, management estimates, based upon information derived from the FY 2006 and requested FY 2007 United States Department of Homeland Security (DHS) budget, that the DHS budget allocation for FY 2006 for software solutions that are able to detect threat items at U.S. airports and other facilities, such as PinPointTM, was approximately .77% of the DHS’ $41.1B budget, and that the budget allocation for the proposed FY 2007 DHS budget will be approximately 2.25%.  In addition, management estimates that the worldwide market for solutions such as PinPointTM is estimated to be approximately twice the United States’ Homeland Security budget.  These estimates have been prepared by Applied Visuals management and reflect certain assumptions of such management.  There can be no assurance that these estimates are or will prove to be accurate or that budget allocations or these estimates may not change, based upon changes in governments budget priorities and other factors.    26  In addition to the baggage screening market, management expects to target the following additional markets for PinPointTM.  Further evaluation and market studies are required in order for a business plan to be developed and the assessment of development efforts necessary before entering the “People Portal” (whole body imagers) and “Cargo Scanning” markets.  Whole Body Imagers  Almost every threat that requires people screening is currently monitored by a different system (explosives, weapons, biological, chemical, and nuclear/radiological).  Management believes that today's people screening systems deliver unacceptable performance (high false alarm rates, slow processing throughput, continued dependence on human detection, and high transaction costs).  Over a period of 10 years (2001-2010) the total U.S. annual people screening outlay is expected to grow to over 15 times its current size.  Sales of $590 million in 2001 are forecasted to grow to $3.5 billion in 2006 and to $9.9 billion in 2010. The compound annual growth rate is expected to be over 50% for the 2003-2010 periods. Management believes that the market for people portals that utilize imaging as its detection methodology is a sub-set, and is estimated at 50% of the entire forecasted market of which management believes PinPointTM can address.  See HSRC report, “2003-2010 People Screening Weapon & Explosives Detection Market Report.”  It is management’s belief that the current people portal technology fails to meet the post-9/11 requirements. It is management’s belief that the technology will undergo dramatic technological changes when the multiple-threats "checkpoint of the future" is introduced.  The accumulated U.S. investment in people screening during the 2003-2010 period is expected to be over $50 billion.  During the 2006-2010 periods, over 80% of sales of people portal systems in the US are expected to be for technologies that were not in existence in 2003.  Cargo Scanning Currently, less than 10% of worldwide shipped cargo is screened, and even with that small of a sampling the screening is only preformed to identify a limited number of threats, not the entire array of threats (explosives, weapons, biological, chemical and radiological/nuclear). Terrorism threats to disrupt western economies, and regulatory changes driven by the U.S., specifying requirements for cargo shipped into the U.S., are expected to bring dramatic changes in this industry.  Management believes that the 10 companies currently active in the field of cargo inspections will have to redesign their systems to meet the post 9/11 threat of weapons of mass destruction.  Through market studies, which we will undertake before expending significant resources, an assessment of market penetration and developmental requirements will be completed which we expect will clearly identify our PinPointTM product introduction into this market.  The aviation sector alone handles more than 60 billion tons of cargo per year, and is growing at a rate of 9% per year.  Total cost of added security for airline cargo alone was forecasted to surpass $2 billion in 2006 in the U.S.  Present airline insurance costs are $6 billion/year, six times higher than their pre 9/11 levels.  See HSRC report, 2003-2010 Cargo Screening Market Report. A single cargo terror event is expected to drive these costs even higher. The events of 9/11 caught the luggage and large parcel industry by surprise, since this industry was operating on a schedule that required the introduction of proper solutions only by 2025. With existing technologies and budgets, it is impossible to deliver screening for more than a small fraction of luggage and parcels, and even that only at essential and ultra sensitive sites.  Competition  The competition between the manufacturers of baggage (hand-held and small parcel) screening, luggage and large parcel screening, people screening for weapons and explosives detection, container and vehicle screening, and cargo screening is intense.  These same equipment manufacturers represent Applied Visual Sciences, Inc.s major competition, and include: AS&E, Smiths-Detection, OSI Rapiscan, GE-InVision, and L3, each of which is better capitalized and has greater marketing and other resources than Applied Visual Sciences, Inc. The competition between manufacturers is intense in view of amounts appropriated by the U.S. Government for threat detection technologies. What is not so obvious is that the manufacturers that once held the largest share of installed base are at risk due to aging and inadequate technology.  Due to the agnostic nature of PinPointTM, we believe we can integrate PinPointTM with any manufacturer’s scanning equipment.  We believe our technology improves the efficiency of the underperforming hardware and extends the obsolescence of the existing scanning equipment.  Funds previously appropriated for the upgrade or replacement of the in-place scanners could then be redeployed for the acquisition of required technologies such as body scanners or cargo scanners.  The equipment manufacturers in conjunction with software companies and academic institutions are attempting to develop sophisticated solutions to aid in the detection of contraband substances.  To date there has been no known solution developed.  We believe that Applied Visual Sciences, Inc.s approach is unique in that it is a non-intrusive adjunct to the current manufacturers products.  The enhancement identifies contraband at an accuracy level that is higher than the methodology used today by TSA.  The market for contraband detection systems software is anticipated to become intensely competitive and is characterized by continuously developing technology and frequent introductions of new products and features. We expect competition to increase as other   27  companies introduce additional and more competitive products in the aviation security market and as we develop additional capabilities and enhancements for PinPointTM and new applications for our technology. Historically, the principal competitors in the market for explosive detection systems have been GE-InVision, Vivid Technologies, Inc., EG&G Astrophysics, Smiths-Detection, Thermedics Detection Inc., and Barringer Technologies Inc. Each of these competitors provides aviation security solutions and products for use in the inspection of checked and carry-on luggage.  We expect certain major corporations competing in other markets to enter the aviation security market.  Applied Visual Sciences, Inc. believes that its ability to compete in the aviation security market is based upon such factors as: product performance, functionality, quality and features; quality of customer support services, documentation and training; and the capability of the technology to appeal to broader applications beyond the inspection of checked and carry-on baggage. Although we believe that PinPointTM is superior to our competitors’ products in its detection capability and accuracy, PinPointTM must also compete on the basis of price, throughput, and the ease of integration into existing baggage handling systems. Certain of our competitors may have an advantage over our existing technology with respect to these factors.  Healthcare Products  Market  CAD vendors today have developed and sold clinical products in three major applications segments; mammography as a second look for the screening and early detection of breast cancer; chest CT for the early detection of nodules and CT of the colon for the non-endoscope screening of polyps.  In 2006, an analyst at Frost & Sullivan stated "Early introduction of integrated CAD solutions is critical for gaining market share and may lead to higher profitsThese new systems will enable workflow improvements while providing a smooth migration to the digital solution. This will increase the viability and broaden the appeal of these systems, and is likely to result in increased sales and revenues."  These are new markets with new applications. The market is shifting towards CAD as physicians confidence levels continue to grow. For example, the radiologist who uses CAD for Mammography (one of the most prevalent today) would most likely be very willing to trying new clinical applications.  This is true for general radiologists and specialty radiologists.  Frost and Sullivan studies published in 2006 estimated world wide radiology imaging procedures for all modalities at slightly a billion procedures per year and estimated that approximately 300 million to 350 million procedures were attributed to the USA.  In 2006, Frost & Sullivan projected CAD sales to reach $600 million by 2009 with a Compound Annual Growth Rate (CAGR) of +18% by 2010. With replacement expected in full force in the two segments with the most demand by that point, namely, the breast MRI CAD segment and the mammography CAD segment, overall replacement in the total CAD market is expected to reach almost 50 percent of demand by 2012. With each new CAD technology introduced to the market, the potential size of this new market grows exponentially Given the myriad of body parts and systems that CAD technology could be applied to in the future, as well as the different imaging modalities associated with each, growth in this market could be virtually unstoppable. Such as, new technology introduced for CT would be applicable to the brain, chest, neck, abdominal and other areas of the body; and new technology for Ultrasound would be applicable for the breast, liver, prostate and abdominal.  Shalom S. Buchbinder, M.D., FACR, Chairman, Department of Radiology, Staten Island University Hospital, and Clinical Associate Professor of Radiology, Obstetrics, Gynecology and Womens Health, Albert-Einstein College of Medicine of Yeshiva University, New York, U.S.A. (Changing the Way Healthcare is Delivered, RSNA 2004, p89) states This relatively new technology improves the decision making compatibilities of cliniciansIn my opinion mammography CAD has proven its clinical value and the future is about more robust and sophisticated tools that can, in addition to detection, help in the analysis of lesions. Innovative technologies can provide valuable information to support lesion classification.  Financial support to fight TB comes from multiple sources world leaders, public health officials and international donors have taken action against TB and financial resources for control and research have increased dramatically in recent years.  Public-private partnerships like the Foundation for Innovative New Diagnostics (find) have emerged to bring together key players in these sectors to move research and development forward for the needs of patients.  Primarily, the government of each country is financially responsible for fighting TB with outside support of international organizations.   Market Conditions  Managements review of current market conditions has identified the following trends:  · TB is becoming a worldwide epidemic · Automatic differentiation of TB bacilli is a very challenging issue   28  · Currently no such CAD product exists · Steady adoption of digital microscopy · Need for higher throughput and continued cost reduction without sacrificing quality · CAD is evolving as a clinical tool and physicians are adopting it · Current graphics cards and computational processing power are sufficient · Retiring workforce and  the current  prediction that there will be a shortage of pathologists · Economic pressures and increasing clinical demands · Facilitates productivity gains with inclusion of CAD · Pathologist can performs diagnosis on digital images and monitor · PMA FDA approvals of digital pathology tests is increasing · Facilitates improved workflow efficiency and enhances patient management practices · Pathology lab is poised for digital revolution · Pressures on the anatomical pathology sciences will drive change · STOP TB has stated they want effective, efficient and validated clinical algorithms  Potential Market For New TB Diagnostics  The persistent TB epidemic and expanding global population ensure that the total market for a range of TB diagnostic products is likely to increase yearly over the next decade by approximately 16%.  The current international policy on TB case detection recommends the examination of three sputum smears for the diagnosis of pulmonary tuberculosis (PTB). The present definition of a smear-positive case states "Tuberculosis in a patient with at least two initial sputum smear examinations (direct smear microscopy) positive for acid fast bacilli (AFB+)".  Worldwide, WHO estimates that the largest potential available market for a new TB diagnostic would be for a test that both detects latent infection and predicts progression to active disease (767 million patient evaluations/year). Such a test, if widely implemented and accompanied by successful treatment, has the potential to revolutionize TB control.  The infrastructure to achieve this globally is not available at this moment.  (See Global Tuberculosis Control- surveillance, planning and financing, WHO Reports: 2005 through 2008.)  The next largest total available market is for a point-of-care screening test, which is estimated to be 193 million patients evaluations/year, of which approximately 70%, or 137 million patients evaluations/year is concentrated in the 22 high-burden countries.  Substantial markets also exist for less revolutionary replacement technologies.  Specifically, the total available markets for smear, culture, and monitoring and DST replacement tests are 83 million, 57 million, 40 million, and 6 million patient evaluations, respectively in 2005.  We estimate that replacement technologies could capture a greater proportion of the market by 2020: smear 59% (49 million), culture 35% (20 million), monitoring 58% (23 million) and DST 45% (3 million).  Without exception, between 70%90% of the potential available markets for these replacement technologies are in the 22 high-burden countries.  The continued emphasis on improving market conditions will encourage market growth in the high-burden countries and increase the accessibility to new products.  (See Global Tuberculosis Control - surveillance, planning and financing, WHO Report 2008.)  Competition  We expect to compete with existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health and manufacturers of dipstick or biomarker manufacturers, including SPAN Diagnostics Ltd., India,  Yayasan Hati Sehat (YHS), Indonesia and Wiener Laboratorios, Argentina.  We may also partner with one or more of these existing CAD manufacturers, or an emerging company with new technology for the CAD arena.  Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (OEM), or system integrators.  Although there is no current computer-aided-detection for TB sputum microscopy analysis, which can be identified as competition to Signature MappingTM, there are substitute technologies, which in the long run could compete for sputum specimen analysis.  The dipstick or biomarker approach could be considered a future competitor to Signature MappingTM. Ultimately, competition to our approach will be driven by its cost per procedure, ease-of-use, sensitivity and specificity, and ability to be used by non-trained or lightly trained personnel in the point of care environment. These emerging tests are Polymerase Chain Reaction, TB Breathalyzer, Q-Beta Replicase Assay, Transcription-Medicated Amplification, Ligase Chain Reaction, Strand Displacement Amplification, Nucleic Acid Sequence-Based Amplification and Branched DNA and Cepheid Systems GeneXpert® System.  SALES, MARKETING AND DISTRIBUTION  PinpointTM   29       We market and sell our PinPointTM product through our internal sales force, agents, distributors and consultants.  At the same time, we have escalated our efforts with the TSA. Additionally, we will seek the support of politicians through our lobbying efforts and the support of certain scanning equipment manufacturers.  While TSA certification is not absolutely essential to the acceptance of our PinPointTM product, management believes that TSA certification and a business relationship with the TSA is important to our strategic growth plans as the relationship offers the opportunity to obtain potential sub-contracts for baggage scanning applications and for additional aviation and transportation security contracts. Management remains focused on the ongoing development of PinPointTM, particularly with respect to test results.  This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country.  Market acceptance is a key to our future success and there can be no assurance that our PinPointTM products will achieve that acceptance.  Healthcare  Signature MappingTM Products We signed a joint development agreement with the Aurum Institute, a leading international research institute in South Africa that is committed to the detection and treatment of HIV, malaria and tuberculosis. Together, we expect to work towards the development of a fully automated imaging analysis system for the early identification of tuberculosis and malaria.  We may partner with one or more of the existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health, or an emerging company with new technology for the CAD arena.  Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (OEM), or system integrators.  PRODUCT DISTRIBUTION AND MARKETING  We have entered into the following distributor, strategic partnership, development, and consulting agreements with regard to our products:  Preferred International Distributor Agreement with Rodash 136 (Pty) Ltd, of South Africa  On May 25, 2010, the Company and Rodash 136 (Pty) Ltd, of South Africa, entered into a Preferred International Distributor Agreement.  Under the agreement, Rodash has agreed to promote the licensing and distribution of Applied Visual Sciences’ PinPointTM suite of software. Rodash will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the end of the then-current period. The Company appointed Rodash as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of PinPointTM products.  Preferred International Distributor Agreement Romador 168 (Pty) Ltd, of South Africa  On May 25, 2010, the Company and Romador 168 (Pty) Ltd, of South Africa, entered into a Preferred International Distributor Agreement.  Under the agreement, Romador has agreed to promote the licensing and distribution of Applied Visual Sciences’ Signature MappingTM suite of software. Romador will also provide support to licensees of the products. The three year agreement provides for automatic successive one year renewal periods, unless either party provides written notice to the other of its intention to terminate or to re-negotiate the agreement no less then one hundred and twenty days prior to the then-current period. The Company appointed Romador as the exclusive distributor for such products in Africa, Brazil, Argentina, Indonesia and Australia, although the agreement permits Applied Visual Sciences to enter into business relationships with original equipment manufactures for the licensing, distribution, or resale of Signature MappingTM products.  Memorandum of Understanding with Aurum Innova (Pty) Limited and the National Health Laboratory Services of South Africa  On March 24, 2009, Applied Visual Sciences, Inc. signed a Memorandum of Understanding (MOU) with Aurum Innova (Pty) Limited (Innova) and the National Health Laboratory Services of South Africa (NHLS).  The purpose of the agreement is for the parties to jointly undertake activities for the completion of our Signature MappingTM Tuberculosis (“TBDx”) product for deployment in the NHLS laboratories.  The parties will collaborate to enhance TBDxTM’s overall performance, customize its use for application in the National Health Laboratory Services tuberculosis diagnosis and quality management program, and clinically evaluate, measure, and test TBDx performance.  The collaboration includes conducting the clinical evaluation at selected NHLS laboratories that conduct sputum slide tuberculosis analysis and diagnosis.   30   Scientific Advisory Board in South Africa  In February 2009, Applied Visual Sciences, Inc. in conjunction with our partner the Aurum Institute established a Scientific Advisory Board in South Africa, and its members include Dr. Gavin J. Churchyard, founder and CEO of Aurum Institute for Health Research, Dr. David Clark, President of the Aurum Institute for Health Research, Dr. Gerrit Coetzee, Head of the National Tuberculosis Reference Laboratory of the National Health Laboratory Services, Dr. Bernard Fourie, Chief Scientific Officer with the Medicine in Need Inc organization, Mr. Stan Harvey, Acting Executive Regional Manager of the National Health Laboratory Services, and Dr. Natalie Beylis, Director of Laboratory Tuberculosis Services at the National Health Laboratory Services Braamfontein Hospital.  The responsibilities of the Scientific Advisory Board include the identification of product specifications for our Signature MappingTM Tuberculosis (“TBDxTM”) product, and determine how the technology will be implemented in South Africa.  The Scientific Advisory Board met in May 2009, and agreed on the requirements for TBDx application and detection performance, and overall customer requirements.  The establishment of the Scientific Advisory Board led to the memorandum of understanding between Applied Visual Sciences, Inc., Aurum, and NHLS, discussed above.  Master Development Agreement with Aurum Innova (Pty), Ltd.  On February 4, 2009, Applied Visual Sciences, Inc. signed a Master Development Agreement Aurum Innova (Pty), Ltd., a company related to the Aurum Institute for Health Research, and installed in February 2009 an alpha product of Signature MappingTM tuberculosis (“TBDx”) software in a “retrofit configuration” for an evaluation by the National Health Laboratories (NHLS) in South Africa. This agreement extends the Companys contractual relationship with Aurum that was first established with the signing of a Memorandum of Understanding on July 25, 2008.  The new agreement provides for the joint development of products and services aimed at the screening, early detection and staging of diseases including TB, silicosis, and malaria.  Each product will be the subject of a separate project specifications and the MDA included project specifications for our joint development of an automated TB sputum detection product.  Aurum has agreed to clinically evaluate the products, and the parties agreed to jointly market and sell, initially in South Africa but eventually in sub-Saharan Africa, the jointly developed products, including our Signature MappingTM TBDxTM product, through third parties and/or through Aurum.  The Company agreed to pay Aurum a royalty on a product by products basis, based on the net revenue received by us through our distributors, and to be delineated by the parties.  Also, the Company agreed to pay Aurum a commission with regard to sales of the products by Aurum.  Further, Aurum has agreed to use every reasonable effort to raise funding to complete the development of a product following completion of the initial proof of concept.  Any intellectual property jointly developed by us and Aurum will be jointly owned.  The agreement may be terminated on one years prior written notice by either party, automatically terminates upon completion of project specifications and if no products are being marketed under the agreement, or for cause.  The agreement also contains certain confidentiality and indemnification provisions.    EMPLOYEES  As of December 31, 2010, we employed 13 full-time employees, and two prior full-time employees that continue to support the Company on a part-time as needed basis, as well as six that are on a temporary leave of absence. None of our employees is a party to a collective bargaining agreement and we believe our relationship with our employees is good. Moreover, we have accrued and unpaid salaries due to our employees and management in the amount of $4,986,115. We also employ certain consultants and independent contractors on a regular basis to assist in the completion of projects. It is our practice to require all our employees, consultants and independent contractors to enter into proprietary information and inventions agreements containing non-disclosure, non-compete and non-solicitation restrictions or covenants.   PATENTS AND PROPRIETARY RIGHTS  We rely on a combination of common law trademark, service mark, copyright and trade secret law and contractual restrictions to establish and protect our proprietary rights and promote our reputation and the growth of our business.  We do not own any patents that would prevent or inhibit our competitors from using our technology or entering our market, although we intend to seek such protection as appropriate.  It is our practice to require all of our employees, consultants and independent contractors to enter into agreements containing non-disclosure, non-competition and non-solicitation restrictions and covenants, and while our agreements with some of our customers and suppliers include provisions prohibiting or restricting the disclosure of proprietary information, we can not assure you that these contractual arrangements or the other steps taken by us to protect our proprietary rights will prove sufficient protection to prevent misappropriation of our proprietary rights or to deter independent, third-party development of similar proprietary assets.  We were granted by the United States Patent & Trademark Office (USPTO) five patents related to our underlying 3i technology.  They are:    31   Date GrantedPatent No.Patent DescriptionFebruary 17, 20097,492,937System and Method for Identifying Objects of Interest in Image Data – for Signature MappingTMFebruary 24, 20097,496,218System and Method for Identifying Objects of Interest in Image Data – for PinPointTMOctober 19, 20107,817,833System and Method for Identifying Feature of Interest in Hyperspectral DataNovember 23, 20107,840,048System and Method for Determining Whether There is an Anomaly in DataMarch 15, 20117,907,762Method of Creating a Divergence Transform for Identifying a Feature of Interest in Hyperspectral Data  As of the date of this report, we have 11 pending patents applications (U.S. and foreign) and one U.S. provisional patent application further covering the implementation of our core 3i technology.   We cannot provide assurance that any or all of the remaining patent applications will issue to patents or that they will not be challenged, or that rights granted to us would actually provide us with an advantage over our competitors. Prior art searches have been conducted and, based on the results of these searches; we believe that we do not infringe any third party patents identified in the searches.  Due to the rapid pace of technological change in the software industry, we believe patent, trade secret and copyright protection are less significant to our competitive edge than factors such as the knowledge, ability and experience of our personnel, new product development, frequent product enhancements, name recognition and the ongoing reliability of our products.  RESEARCH AND DEVELOPMENT  Under United States generally accepted accounting principles, until technology is determined to be feasible, all related research and development expenditures must be expensed rather than capitalized. When a determination is made that software is feasible (commercially viable), then expenditures may be capitalized, as long as there are no high-risk development issues.  We determined that a high-risk development issue existed for integrating PinPoint into already existing scanning equipment.  Therefore, we have concluded that capitalizing such expenditures for PinPointTM is currently inappropriate and have expensed all research and development costs to date. The PinPointTM research and development costs for the years ended December 31, 2010, and 2009 were $4,669 and $141,836, respectively.  We also expense the research and development costs for our Signature MappingTM (Medical Computer Aided Diagnosis) projects as these projects are not considered to be ready for commercial distribution. The Signature MappingTM research and development costs for the years ended December 31, 2010, and 2009, were $152,686 and $347,755, respectively.  Our research and development costs are comprised of staff and consultancy expenses on our core technology in intelligent imaging informatics (“3iTM”) engine that is capable of extracting embedded knowledge from digital images, as well as the capacity to analyze and detect image anomalies for our development of our PinPointTM and Signature MappingTM.  GOVERNMENTAL REGULATION  Many of our prospective customers and the other entities with which we may develop a business relationship operate in the healthcare industry and, as a result, are subject to governmental regulation. Because our healthcare products and services are designed to function within the structure of the healthcare financing and reimbursement systems currently in place in the United States, and because we are pursuing a strategy of developing and marketing products and services that support our customers' regulatory and compliance efforts, we may become subject to the reach of, and liability under, these regulations.  The federal Anti-Kickback Law, among other things, prohibits the direct or indirect payment or receipt of any remuneration for Medicare, Medicaid and certain other federal or state healthcare program patient referrals, or arranging for or recommending referrals or other business paid for in whole or in part by the federal health care programs. Violations of the federal Anti-Kickback Law may result in civil and criminal sanction and liability, including the temporary or permanent exclusion of the violator from government health programs, treble damages and imprisonment for up to five years for each violation. If the activities of a customer or other entity with which we have a business relationship were found to constitute a violation of the federal Anti-Kickback Law and we, as a result of the provision of products or services to such customer or entity, were found to have knowingly participated in such activities, we could be subject to sanction or liability under such laws, including exclusion from government health programs. As a result of exclusion from government health programs, our customers would not be permitted to make any payments to us.  The federal Civil False Claims Act and the Medicare/Medicaid Civil Money Penalties regulations prohibit, among other things, the filing of claims for services that were not provided as claimed, which were for services that were not medically necessary, or which were otherwise false or fraudulent. Violations of these laws may result in civil damages, including treble and civil penalties. In addition the Medicare/Medicaid and other federal statutes provide for criminal penalties for such false claims. If, as a result of the provision by us of products or services to our customers or other entities with which we have a business relationship, we provide assistance with the provision of inaccurate financial reports to the government under these regulations, or we are found to have knowingly recorded or reported data relating to inappropriate payments made to a healthcare provider, we could be subject to liability under these laws.    32  The United States Food and Drug Administration promulgated a draft policyfor the regulation of computer software products as medical devices under the 1976 Medical Device Amendments to the Federal Food, Drug and Cosmetic Act. To the extent that computer software is a medical device under the policy, we, as a manufacturer of such products, could be required, depending on the product, to: · register and list its products with the FDA; · notify the FDA and demonstrate substantial equivalence to other products on the market before marketing such products; or · obtain FDA approval by demonstrating safety and effectiveness before marketing a product.  Depending on the intended use of a device, the FDA could require us to obtain extensive data from clinical studies to demonstrate safety or effectiveness, or substantial equivalence. If the FDA requires this data, we would be required to obtain approval of an investigational device exemption before undertaking clinical trials. Clinical trials can take extended periods of time to complete. We cannot provide assurances that the FDA will approve or clear a device after the completion of such trials. In addition, these products would be subject to the Federal Food, Drug and Cosmetic Act's general controls, including those relating to good manufacturing practices and adverse experience reporting. Although it is not possible to anticipate the final form of the FDA's policy with regard to computer software, we expect that the FDA is likely to become increasingly active in regulating computer software intended for use in healthcare settings regardless of whether the draft is finalized or changed. The FDA can impose extensive requirements governing pre- and post-market conditions like service investigation, approval, labeling and manufacturing. In addition, the FDA can impose extensive requirements governing development controls and quality assurance processes.  PRINCIPAL OFFICES  We maintain our principal offices at 250 Exchange Place, Suite H, Herndon, Virginia  20170.  Our telephone number in the U.S. is (703) 464-5495.  Our Internet address is www.appliedvs.com.  Information on our website is not deemed to be part of this Annual Report on Form 10-K.        ITEM 1A.  RISK FACTORS  An investment in our common stock involves a high degree of risk.  You should carefully consider the risks described below and other information contained in this report before deciding to invest in our common stock.  The risks described below are not the only ones facing our company. Additional risks not presently known to us or which we currently consider immaterial may also adversely affect our company.  If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.  In such case, the trading price of our common stock could decline, and you could lose a part or all of your investment.  Risks Related to Our Company and Our Operations  We have insufficient cash resources to repay the amounts due to our debenture holders.  As of December 31, 2010, $1,688,205 in principal amount was outstanding under the debentures, and is due on June 30, 2011. Currently, we do not have sufficient cash resources to pay such debentures.  We may in the future seek to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to further extend their maturity date, although we have not reached any agreement with our 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 and related Series D Warrants.    Our business plan and technologies are unproven. We have generated minimal revenues from our operation, and incurred substantial operating losses since our inception.  We have very limited cash resources and we are reliant on external sources of financing to fund our operations, including our ongoing product development.  As of December 31, 2010, our 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.  The principal amount due to our debenture holders as of December 31, 2010, was approximately $1,688,205, and matures on June 30, 2011. Also, we have outstanding trade and accrued payables of $6,788,582 including accrued salaries due to our employees and management of $4,986,115. Also, our Chief Executive Officers net outstanding noninterest-bearing loans were $117,100.    33  As of December 31, 2010, we had a cash balance of $4,874.  Subsequently and through April 5, 2011, at a series of closings, we received an aggregate of $350,000 (or $338,000, net of commissions and expenses of $12,000) from the issuance and sale of common stock and warrants, including $150,000 from Seaside, an institutional accredited investor.  Seaside has agreed to purchase additional shares if pre-established stock price and volume conditions are met during the eight months following the closing.  The stock price and volume conditions for the second closing were not met and there can be no assurance our shares will satisfy such conditions in connection with any subsequent closing. During the same period, certain vendors converted an aggregate of $242,650 of outstanding accounts payable into stock. In view of the foregoing, management believes these funds to be insufficient to fund our operations, 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 and including 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 and interest, 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 our limited revenues to date, we have relied and continue to rely substantially upon equity and debt financing to fund our ongoing operations, including the research and development conducted in connection with its products.  The proceeds from our financings are insufficient to fund our operations, pay our trade payables, to repay our unconverted debentures, or accrued and unpaid wages to our employees.  Therefore, the debentures holders, our employees or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations.  Also, in the event we are unable to pay our employees, we may suffer employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of our stock, we may have limited or no access to the capital markets.  Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.  During the twelve months ended December 31, 2010, our total stockholders deficit decreased by $2,529,598 to $10,164,515 and our consolidated net loss was $3,650,231 for the twelve months ended December 31, 2010. 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.  Our independent registered public accounting firm has expressed uncertainty regarding our ability to continue as a going concern.  Our independent registered public accounting firm has expressed uncertainty regarding our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on recoverability and classification of assets or the amounts and classification of liabilities that might occur if we are unable to continue in business as a going concern.  We have generated limited revenue from our PinPointTMand Signature MappingTMproducts.  We have generated limited revenue from the sale of our aviation and healthcare products.  We anticipate launching of our TBDx product during 2011; however, there can be no assurance we will be successfully in such launch or that we will generate revenue from our product.  We expect to incur additional product development costs to complete our Signature MappingTM Tuberculosis project and other proof of concept projects as outside partners are solidified.  We completed a proof of concept project for the U.S. Department of Homeland Security (DHS) with regard to our PinPoint product in the first quarter of 2009 and we expect to incur additional product development cost for PinPointsTM cargo solution.  We expect to be able to start offering to cargo companies a threat detection solution to meet DHS guidelines that is expected to go into effect during 2012. There can be no assurance that we will be successful in launching the foregoing products in accordance with the foregoing timelines or that we will be successful in marketing and selling such products or generating significant revenue as anticipated.    34  We have a severe working capital deficit and, in addition to proceeds from financings, we continue to have outstanding loans from our chief executive officer and deferrals of salaries by our executive officer, employees and a consultant to indirectly continue to fund operations. In the event we are unable to pay our employees salaries, we may experience employee attrition which could materially and adversely affect our business and operations.  During the year ended December 31, 2010, our total stockholders deficit decreased by $2,529,598 to $10,164,515, and our consolidated net loss was $3,650,231 for the year ended December 31, 2010. During 2010, our revenue generating activities had not produced sufficient funds for profitable operations and we have incurred operating losses since inception. Although we have obtained cash from certain financings, we continue to have outstanding loans from our chief executive officer of approximately $117,100, and accrued and unpaid salaries of our executive officers in the amount of $2,304,205 and to other employees of $2,681,910. In the event we are unable to pay our employees, we may continue to experience employee attrition which could materially adversely affect our business and operations, including our ongoing research and development activities. As of December 31, 2010, we employed 13 full-time employees, and two prior full-time employees that continue to support the Company on a part-time as needed basis, although their return to full-time is uncertain.  We also have six employees that are on a temporary leave of absence, and their return is also uncertain.  Dilutive effect of conversion of Series A Senior Convertible Debentures, exercise of Series D Warrants and Midtown placement agents warrants, and other warrants.  Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. The Company issued an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants at a first closing held on November 8, 2006 and, due to the price reset conversion feature embedded in the notes and the warrants, the transaction was recognized as a liability under generally accepted accounting principles. We also issued an aggregate of 623,520 common stock purchase warrants to the placement agent in such financing which were upon terms substantially similar to the Series D Warrants. Due to milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was indeterminable as of December 31, 2007. The Company issued an additional $2,575,000 in principal amount of the Series A Debentures at a second closing held on April 12, 2007, following the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. The Company allocated proceeds from the second closing to the embedded conversion features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. One-half of the Series D Warrants became exercisable on November 8, 2006 (2,226,854 warrants), and the remaining one-half became exercisable on April 12, 2007 (2,226,855 warrants). The Series D Warrants and the placement agents warrants issued as compensation in the offering to Midtown Partners & Co., LLC, may be exercised via a cashless exercise if certain conditions are met. The Company considered ASC 815-40 (formerly EITF 00-19, relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock), and concluded that there were insufficient shares to share settle the contracts. The Series D Warrants that became exercisable at the first closing will expire on November 8, 2011, and those related to the second closing will expire in April 12, 2012. On April 1, 2007, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agents Warrants issued as compensation to Midtown Partners & Co., LLC, were reset to a price $0.7453 per share, to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. As a result of a June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,281,109 Series D warrants. Our outstanding Series A convertible debentures became due on November 7, 2008.  During the twelve months ended December 31, 2010, our debenture holders converted an aggregate of $427,500 in principal amount, and $638,163 of accrued interest into an aggregate of 4,262,653 shares of our common stock. As of December 31, 2010, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of December 31, 2010, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted, and 4,995,222 Series D Warrants remain unexercised. Proceeds of the two offerings were used for the purpose of hiring new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO.  As of the date of the filing of this report, approximately 13,566,734 warrants (excluding the warrants exercisable by the debenture holders) may be exercised pursuant to the cashless exercise provisions of such warrants, which may be subsequently resold as restricted securities under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Companys common stock could cause the market price of the Companys common stock to drop.  We have incurred substantial debt which could affect our ability to obtain additional financing and may increase our vulnerability to business downturns. We may be unable to repay our Series A Debentures when they become due.   35   As of December 31, 2010, the aggregate principal due under our outstanding Series A Debentures was $1,688,205, which matures on June 30, 2011. Also, we have outstanding trade and accrued payables of $1,347,819, other accrued liabilities of $454,648, and accrued salaries due to our employees and management of $4,986,115. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $117,100.  We are subject to the risks associated with substantial indebtedness, including that we may be unable to repay our Debentures when they come due; it may be more expensive and difficult to obtain additional financing; we are more vulnerable to economic downturns; and if we default under our indebtedness, we may not have sufficient funds to repay any outstanding principal.  Our certifying officers evaluated the effectiveness of our disclosure controls and procedures, and concluded that our disclosure controls were not effective for prior periods and that we had certain weaknesses in our internal controls over timely reporting. Our Chief Executive Officer and Chief Financial Officer (the Certifying Officers) are responsible for establishing and maintaining our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)).  The Certifying Officers designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under their supervision, to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the SECs rules and forms, and is made known to management (including the Certifying Officers) by others within the Company, including its subsidiaries. We regularly evaluate the effectiveness of our disclosure controls and procedures and report our conclusions about the effectiveness of the disclosure controls quarterly in our Forms 10-Q and annually in our Forms 10-K. In completing such reporting, we disclose, as appropriate, any significant change in our internal control over financial reporting that occurred during our most recent fiscal period that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  As we disclosed in our Form 10-Q for the periods ended March 31, 2009 and June 30, 2009, our Certifying Officers concluded that our disclosure controls and procedures were not effective as of the end of the periods covered by such reports. Although the Certifying Officers have determined that our disclosure controls and procedures were effective as of September 30, 2009, December 31, 2009, and during 2010, management continues to believe that refinement to our disclosure controls and procedures is an ongoing progress. The Audit Committee believes the Company should continue the following activities: (a) additional education and professional development for the Companys accounting and other staff on new and existing applicable SEC filing requirements, certain applicable SEC disclosure requirements, and the timing of the filing thereof, and (b) reviewing disclosure requirements, including Form 8-K and Regulation S-K disclosure requirements, SEC staff guidance and interpretations related thereto. While management is responsible for establishing and maintaining our disclosure controls and procedures and has taken steps to ensure that the disclosure controls are effective and free of significant deficiencies and/or material weaknesses, the ability of management to implement the remediation of such weaknesses and deficiencies and the inherent nature of our business and rapidly changing environment may affect managements ability to be successful with this initiative.  Current shareholdings may be diluted if we make future equity issuances or if outstanding debentures, warrants, and options are exercised for or converted into shares of common stock.  Dilution refers to the reduction in the voting effect and proportionate ownership interest of a given number of shares of common stock as the total number of shares increases.  Our issuance of additional stock, convertible preferred stock and convertible debt may result in dilution to the interests of shareholders and may also result in the reduction of your stock price.  The sale of a substantial number of shares into the market, or even the perception that sales could occur, could depress the price of the common stock.  Also, the exercise of warrants and options may result in additional dilution.  The holders of outstanding options, warrants and convertible securities have the opportunity to profit from a rise in the market price of the common stock, if any, without assuming the risk of ownership, with a resulting dilution in the interests of other shareholders.  We may find it more difficult to raise additional equity capital if it should be needed for our business while the options, warrants and convertible securities are outstanding.  At any time at which the holders of the options, warrants or convertible securities might be expected to exercise or convert them, we would probably be able to obtain additional capital on terms more favorable than those provided by those securities. Also, some holders of our warrants have piggy back registration rights requiring us to register their shares underlying such options and warrants in any registration statement we file under the Securities Act.  The cost to us for such required registration may be substantial.  We may undertake acquisitions which pose risks to our business.  As part of our growth strategy, we have and may in the future acquire or enter into joint venture arrangements with, or form strategic alliances with complimentary businesses. Any such acquisition, investment, strategic alliance or related effort will be accompanied by the risks commonly encountered in such transactions.  These risks may include:    36  · Difficulty of identifying appropriate acquisition candidates; · Paying more than the acquired company is worth; · Difficulty in assimilating the operations of the new business; · Costs associated with the development and integration of the operations of the new entity; · Existing business may be disrupted; · Entering markets in which we have little or no experience; · Accounting for acquisitions could require us to amortize substantial intangible assets (goodwill), adversely affecting our results of operations; · Inability to retain the management and key personnel of the acquired business; · Inability to maintain uniform standards, controls, policies and procedures; or · Customer attrition with respect to customers acquired through the acquisition.  We cannot assure you that we would successfully overcome these risks or any other problems associated with any acquisition, investment, strategic alliances, or related efforts.  Also, if we use our common stock in connection with an acquisition, your percentage ownership in us will be reduced and you may experience additional dilution.  Investor confidence in the price of our stock may be adversely affected if we are unable to comply with Section 404 of the Sarbanes-Oxley Act of 2002.  As an SEC registrant, we are subject to the rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, which require us to include in our annual report on Form 10-K our managements report on, and assessment of the effectiveness of, our internal control over financial reporting (managements report).  If we fail to achieve and maintain the adequacy of our internal control over financial reporting, there is a risk that we will not comply with all of the requirements imposed by Section 404.  Moreover, effective internal control over financial reporting, particularly that relating to revenue recognition, is necessary for us to produce reliable financial reports and is important in helping to prevent financial fraud.  Any of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss in investor confidence in the reliability of our financial statements, which ultimately could harm our business and could negatively impact the market price of our common stock.  Investor confidence and the price of our common stock may be adversely affected if we are unable to comply with Section 404 of the Sarbanes-Oxley Act of 2002.  In order to comply with public reporting requirements, we must continue to strengthen our financial systems and controls, and failure to do so could adversely affect our ability to provide timely and accurate financial statements. Refinement of our internal controls and procedures will be required as we manage future growth successfully and operate effectively as a public company. Such refinement of our internal controls, as well as compliance with the Sarbanes-Oxley Act of 2002 and related requirements, will be costly and will place a significant burden on management.  We cannot assure you that measures already taken, or any future measures, will enable us to provide accurate and timely financial reports, particularly if we are unable to hire additional personnel in our accounting and financial department, or if we lose personnel in this area. Any failure to improve our internal controls or other problems with our financial systems or internal controls could result in delays or inaccuracies in reporting financial information, or non-compliance with SEC reporting and other regulatory requirements, any of which could adversely affect our business and stock price. Our stock price is volatile.  The stock market from time to time experiences significant price and volume fluctuations that are unrelated to the operating performance of particular companies.  These broad market fluctuations may cause the market price of our common stock to drop.  In addition, the market price of our common stock is highly volatile.  Factors that may cause the market price of our common stock to drop include: · Fluctuations in our results of operations; · Timing and announcements of new customer orders, new products, or those of our competitors; · Any acquisitions that we make or joint venture arrangements we enter into with third parties; · Changes in stock market analyst recommendations regarding our common stock; · Failure of our results of operations to meet the expectations of stock market analysts and investors;   37  · Increases in the number of outstanding shares of our common stock resulting from sales of new shares, or the exercise of warrants, stock options or convertible securities; · Reluctance of any market maker to make a market in our common stock; · Changes in investors perception of the transportation security scanning and healthcare information technology industries generally; and · General stock market conditions.  There is a limited market for our common stock.  Our common stock is quoted on OTC Bulletin Board under the symbol APVS.  As a result, relatively small trades in our stock could have disproportionate effect on our stock prices.  No assurance can be made that an active market for our common stock will continue.  The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices and volume information for shares of stock that are not designated for quotation on a national securities exchange.  Trades in OTC Bulletin Board quoted stocks will be displayed only if the trade is processed by an institution acting as a market maker for those shares. Although there are approximately 12 market makers for our stock, these institutions are not obligated to continue making a market for any specific period of time.  Thus, there can be no assurance that any institution will be acting as a market maker for our common stock at any time.  If there is no market maker for our stock and no trades in those shares are reported, it may be difficult for you to dispose of your shares or even to obtain accurate quotations as to the market price for your shares.  Moreover, because the order handling rules adopted by the SEC that apply to other listed stocks do not apply to OTC Bulletin Board quoted stock, no market maker is required to maintain an orderly market in our common stock.  Accordingly, an order to sell our stock placed with a market maker may not be processed until a buyer for the shares is readily available, if at all, which may further limit your ability to sell your shares at prevailing market prices.  Because we became public through a reverse acquisition, we may not be able to attract the attention of major brokerage firms or institutional investors.  We became a public company through a reverse acquisition in June 2003.  Accordingly, securities analysts and major brokerage firms and securities institutions may not cover our common stock since there is no incentive to recommend the purchase of our common stock.  No assurance can be given that established brokerage firms will want to conduct any financing for us in the future.  Our common stock is subject to the SECs Penny Stock Regulations.  Our common stock is subject to the SECs penny stock rules.  These regulations define a penny stock to be any equity security that has a market price (as defined) of less than $5.00 per share, subject to certain exceptions.  For any transaction involving a penny stock, unless exempt, these rules require the delivery, prior to the transaction, of a disclosure schedule prepared by the SEC relating to the penny stock market.  The broker-dealer also must disclose the commissions payable to the broker-dealer and the registered underwriter, current quotations for the securities, information on the limited market in penny stocks and, if the broker-dealer is the sole market-maker, the broker-dealer must disclose this fact and the broker-dealers presumed control over the market.  In addition, the broker-dealer must obtain a written statement from the customer that such disclosure information was provided and must retain such acknowledgment for at least three years.  Further, monthly statements must be sent disclosing current price information for the penny stock held in the account.  The penny stock rules also require that broker-dealers engaging in a transaction in a penny stock make a special suitability determination for the purchaser and receive the purchaser's written consent to the transaction prior to the purchase.  The foregoing rules may materially and adversely affect the liquidity for the market of our common stock.  Such rules may also affect the ability of broker-dealers to sell our common stock, the ability of holders of such securities to obtain accurate price quotations and may therefore impede the ability of holders of our common stock to sell such securities in the secondary market.  Certain provisions of our charter and bylaws may discourage mergers and other transactions.  Certain provisions of our certificate of incorporation and bylaws may make it more difficult for someone to acquire control of us.  These provisions may make it more difficult for stockholders to take certain corporate actions and could delay or prevent someone from acquiring our business.  These provisions could limit the price that certain investors might be willing to pay for shares of our common stock.  The use of a staggered board of directors and the ability to issue blank check preferred stock are traditional anti-takeover measures.  These provisions may be beneficial to our management and the board of directors in a hostile tender offer, and may have an adverse impact on stockholders who may want to participate in such tender offer, or who may want to replace some or all of the members of the board of directors.  Our board of directors may issue additional shares of preferred stock without stockholder approval.   38   Our certificate of incorporation authorizes the issuance of up to 1,000,000 shares of preferred stock of which 6,000 have been designated as Series A Convertible Preferred Stock, 6,000 shares as Series B Convertible Preferred Stock, and 1,000 shares as Class C Convertible Preferred Stock, none of which shares are outstanding on the date of the filing of this report.  Accordingly, our board of directors may, without shareholder approval, issue one or more new series of preferred stock with rights which could adversely affect the voting power or other rights of the holders of outstanding shares of common stock.  In addition, the issuance of additional shares of preferred stock may have the effect of rendering more difficult or discouraging, an acquisition or change of control of Applied Visual Sciences, Inc.  Although we do not have any current plans to issue any shares of preferred stock, we may do so in the future.  We depend on key personnel.  Our success depends of the contributions of our key management personnel, including Mr. Michael W. Trudnak, Chairman, Chief Executive Officer, and Secretary, Mr. William J. Donovan, President and Chief Operating Officer, and Mr. Gregory E. Hare, our Chief Financial Officer and Treasurer.  If we lose the services of any of such personnel we could be delayed in or precluded from achieving our business objectives.  We do not have key man life insurance on any of our officers.  In addition, the loss of key members of our sales and marketing teams or key technical service personnel could jeopardize our positive relations with our customers.  Any loss of key technical personnel would jeopardize the stability of our infrastructure and our ability to provide the service levels our customers expect.  The loss of any of our key officers or personnel could impair our ability to successfully execute our business strategy, because we substantially rely on their experience and management skills.  Our directors and named executive officers own a substantial percentage of our common stock.  As of March 30, 2011, our directors and executive officers beneficially owned approximately 23.1% of our shares of common stock.  Accordingly, our directors, executive officers and two most highly compensated employees are entitled to cast an aggregate of 10,871,752 votes on matters submitted to our stockholders for a vote or approximately 12.8% of the total number of votes entitled to be cast at a meeting of our stockholders. These stockholders, if they acted together, could exert substantial control over matters requiring approval by our stockholders. These matters would include the election of directors and the approval of mergers or other business combination transactions. This concentration of ownership may discourage or prevent someone from acquiring our business.  Our ability to attract and retain additional skilled personnel may impact our ability to develop our technology and attract customers in growing our business. However, we have limited cash resources to hire additional personnel and have experienced employee attrition due to our inability to pay our employees.  We believe that our ability to attract, train, motivate and retain additional highly skilled technical, managerial and sales personnel, particularly in the areas of technology-based application development, business intelligence, knowledge extraction, management, product development, healthcare economics, radiology, integration and technical support, is essential to our future success.  Our business requires individuals with significant levels of expertise in knowledge extraction, business operations, mathematics, quantitative analysis, and machine learning.  Competition for such personnel is intense, and qualified technical personnel are likely to remain a limited resource for the foreseeable future.  Locating candidates with the appropriate qualifications, particularly in the desired geographic location, can be costly and difficult.  We may not be able to hire the necessary personnel to implement our business strategy, or we may need to provide higher compensation to such personnel than we currently anticipate.  Also, due to our limited cash resources, we have not been able to pay our employees and have accrued and unpaid wages and other perquisites due to our current and certain former employees of approximately $4,986,115.  Accordingly, we have experienced employee attrition and may not be able to attract new employees when we need to do so. If we fail to attract and retain sufficient numbers of highly skilled employees, our ability to provide the necessary products, technologies, and services may be limited, and as a result, we may be unable to attract customers and grow our business.  Our lease expires in April 2011 and we may not be able to extend our existing lease or obtain a lease for new office space because of our financial condition and limited cash resources.  In February 2010, the Company elected not to exercise the renewal option provision with regard to our prior principal executive offices, and negotiated with the landlord to lease 3,269 square feet of office space in the same business park.  The new lease was entered into on April 13, 2010 and expires on April 30, 2011. Although the lease does not contain a renewal provision, we are negotiating to extend the lease. Due to our financial condition and limited cash, we may be unable to obtain a lease for new office space or on terms that are acceptable to us.  We have never paid a cash dividend    39  We have not declared a cash dividend and we do not anticipate paying such dividends in the foreseeable future.  Risks Related to Our Industries    Changes may take place in funding for healthcare.  We expect to derive a substantial portion of our revenues from sales of clinical healthcare information systems, and other related services within the healthcare industry. As a result, our success is dependent in part on political and economic conditions as they relate to the healthcare industry.  Virtually all of our prospective customers in the healthcare industry are subject to governmental regulation, including Medicare and Medicaid regulation.  Accordingly, our prospective customers and other entities with which we may develop a business relationship are affected by changes in such regulations and limitations in governmental spending for Medicare and Medicaid programs. Recent actions by Congress have limited governmental spending for the Medicare and Medicaid programs, limited payments to hospitals and other providers under such programs, and increased emphasis on competition and other programs that potentially could have an adverse effect on our customers and the other entities with which we have a business relationship. In addition, federal and state legislatures have considered proposals to reform the U.S. healthcare system at both the federal and state level. If enacted, these proposals could increase government involvement in healthcare, lower reimbursement rates and otherwise change the business environment of our prospective customers and other entities with which we may develop a business relationship. Our prospective customers and other entities with which we may develop a business relationship could react to these proposals and the uncertainty surrounding these proposals by curtailing or deferring investments, including those for our products and services.  In addition, many healthcare providers are consolidating to create integrated healthcare delivery systems with greater market power. These providers may try to use their market power to negotiate price reductions for our anticipated products and services, which would negatively impact our expected operating margins. As the healthcare industry consolidates, competition for customers will become more intense and the importance of acquiring each customer will become greater.  Product liability claims may occur.  Any failure by our products that provide applications relating to patient diagnostic procedures, and treatment plans could expose us to product liability claims for personal injury and wrongful death. Unsuccessful claims could be costly to defend and divert management time and resources. In addition, we cannot make assurances that we will have appropriate insurance available to us in the future at commercially reasonable rates. Currently, we maintain Property, General/Umbrella Liability, and Directors and Officers insurance.  We expect to seek product liability, errors and omission, and other customary coverage upon the commercialization of our intelligent imaging informatics (3iTM”) technology.  Specific government regulations relating to Medicare and Medicaid may impinge on us.  Many of our prospective customers and the other entities with which we may develop a business relationship operate in the healthcare industry and, as a result, are subject to governmental regulation. Because our healthcare products and services are designed to function within the structure of the healthcare financing and reimbursement systems currently in place in the United States, and because we are pursuing a strategy of developing and marketing products and services that support our customers' regulatory and compliance efforts, we may become subject to the reach of, and liability under, these regulations.  The federal Anti-Kickback Law, among other things, prohibits the direct or indirect payment or receipt of any remuneration for Medicare, Medicaid and certain other federal or state healthcare program patient referrals, or arranging for or recommending referrals or other business paid for in whole or in part by the federal health care programs. Violations of the federal Anti-Kickback Law may result in civil and criminal sanction and liability, including the temporary or permanent exclusion of the violator from government health programs, treble damages and imprisonment for up to five years for each violation. If the activities of a customer or other entity with which we have a business relationship were found to constitute a violation of the federal Anti-Kickback Law and we, as a result of the provision of products or services to such customer or entity, were found to have knowingly participated in such activities, we could be subject to sanction or liability under such laws, including exclusion from government health programs. As a result of exclusion from government health programs, our customers would not be permitted to make any payments to us.  The federal Civil False Claims Act and the Medicare/Medicaid Civil Money Penalties regulations prohibit, among other things, the filing of claims for services that were not provided as claimed, which were for services that were not medically necessary, or which were otherwise false or fraudulent. Violations of these laws may result in civil damages, including treble and civil penalties. In addition   40  the Medicare/Medicaid and other federal statutes provide for criminal penalties for such false claims. If, as a result of the provision by us of products or services to our customers or other entities with which we have a business relationship, we provide assistance with the provision of inaccurate financial reports to the government under these regulations, or we are found to have knowingly recorded or reported data relating to inappropriate payments made to a healthcare provider, we could be subject to liability under these laws.    Medical device regulation may require us to obtain approval for our products.  The United States Food and Drug Administration (FDA) have promulgated a policyfor the regulation of computer software products as medical devices under the 1976 Medical Device Amendments to the Federal Food, Drug and Cosmetic Act. To the extent that computer software is a medical device under the policy, we, as a manufacturer of such products, could be required, depending on the product, to: · register and list its products with the FDA; · notify the FDA and demonstrate substantial equivalence to other products on the market before marketing such products; or · obtain FDA approval by demonstrating safety and effectiveness before marketing a product.  Depending on the intended use of a device, the FDA could require us to obtain extensive data from clinical studies to demonstrate safety or effectiveness, or substantial equivalence. If the FDA requires this data, we would be required to obtain approval of an investigational device exemption before undertaking clinical trials. Clinical trials can take extended periods of time and substantial funds to complete. We cannot provide assurances that the FDA will approve or clear a device after the completion of such trials. In addition, these products would be subject to the Federal Food, Drug and Cosmetic Act's general controls, including those relating to good manufacturing practices and adverse experience reporting. Although it is not possible to anticipate the final form of the FDA's policy with regard to computer software, we expect that the FDA is likely to become increasingly active in regulating computer software intended for use in healthcare settings regardless of whether the draft is finalized or changed. The FDA can impose extensive requirements governing pre- and post-market conditions like service investigation, approval, labeling and manufacturing. In addition, the FDA can impose extensive requirements governing development controls and quality assurance processes.  System errors and warranties may subject us to liability.  Our technology is very complex. As is the case with all complex and new systems, our product may contain errors especially when first introduced. Our technology is intended to provide information to security agencies for threat detection, and to healthcare providers for use in medical diagnosis. Therefore, users of our products may have a greater sensitivity to system errors than the market for software products generally. Failure of a system to perform in accordance with its documentation could constitute a breach of warranty and require us to incur additional expenses in order to make the system comply with the documentation. If such failure is not timely remedied, it could constitute a material breach under a contract allowing the client to cancel the contract and subject us to liability.  We retain and transmit confidential information; including patient health information. A security breach could damage our reputation or result in liability. It is critical that these facilities and infrastructure remain secure and be perceived by the marketplace as secure. We may be required to expend significant capital and other resources to protect against security breaches and hackers or to alleviate problems caused by breaches. Despite the implementation of security measures, this infrastructure or other systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, computer viruses, programming errors, attacks by third parties or similar disruptive problems. Any compromise of our security, whether as a result of our own systems or systems that they interface with, could reduce demand for our services and products.  Customer satisfaction and our business could be harmed if our business experiences delays, failures or loss of data in its systems. The occurrence of a major catastrophic event or other system failure at any of our facilities, or at any third party facility, including telecommunications provider facilities, could interrupt data processing or result in the loss of stored data, which could harm our business.  We may infringe the proprietary rights of others.  If any of our products violate third party proprietary rights, we may be required to reengineer our products or seek to obtain licenses from third parties to continue offering our products without substantial reengineering. Any efforts to reengineer our products or obtain licenses from third parties may not be successful, in which case we may be forced to stop selling the infringing product or remove the infringing functionality or feature. We may also become subject to damage awards as a result of infringing the proprietary rights of others, which could cause us to incur additional losses and have an adverse impact on our financial position. We do not conduct comprehensive patent searches to determine whether the technologies used in our products infringe patents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending; many of which are confidential when filed, with regard to similar technologies.    41  Unforeseeable disruption in the economy may take place consequent to terrorism or other international events.  The terrorist events of September 11, 2001, as well as new terrorists threats, the war in Iraq and Afghanistan, and the possibility of war in other areas of the Middle East, have sensitized us and many other businesses to the potential disruption that such activities can have on the economy, the business cycle and, ultimately on the financial performance of these organizations. It is impossible to know whether such terrorist or military activities will continue, and whether, and to what extent, they may cause a disruption that may have a material adverse effect on our business and financial condition.  We may face competition from other developers or sellers of imaging and radiology technology and baggage screening technology.  While the market for imaging and radiology technology is highly fragmented, we face competition from other companies which are developing products that are expected to be competitive with our products.   We also face potential competition from other companies developing baggage screening technology and from baggage scanner manufacturers.  Business in general is highly competitive, and we compete with both large multinational solution providers and smaller companies. Some of our competitors have more capital, longer operating and market histories, and greater resources than we have, and may offer a broader range of products and at lower prices than we offer.  A number of factors that will affect our revenues will make our future results difficult to predict, and therefore we may not meet expectations for a particular period.  We believe that our future revenues when it occurs may have the potential to vary significantly from time to time. We believe that these variations may result from many factors, including: · the timing, size and mix of orders from our major customers including, in particular, the TSA and agencies of other governments; · legislative or other government actions driven, in part, by the publics perception of the threats facing commercial aviation, leading to fluctuations in demand for transportation security scanning  products and services; · delays in product shipments caused by the inability of airports to install or integrate our products in a timely fashion; · the availability and cost of key components; · the timing of completion of acceptance testing for some of our products; · the introduction and acceptance of new products or enhancements to existing products offered by us or our competitors; · changes in pricing policies by us, our competitors or our suppliers, including possible decreases in average selling prices of our products caused by customer volume orders or in response to competitive pressures; and · our sales mix to domestic and international customers.  We expect to depend on a small number of customers for a substantial portion of our future revenues. A significant portion of our quarterly and annual operating expenses is expected to be relatively fixed in nature. This means that future revenue fluctuations will cause our quarterly and annual operating results to vary substantially. We also may choose to increase spending to pursue new market opportunities, which may negatively affect our financial results. We cannot assure investors that our PinPointTM product will be selected by the U.S. DHS or other countries’ security departments or address their solutions needs for threat detection, or that our Signature MappingTM product will be accepted in the healthcare arena. Governmental agencies, the primary customers for our PinPointTM products are subject to budget processes which could limit the demand for these products. Substantially all of the potential customers for our PinPointTM products under development to date have been public agencies or quasi-public agencies, such as the FAA, the TSA, airport authorities and manufactures of threat detection devices. Public agencies are subject to budgetary processes and expenditure constraints.  The funding of government programs is subject to legislative appropriation. Budgetary allocations for PinPointTM depend, in part, upon governmental policies, which fluctuate from time to time in response to political and other factors, including the public’s perception of the threat of commercial airline bombings. For example, the terrorist attacks of September 11, 2001 resulted in the passage of the Aviation and Transportation Security Act of 2001, or Transportation Security Act, mandating a small surcharge on each airline ticket purchase to fund airline security. This surcharge was suspended from June 1, 2003 to September 30, 2003. We cannot assure investors that the surcharge will not again be suspended or that the funds generated by these surcharges will be used to purchase our PinPointTM products. We cannot assure investors that funds will continue to be appropriated by Congress or allocated by the TSA or other   42  agencies for the purchase of PinPointTM product or any other such product we develop and market. Moreover, we expect that similar funding and appropriations issues will affect our ability to market and sell our PinPointTM product outside the United States. Legislative actions could lead to fluctuations in demand for transportation security scanning products and services. In addition to the Congressional budgetary process, other legislation could be introduced that would impact demand for transportation security scanning products and services. In response to fluctuation in concern on the part of voters about transportation security scanning and competing homeland security demands, or for other reasons, the plans for deployment of our PinPointTM product to screen baggage could be changed. Budgetary debates and delays could result in fewer PinPointTM products being sold to the TSA. Governmental agencies have special contracting requirements, which create additional risks. In contracting with public agencies, we are subject to public agency contract requirements that vary from jurisdiction to jurisdiction. Future sales to public agencies will depend, in part, on our ability to meet public agency contract requirements, certain of which may be onerous or even impossible for us to satisfy. Government contracts typically contain termination provisions unfavorable to us and are subject to audit and modification by the government at its sole discretion, which subject us to additional risks. These risks include the ability of the U.S. government to unilaterally: · suspend or prevent us for a set period of time from receiving new contracts or extending existing contracts based on violations or suspected violations of laws or regulations; · terminate our future contracts; · reduce the scope and value of our future contracts; · audit and object to our contract-related costs and fees, including allocated indirect costs; · control and potentially prohibit the export of our products; and · change certain terms and conditions in our contracts.  The U.S. government can terminate any of its contracts with us either for its convenience or if we default by failing to perform in accordance with the contract schedule and terms. Termination for convenience provisions generally enable us to recover only our costs incurred or committed, and settlement expenses and profit on the work completed prior to termination. Termination for default provisions do not permit these recoveries and make us liable for excess costs incurred by the U.S. government in procuring undelivered items from another source. Our contracts with foreign governments may contain similar provisions.   In the event we enter into one or more government contracts for PinPointTM, the government’s termination of any such contracts for our PinPointTM product under development would harm our business.  In addition, U.S. government contracts are conditioned upon the continuing availability of Congressional appropriations. Congress usually appropriates funds annually for a given program on a September 30 fiscal year-end basis, even though contract performance may take years. Consequently, our future contracts with the TSA may only be partially funded at the outset, and additional monies are normally committed to the contract by the TSA only as appropriations are made by Congress for future periods. The governments failure to fully fund one or more of the contracts for our PinPointTM product under development would harm our business.  Because we expect to contract with the U.S. government, we will be subject to periodic audits and reviews. Based on the results of its audits, the U.S. government may adjust our contract-related costs and fees, including allocated indirect costs. In the future, government audits and reviews could result in adjustments to our revenues and cause other adverse effects, particularly to our relationship with the TSA. In addition, under U.S. government purchasing regulations, some of our costs, including most financing costs, amortization of intangible assets, portions of our research and development costs, and some marketing expenses may not be reimbursable or allowed in our negotiation of fixed-price contracts. Further, because we expect to contract with the U.S. government, we will be subject to an increased risk of investigations, criminal prosecution, civil fraud, whistleblower lawsuits and other legal actions and liabilities to which purely private sector companies are not.  In addition, public agency contracts are frequently awarded only after formal competitive bidding processes, which are often protracted and typically contain provisions that permit cancellation in the event that funds are unavailable to the public agency. We may not be awarded any of the contracts for which we submit a bid. Even if we are awarded contracts, substantial delays or cancellations of purchases could result from protests initiated by losing bidders.   43  Our growth depends on our introduction of new products and services, which may be costly to develop and may not achieve market acceptance. As part of our strategy for growth, we intend to develop products to address additional transportation security scanning opportunities, such as passenger, carry-on baggage and air cargo screening. We also intend to address homeland security requirements beyond aviation, such as screening at border checkpoints, government offices and transportation terminals and ports. We will be required to spend funds to develop or acquire technologies and products for these initiatives and these initiatives may divert our development and management resources away from our core PinPointTM product. In addition, we have acquired, rather than developed internally, some of our technologies in connection with our acquisitions of companies and businesses, and these technologies may not perform as we expect. The development of new products may require greater time and financial resources than we currently anticipate and, despite significant investments in research and development, may not yield commercially successful products.  The development of our products for explosives and weapons detection is highly complex. Successful product development and market acceptance of any new products and services that we develop depends on a number of factors, including: · our timely completion and introduction of new products; · our accurate prediction of the demand for homeland security products and the changing requirements of the homeland security industry, including certification or other required performance standards; · the availability of key components of our products; · the quality, price and operating performance of our products and those of our competitors; · our customer service capabilities and responsiveness; and · the success of our relationships with potential customers. Our PinPointTM product may fail to obtain certification by the TSA. New products for transportation security scanning applications may require certification or approval by the TSA, and we believe that the TSA does not currently have standards for the certification of transportation security scanning products other than bulk explosives detection systems and explosives trace detectors, or ETD. Other products, such as metal detectors, are subject to TSA testing prior to approval. Market acceptance of new products may be limited if the TSA has not developed standards for certification or approval of such products, and even if it does develop such standards, we may be unable to obtain any such certification or approval, which could materially limit market acceptance of such products. If we fail to timely introduce new products or if these products fail to gain market acceptance, our results of operations would be harmed.  In addition, even if successful in the United States, new products that we develop may not achieve market acceptance outside of the United States. Foreign governments may be unwilling to commit financial resources to purchase our new products, which would reduce our potential revenues and harm our business. Our existing PinPointTM product may fail to obtain re-certification by the TSA for changes in the PinPointTM system. Our existing PinPointTM product can be required to be re-certified by the TSA. This can happen when a critical component is changed, or we wish to make other changes to the PinPointTM systems. When this happens, the affected PinPointTM model requires re-certification by the TSA. The failure or delay in gaining re-certification for an existing PinPointTM product could harm our ability to continue to sell the product and recognize associated revenues. Our major potential customer, the TSA, is a part of the Department of Homeland Security, a newly created agency that has experienced, and may continue to experience, delays in its operations, which may cause delays in our receiving orders for our products from the TSA. The TSA is a relatively new agency that was created in November 2001 by the Transportation Security Act. As a result, it has experienced, and may continue to experience, delays in fulfilling its mandate as a result of delays in establishing the necessary infrastructure to operate in an efficient manner. This may result in delays in our receiving orders for our PinPointTM product. Further, the TSA is now a part of the Department of Homeland Security, which was created subsequent to the creation of the TSA and is therefore in an earlier stage of formation, which may further create delays in our receiving orders as this agency is organized.   44  Future sales of our PinPointTM products will depend on the ability of airports to secure funding to build baggage handling systems and to integrate our PinPointTM product into such systems, which they may not be able to do. Future sales will depend on integrating PinPointTM into existing baggage and luggage handling systems within airports. If an airport is not configured for these systems, deployment of our PinPointTM products may require changes in the airport infrastructure. If our PinPointTM product cannot easily be integrated into existing baggage handling systems, we may experience reduced sales of our PinPointTM products or these sales may be delayed. There can be no assurance that the government will continue to fund installations, integrations and reimbursements at the current level or at all. If there is a reduction in funding, we may experience reduced sales of our PinPointTM products or these sales may be delayed.  We believe that a substantial opportunity exists for our PinPointTM system to be integrated into baggage handling systems. If airports determine, in conjunction with governmental authorities, that they will be unable or unwilling to modify or finance baggage handling systems, this opportunity may be limited. If our PinPointTM product fails to detect explosives, we could be exposed to product liability and related claims for which we may not have adequate insurance coverage, and we may lose current and potential customers. Our transportation security scanning business exposes us to potential product liability risks, which are inherent in the development, sale and maintenance of transportation security scanning products. Our software is not designed to detect, and FAA/TSA certification does not require, 100% detection of any and all explosives contained in scanned baggage. For this reason, or if our products malfunction, it is possible that explosive material could pass undetected utilizing our product, which could lead to product liability claims. There are also many other factors beyond our control that could lead to liability claims, such as the reliability and competence of the customers operators and the training of the operators.  Such liability claims are likely to exceed any product liability insurance that we may have obtained.  In addition, the failure of any PinPointTM product to detect explosives, even if due to operator error and not to the mechanical failure of a PinPointTM product, could result in public and customer perception that our products do not work effectively, which may cause potential customers to not place orders and current customers to cancel orders already placed or to not place additional orders, any of which would harm our business and financial results. We expect to substantially depend on large orders from a limited number of customers. As a result, order cancellations from any of our customers or the failure of these customers to continue to purchase PinPointTM products could have a material negative impact on our business and financial results. In any given fiscal quarter or year, our revenues will be derived from orders of multiple units of our PinPointTM product from a limited number of customers. The failure of these customers, particularly the U.S. government, to purchase our PinPointTM products or the cancellation of future orders would harm our business. The sales cycle for our PinPointTM product is lengthy and we may expend a significant amount of effort in obtaining sales orders and not receive them. The sales cycle of our PinPointTM product is expected to be lengthy due to the protracted approval process that typically accompanies large capital expenditures and the time required to install our PinPointTM product. In addition, in the United States, the creation of the TSA and formation of a Department of Homeland Security, as well as budgetary debates in Congress, may result in additional delays in the purchase of our PinPointTM products. During the sales cycle we may expend substantial funds and management resources but recognize no associated revenue. Our future international sales subject us to risks that could materially harm our business. It is part of our growth strategy to establish international sales. A number of factors related to our international sales and operations could adversely affect our business, including: · changes in domestic and foreign regulatory requirements; · political instability in the countries where we sell products; · possible foreign currency controls;   45  · fluctuations in currency exchange rates; · our ability to protect and utilize our intellectual property in foreign jurisdictions; · tariffs, embargoes or other barriers; · difficulties in staffing and managing foreign operations; · difficulties in obtaining and managing distributors; and · potentially negative tax consequences.  Our failure to obtain the requisite licenses, meet registration standards or comply with other government export regulations, may affect our ability to generate revenues from the sale of our products outside the United States, which could harm our business. In particular, our PinPointTM product may be deemed regulated and subject to export restrictions under the U.S. Department of State regulations. Consequently, these regulations may make the product more difficult to sell to a number of countries. Compliance with government regulations may also subject us to additional fees and costs. The absence of comparable restrictions on competitors in other countries may adversely affect our competitive position. Exchange rate fluctuations could cause a decline in our financial condition and results of operations. In 2010, the cost of certain international currencies has decreased, yet such costs may later increase, due to fluctuations in the exchange rate of the U.S. dollar against the Euro or other currencies.  Future fluctuations in this exchange rate or other currencies could adversely affect our results in the event we make foreign sales of our products.  From time to time, as and when we determine it is appropriate and advisable to do so, we will seek to mitigate the effect of exchange rate fluctuations through the use of derivative financial instruments. We cannot assure you, however, that we will continue this practice or be successful in these efforts. Our inability to adapt to rapid technological change could impair our ability to remain competitive. The transportation security scanning industry may undergo significant technological development in response to increased demand for transportation security scanning products. A fundamental shift in technology in our product markets could harm our ability to generate revenues from sales of PinPointTM product and services.  We anticipate that we will incur expenses in the design and initial development and marketing of new products and services. Our competitors may implement new technologies before we are able to, allowing them to provide more effective products at more competitive prices. Future technological developments could: · adversely impact our competitive position; · require write-downs of obsolete technology; · require us to discontinue production of obsolete products before we can recover any or all of our related research, development and commercialization expenses; or · require significant capital expenditures beyond those currently contemplated.  We cannot assure investors that we will be able to achieve the technological advances to remain competitive and profitable, that new products and services will be developed and developed on schedule or on a cost-effective basis that anticipated markets will exist or develop for new products or services, or that our existing product and services will not become technologically obsolete. The transportation security scanning industry is highly competitive. Given the anticipated continuing demand for airport security products, competition may increase. The transportation security scanning industry is intensely competitive and we may not compete successfully. As a result of increased demand for security systems, additional companies may enter the industry. Some of our competitors, and many of the potential new entrants into the transportation security scanning  industry, have financial, technical, production and other resources substantially greater than ours. We believe that some of our competitors have products undergoing TSA certification. Our failure to compete successfully could result in lost sales and could hamper our financial results.  We are reliant upon third party distributors for the distribution and licensing of our PinPointTM and Signature MappingTMproducts in several domestic or foreign jurisdictions, and have reduced our reliance upon our own internal sales force.   46   During the latter half of 2006, we decided to establish a network of distributors, sales representatives and consultants to assist us in the distribution and licensing of our products domestically and in certain foreign countries, including those business relationship established during 2009 and 2010.  Such distributors, sales representatives and consultants have not effected any sales of our PinPointTM, or Signature MappingTM products to date and we have no assurance they will be able to effect any such sales in the future.  We continue to review sales activities under certain of such arrangements and, as our agreements with such third parties expire, we may determine not to renew or we may terminate such agreements, or establish new relationships. Litigation may be necessary to enforce or defend against claims of intellectual property infringement, which could be expensive and, if we lose, could prevent us from selling our products. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation, regardless of the outcome, could be costly and require significant time and attention of key members of our management and technical personnel.  Our domestic and international competitors, many of whom have substantially greater resources and have made substantial investments in competing technologies, may have patents that will prevent, limit or interfere with our ability to manufacture and sell our products. We have not conducted an independent review of patents issued to third parties. Because of the perceived market opportunity we face, companies possessing technology rights that they believe we might be infringing will now be much more motivated to assert infringement of their rights. These third parties may assert infringement or invalidity claims against us and litigation may be necessary to defend against these claims. An adverse outcome in the defense of a patent suit could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease selling our products. Even successful defenses of patent suits can be costly and time-consuming.        ITEM 1B.  UNRESOLVED STAFF COMMENTS  Not applicable to Registrant as Registrant is not an accelerated filer or large accelerated filer as such terms are defined in Rule 12b-2 under the Exchange Act.        ITEM 2.     PROPERTIES Applied Visual Sciences, Inc. previously leased 15,253 square feet for its headquarters building in Herndon, Virginia, pursuant to a 5 year commercial lease that expired on April 30, 2010.  The monthly rent during the lease was approximately $27,619.  The Company elected not to exercise the renewal option provision of the lease, and negotiated with the landlord to lease 3,269 square feet of office space in the same business park.  The new lease, for a monthly lease payment of $5,585, was entered into on April 13, 2010 and expires on April 30, 2011. The lease term included a security deposit of $22,244, of which one-half of the security deposit was returned after the first six months of the lease, resulting in a net security deposit at December 31, 2010 of $11,122. The Company believes that such office space will be sufficient for its current needs.  Although the lease does not contain a renewal provision, we are negotiating to extend the lease with provisions to expand as needed during the next 12 months.  The Companys principal offices are located at 250 Exchange Place, Suite H, Herndon, Virginia 20170. Our telephone number at such address is (703) 464-5495.         ITEM 3.     LEGAL PROCEEDINGS  None.                PART II        ITEM 5.     MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES  Our common stock is quoted on the OTC Bulletin Board. Since, July 9, 2010, our stock has been quoted under the symbol APVS, and prior such time our stock was quoted under the symbol GDTI.  The following table sets forth the high and low bid prices for each quarter during 2010 and 2009.  Fiscal Year Ended December 31, 2010:HighLow   47   First Quarter$0.23$0.11Second Quarter$0.48$0.13Third Quarter$0.69$0.25Fourth Quarter$0.38$0.25Fiscal Year Ended December 31, 2009:First Quarter$0.50$0.08Second Quarter$0.40$0.22Third Quarter$0.30$0.17Fourth Quarter$0.25$0.10  These quotations reflect interdealer prices, without retail markup, markdown, or commission and may not represent actual transactions.  As of March 30, 2011, there were approximately 330 holders of record of our common stock.  This amount does not include beneficial owners of our common stock held in street name.  Our stock and warrant transfer agent is Signature Stock Transfer, Inc., 2632 Coachlight Court, Plano, Texas. Signatures telephone number in the U.S. is (972) 612-4120, and their Internet address is www.signaturestocktransfer@msn.com. Dividends We have never declared or paid cash dividends on our common stock.  Currently, we intend to retain earnings, if any, to support our growth strategies and do not anticipate paying cash dividends in the foreseeable future. Payment of future dividends, if any, will be at the discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion.  SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS  The following table sets forth, as of December 31, 2010, information with regard to equity compensation plans (including individual compensation arrangements) under which our securities are authorized for issuance.                                                Plan CategoryNumber of Securities to be issued upon exercise of outstanding options (a)Weighted-average exercise price of outstanding optionsNumber of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))Equity compensation plans approved by stockholders16,394,621$0.3211,812,819Equity compensation plans not approved by stockholders0015,929,563Total16,394,621$1.0327,742,382  RECENT SALES OF UNREGISTERED SECURITIES  On February 24, 2011, we sold to an institutional accredited investor an aggregate of 600,000 shares of common stock and common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds to us of $150,000 (or $136,000 net of certain expenses and sales commissions in the amount of $14,000).  The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agents warrants as compensation in connection with the offering.  The placement agents warrants are under the same terms and conditions as those issued to the institutional investor.  We paid a commission to the broker in the aggregate amount of $9,000 in connection with the offering.  The Common Stock and Warrants were sold to an accredited investor in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  From February 1 - 23, 2011, the Company sold an aggregate of 800,000 shares of Common Stock and an aggregate of 800,000 Class Q Common Stock Purchase Warrants to three accredited investors for gross proceeds to the Company of approximately $200,000 ($197,000, net of commissions and expenses in the amount of $3,000).  In connection with the sale of securities, a placement agent fee of $3,000 was paid. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price   48  of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in thirty-six (36) months from the date of issuance. The Common Stock and Class Q Warrants were sold in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On February 7, 2011, the Company issued to a vendor 678,861 shares of common stock as full payment towards an outstanding accounts payable, with the fair value of the common stock of $213,163. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On January 31, 2011, the Company issued to a vendor 89,355 shares of common stock as final payment towards an outstanding accounts payable, with the fair value of the common stock of $29,487. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On January 4, 2011, the Company issued to a consultant 175,000 shares of common stock.  The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On December 16, 2010, the Company agreed to convert a $50,000 outstanding convertible promissory note for 200,000 shares of common stock, and 200,000 Class M common stock purchase warrants. The conversion price of the note was $0.25 per share. The note holder also converted a total of $7,630 accrued and unpaid interest for an aggregate of 30,520 shares of common stock, and 30,520 Class M common stock purchase warrants. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. The Common Stock and Class M Warrants were sold in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  During November through December 2010, the Company sold an aggregate of 400,000 shares of Common Stock and an aggregate of 400,000 Class P Common Stock Purchase Warrants to two accredited investors for gross proceeds to the Company of approximately $100,000. In connection with the sale of securities, a finder fee of $7,000 was paid and 28,000 Class P Warrants were issued. The Warrants issued are exercisable at a price of $0.50 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in thirty-six (36) months from the date of issuance. The Common Stock and Class P Warrants were sold in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  During October through December 2010, the Company issued to a vendor 374,605 shares of common stock as payment towards an outstanding accounts payable. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On October 26, 2010, in accordance with an outstanding capital raise, four executives and a consultant/director of the Company converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation in an aggregate of $1,267,706, for a total of 5,070,825 shares of Common Stock, and an aggregate of 5,070,825 Class N Common Stock Purchase Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  The Company also issued to such executives and consultant/director, an aggregate of 1,000,000 shares of common stock, and such issuance was previously authorized for all employees as compensation for the hardship of not regularly receiving their salaries, wages, or other compensation that was due during June 2008 through January 2009, and the continued or continuing nonpayment of such amounts by the Company. The issuance of the Common Stock was not in lieu of the payment of such compensation which remained accrued and unpaid. The Common Stock and Class N Warrants were issued in reliance upon the exemption from the registration requirements set forth in Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On October 18, 2010, the two outstanding debenture holders converted $638,163 of accrued and unpaid interest for 2,552,653 shares of common stock. The conversion price of the interest was $0.25, which was based on the conversion rate per the debenture agreement. The Common Stock was sold in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.  On October 1, 2010, the Company issued to a vendor 95,123 shares of common stock as payment towards an outstanding accounts payable, with the fair value of the stock of $29,488. The Common Stock was issued in reliance upon the exemption from the registration requirements set forth in Section 3(a)(9) and/or Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.   49          ITEM 6.     SELECTED FINANCIAL DATA  The selected financial data set forth below for Applied Visual Sciences, Inc. for the years ended December 31, 2010, and 2009, are derived from the audited consolidated financial statements and related notes included in this report. Historical results are not necessarily indicative of the results of operations for future periods.  The data set forth below is qualified in its entirety by and should be read in conjunction with Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements set forth in full elsewhere in this report.              Selected Financial DateYear Ended December 3120102009Statement of Earnings Data:Revenue$ 110,499$ 91,504Operating loss(4,643,400)(5,583,584)Net loss(3,650,231)(8,533,514)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization110,084116,749Stock-based compensation expense (1)1,559,2151,331,631Amortization of derivative instruments (2)-541,155Fair value of warrants issued - derivative instruments (3)38,550-Revaluation of derivative instruments (income) (4)(1,447,236)2,571,389Gain on settlement of debt (5)(265,600)(931,392)Noncash broker compensation expense-32,000Other noncash - stock issued in lieu of interest paid681,11735,481Per Share Data:Basic and Diluted Loss Per Share$ (0.05)$ (0.16)Cash Flow Data:Net cash provided (used) in operating activities$ (1,230,527)$ (2,320,209)Net cash provided (used) in investing activities(79,926)(37,514)Net cash provided by financing activities1,306,2302,283,454Effect of exchange rates on cash and cash equivalents3902,199Balance Sheet Data:Cash and Cash Equivalents$ 4,874$ 8,707Total Assets756,749746,779Total Liabilities10,822,31813,398,581Common Shares Subject to Repurchase98,94642,311Stockholders' Equity (Deficit)(10,164,515)(12,694,113)(1) Stock-based compensation expense represents the estimated fair value of stock-based compensation to employees and consultants in lieu of cash compensation.(2) Represents non-cash interest expense, note discounts, and amortization of deferred financing costs associated with the convertible debentures issued in November 2006 and April 2007.(3) Represents non-cash expense for issuance of warrants measured at fair value in consideration of ASC 815-40 (formerly EITF 00-19) relating to provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company*s Own Stock.(4) Represents non-cash income from the revaluation of convertible debentures and related warrants issued in November 2006 and April 2007, and other warrants issued between November 2006 and May 20, 2008. This reflects the conclusion that convertible note contracts should be analyzed under the provisions of ASC 815-10 (formerly SFAS 133) relating to  *Accounting for Derivative Instruments and Hedging Activities,* and the embedded derivative features should be bifurcated and separately measured at fair value.  We also considered ASC 815-40 (formerly EITF 00-19) relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company*s Own Stock.  Also represents for 2010 and 2009, $2,587,216 and $1,864,917 respectively, provisions for a contingency due to a default provision of the convertible debentures and in considering FASB No. 5, "Accounting for Contingencies"(5) Represents non-cash income from the elimination of the beneficial conversion feature upon conversion of debt related to the convertible debentures issued in November 2006 and April 2007. We considered ASC 815-40 (formerly EITF 00-19) relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company*s Own Stock.       ITEM 7.     MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  GENERAL   50   You should read the following summary together with the more detailed information and consolidated financial statements and notes thereto and schedules appearing elsewhere in this report.  Throughout this report when we refer to the Company, Applied Visual Sciences, we, our or us, we mean Applied Visual Sciences, Inc., and its subsidiaries.  This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities.  On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to revenue recognition, intangible assets, and contingencies.  We base our estimates on historical experience, where available, and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions and conditions.  Except for historical information, the material contained in this Managements Discussion and Analysis is forward-looking.  Our actual results could differ materially from the results discussed in the forward-looking statements, which include certain risks and uncertainties.  These risks and uncertainties include the rate of market development and acceptance of our intelligent imaging informatics (3iTM”) technology (particularly for our PinPointTM and Signature MappingTM products), the unpredictability of our sales cycle, the limited revenues and significant operating losses generated to date, and the possibility of significant ongoing capital requirements.  Our independent registered public accounting firms report on the consolidated financial statements included herein for the years ended December 31, 2010 and 2009 contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern. Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.  OVERVIEW  We were incorporated under the name Guardian Technologies International, Inc., in the Commonwealth of Virginia in 1989 and reincorporated in State of Delaware in February 1996. We changed our name to Applied Visual Sciences, Inc., on July 9, 2010.  Applied Visual Sciences, Inc. and its subsidiaries are collectively referred to herein as the Company, Applied Visual, us, we, or our.  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” (“3iTM”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists diagnostic imaging tools. Product development in these areas is ongoing, and while there can be no assurance, we believe that the technology should produce results equal to or greater than those currently achieved in baggage scanning.  On July 19, 2010 we announced that we had expanded ours organizational structure to better reflect our business operations and to provide an enhanced operational structure to capitalize on domestic and international business and joint product development opportunities.  We changed our name to Applied Visual Sciences, Inc. (APVS) and our common stock began to be quoted on the OTC Bulletin Board under symbol APVS. APVS serves as the holding company and IT development organization for the group.  The Company has achieved certain significant corporate life cycle milestones that necessitated a more diverse corporate structure.  The purpose of the structure is to segregate distinct business operations into separate corporate entities, all under a single umbrella organization. Our two wholly-owned operating subsidiaries are: Guardian Technologies International, Inc. - the homeland security/defense technology entity, and Signature Mapping Medical Sciences, Inc. - the healthcare technology entity.  APVS will maintain ownership of all existing and in-process patents, as well as any future patentable technology developed by its research and development   51  staffs, or developed as a tangential application of its core patented technologies.  Our subsidiaries will be the business operations focused on new product development, marketing, and sales for their respective markets. By structuring in this manner, as a means to conduct business, we expect to realize the following benefits: · Creation of autonomous business units with defined measurable goals and objects; · Alignment of risk characteristics to the specific product, line of business or foreign market; · Provide a level of legal risk insulation to the core assets, the patents & intellectual property; · Flexibility to maximize tax benefits, both domestic & foreign activities; · Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships; · Facilitate the potential spin-off of one of the subsidiary entities; · Facilitate the potential sale of part of the company; and, · Attract investment from investors that focus on specific industries.  Currently, we are focused on providing technology solutions and services in two primary markets, healthcare and aviation/homeland security. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry. We may also engage in one or more acquisitions of businesses that are complementary to our business.  Further, we may form wholly-owned subsidiaries to operate within defined vertical markets.  Please refer to Item 1A - Risk Factors, above for certain risks related to us and our businesses.  We offer two principal “intelligent imaging informatics” (“3iTM”) products, and a third product, FlowPointTM that was discontinued in 2008:  Aviation/Homeland Security Technology Solution – PinpointTM  Our PinPointTM product is an “intelligent imaging informatics” (3iTM) technology for the detection of guns, explosives, and other threat items contained in baggage in the airport environment or for building security applications.  PinPointTM can identify threat items, notify screeners of the existence of threat items, and speed the security process by eliminating unnecessary baggage checks, provide the screener with an instantaneous second opinion, and reduce processing time spent on false positives (baggage selected for security review that contains no threat items).  We market and seek to license the PinPointTM product primarily to the United States Transportation Services Administration (TSA) for use in airports, the Federal Protection Services for use in federal buildings and to foreign governments and airport authorities. We compete with manufacturers of baggage screening, luggage and large parcel screening, people screening for weapons and explosive detection, container and vehicle screening, and cargo screening equipment and certain software companies and academic institutions that are developing solutions to detect threat items.  It is also our intent to distribute the product through various distribution methods.  The market for contraband detection systems is anticipated to become intensely competitive and many of our competitors are better capitalized and have greater marketing and other resources than Applied Visual Sciences, Inc.  PinPointTM continues to be developed to address the market for contraband detection.The extended alpha version working model of PinPointTM has been tested successfully at live carry-on baggage checkpoints in three international airports. Integration within currently deployed manufacturers’ scanning equipment is a requisite to anticipated sales, and is considered a significant development risk. PinPointTM is available for sale to customers; however no sales are anticipated until we are able to seamlessly integrate with the manufacturers scanning equipment. Towards that end, we signed a Strategic Alliance and Joint Development Agreement with Control Screening (d.b.a. AutoClear), and are integrating our PinPointTM technology with their threat detection hardware (AutoClear 6040 baggage scanner and multi-view AT prototype scanner).  Currently, there are limited standards within the aviation security marketplace for the testing and validation of software technology solutions.  To date the marketplace has placed a premium on the newest innovations in hardware technology and has failed to grasp how a threat detection software solution can succeed.  A major joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) is expected to open a path to both increase the interoperability of security equipment as well as provide a mechanism to use third party threat detection software as part of the screening solution.  This enabling initiative is the Digital Imaging and Communications in Security (DICOS) standard, similar to the Digital Imaging and Communications in Medicine (DICOM) standard.  With a defined standard for the output of each screening device, complimentary automated threat detection software can be appended to any x-ray equipment.  The schedule for publication of this standard is being driven by the expected purchase by DHS/TSA of new   52  security screening equipment for over 400 US airports.  Applied Visual Sciences, Inc. is the co-chair of one of the three NEMA working groups drafting the DICOS standard.  As highlighted below in the NEMA article, DICOS - Homeland Security Spending Keeps on Growing - Published  by  HYPE , expenditures for security solutions are increasing.  Management believes Applied Visual Sciences, Inc. is well positioned to be a third party solution provider leveraging the standard output of all future security equipment procured by the US Government.  Global homeland security spending has received a major boost in light of recent international terrorist events, as countries look at new ways to thwart terrorists and secure borders. Spending in the industry is expected to triple to $178 billion by 2015.  Security-related spending will include more sophisticated information technology and the protection of other vulnerable terrorist targets.  With the initial focus on airport security, NEMA has stepped up its outreach to DHS and TSA. Currently developing DICOS, the new NEMA standard will capture scans of checked baggage so that scans can be read by threat detection software. The new standard will facilitate interoperability of security-imaging equipment. With DHS/TSA expected to purchase new equipment for over 400 U.S. airports, NEMA members have joined with DHS to develop the standard.  With Phase 1 of DICOS expected to be completed this year, NEMA has begun looking at other modalities. The security industry is looking at border, rail, seaport, industrial and nuclear plant security.  Management believes that international market acceptance of PinPointTM as a viable threat detection solution will not only enhance our ability to sell worldwide, but it will open additional opportunities for the development of PinPointTM as the “intelligent image analysis solution for areas such as military target acquisition, satellite remote sensing, and additional opportunities within aviation security such as whole-body scanners and cargo scanning.  Additionally, we will seek support of the U.S. Congress and the equipment manufacturers through lobbying and other efforts.  We remain focused on the ongoing development of PinPointTM, particularly with respect to field test results as well as the promotion of DICOS as the medium for deployment.  This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country. Market acceptance is a key to our future success.  Applied Visual Sciences, Inc. continued to perform research and development activities in accordance with the terms of its February 17, 2009 extension for two years of the Cooperative Research and Development Agreement (CRDA) with the Transportation Security Administration (TSA) that was initially signed on August 18, 2006, and previously renewed on August 8, 2007 and February 12, 2008, with the United States Department of Homeland Security Science and Technology Directorate, for testing and validation of the PinPointTM product capabilities at the Transportation Security Labs (TSL). The project began on September 5, 2006 for explosive image collection, which is being followed by refinement of the development and testing of PinPointTM.  While TSA certification is not absolutely essential to the acceptance of Applied Visual Sciences, Inc.’s PinPointTM product, we believe that having TSA certification and a business relationship with the TSA is important to our strategic growth plans, as the relationship represents an important opportunity to obtain contracts for the licensing of our baggage scanning applications and for future aviation and transportation security applications and solutions that we develop or enhance.  We completed a funded research and development contract with the U.S. Department of Homeland Security (DHS).  As part of the project, we have also entered into a Mutual Non-Disclosure Agreement with DHS. The scope of work is focused on the expansion of PinPoint’sTM capabilities to include the detection of certain TSA specified explosives for future deployment on both existing and future deployed scanners.  We are in discussions with a security company in South Africa as well as the government to provide our PinPointTM technology.  We submitted proposals for locations within the U.S. that are designated ‘high threat targets” to provide PinPointTM for private facility security. These opportunities would permit Applied Visual Sciences, Inc. to have deployed sites in a public facility as well as other advantages.  We will continue to pursue opportunities for the deployment of our PinPointTM product.  During 2009, we received one export licenses for demonstration purposes as we further pursued the opportunity in South Africa.  During 2008, we received three export licenses for demonstration purposes for opportunities in Saudi Arabia, India and South Africa.  We are also pursuing an additional market opportunity using our 3iTM platform technology, adding to our detection family of products.  PinPoint nSightTM provides visualization enhancements that allow bomb technicians and investigators to assess the presence of explosives more rapidly and accurately using single-energy x-ray scanners.  The technology adds textural and color components to such images, helping bomb investigation technicians detect threats that would otherwise be unseen by the human eye. The PinPoint nSightTM product is currently being evaluated at the Federal Bureau of Investigation (FBI) Hazardous Device School at Redstone Arsenal, Alabama.  In May 2006, we entered into a Reseller Agreement with Logos Imaging LLC (Logos), a manufacturer of portable bomb scanning equipment, with regard to the distribution of PinPoint nSightTM.  During fiscal 2007, we sold Logos 10 licenses of our threat assessment software technology for bomb detection scanners, PinPoint nSightTM. We are also continuing to develop other distributor relationships in an effort to increase market penetration our nSightTM product.   53   Management believes that international market acceptance of PinPointTM as a viable threat detection solution will not only enhance our ability to sell worldwide, but it will open additional opportunities for the development of PinPointTM as the intelligent image analysis solution for areas such as military target acquisition, satellite remote sensing, and additional opportunities within aviation security such as people portals and cargo scanning.  Additionally, we will seek support of the U.S. Congress and the equipment manufacturers through lobbying and other efforts.  We remain focused on the ongoing development of PinPointTM, particularly with respect to field test results.  This focus must be even sharper as we enter the pilot test arena where the duration of the pilot test, the conditions under which the pilot test is conducted, and the definition of success and failure will vary country-by-country. Market acceptance is a key to our future success.  Healthcare Signature MappingTM Solution  In an effort to expand upon the use of our core technology 3iTM “intelligent imaging informatics,” we are migrating and adopting our threat detection algorithms and quantitative imaging capabilities for use in the imaging field of diagnostic radiology and pathology.  The technology is called Signature MappingTM.Our Signature MappingTM platform technology represents the technological basis upon which we expect all diagnostic radiology and pathology applications will be developed. Any Signature MappingTM product introduced in the United States may be subject to Food and Drug Administration (“FDA”) review and approval, including with regard to its safety and effectiveness before we may begin marketing and selling any such product in the U.S. Such approval may require us to obtain extensive data from clinical studies to demonstrate such safety or effectiveness.  Within the international markets the regulatory requirements differ, specifically in South Africa, where we are testing our TBDxTM application for the detection of tuberculosis by analyzing digital images of auramine stained sputum slides captured through a photo microscopy system.  There may be similar regulatory requirements in foreign countries in which we seek to market and sell our healthcare CAD products. Similar to a persons fingerprint, each tissue has a unique structure. Each structure creates a unique pattern or signature that can be extracted from an image to differentiate, locate, identify, and classify by using our Signature MappingTM technology.  Signature MappingTM is expected to further help radiologists by visualizing the various structures within a particular tissueso they can be examined and quantified. This capability is expected to provide a next-generation image analysis, clarification, visualization and Signature Mapped TM “tissue characterization” and detection.  Management believes that it will add significant clinical value to a wide range of difficult to detect diseases in diagnostic radiology by distinguishing and characterizing different tissue types in images regardless of the modality that generated the image. Based on its unique properties, Signature MappingTM is expected to be capable of being used to analyze images generated across all imaging modalities without the need for new image capture hardware costs.  It will serve as a software-based, multi-modality approach to image analysis when combined with Signature Mapping’sTM unique” tissue characterization” and detection. As a result, Signature MappingTM is expected to differentiate the contrast resolution between different tissue types, even when the material or tissue in the image is very diffuse or obscured by other objects, such as is the case where diseased lung tissue is located behind a rib in an x-ray chest examination. It is capable of displaying these signatures in a way that empowers radiologists to make a more informed and confident diagnosis, even for hard to distinguish structures such as masses in dense breast tissue.  Signature MappingTM appears to provide advantages for providing the knowledge for automatic detection.  The development of a “tissue characterization” and detection model employs the use of supervised machine learning and contextual image analysis to analyze and classify the features associated with the newly created “signatures.”  The fusion of these three technologies is known as Applied Visual Sciences, Inc.’s Intelligent Imaging Informatics 3iTM. Unlike other pattern recognition methodologies, the 3iTM solution can reveal and differentiate inherent structures for all materials in an image regardless of:  The imaging modality used to create the image, Location within the image, Shape or texture, and Object orientation even if obscured by its relationship to other materials.  Clinical Experience and Medical Accomplishments While Signature MappingTM is expected to be capable of use in a wide range of medical image analysis applications, our initial application product development efforts are focused in four areas:  detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system; breast cancer detection using x-ray mammography, MRI and ultrasound; neurological imaging analysis through the detection and quantification of acute intracranial hemorrhage using non-contrast CT, normal pressure hydrocephalus, and multiple sclerosis using MRI. In addition, chest radiography targeted at tuberculosis and silicosis detection using digital x-ray.  In July 2007, we entered into an agreement with the Medical Imaging Informatics (MI2) at the Keck School of Medicine, University of Southern California to conduct a multiple-phase process to clinically evaluate, and give feedback on potential enhancements   54  to, our 3iTM “intelligent imaging analysis” solutions as applied to medical radiology imaging.  Our 3iTM product segments clarifies, distinguishes and identifies organic objects even when masked by one or more other objects of similar density and chemical composition.  This is an expected product extension of our 3iTM-based computer-aided detection technology in adapting scientific principles employed for explosives detection to medical image analysis.  We continued our collaboration relationship with a new agreement dated July 19, 2007 for a one year term, to include clinical studies for our Signature MappingTM product.  The first half of the collaboration focused on image-based visualization and CAD solutions for the detection of breast cancer on mammograms, and the second half of the collaboration will be for the detection of small acute intracranial hemorrhage (AIH) on CT.  Our research to-date includes five programs and studies conducted under the direction of the Image Processing and Informatics Laboratory at the University of Southern California (USC) using clinical data and images provided by: the Image Processing and Informatics Laboratory at USC, Howard University, and the South Florida Clinical Mammography Data Base.  In addition a program and study for the detection of TB in stained sputum slides through a photo microscopy system at the National Health Laboratories of South Africa.  Competition is expected to be with existing CAD manufactures such as iCAD, Hologic, Medipatten, Confirma, Siemens, or Carestream Health.  We may also partner with one or more of these existing CAD manufacturers, or an emerging company with new technology for the CAD arena.  Once our products are commercially viable, we anticipate marketing and selling our products through original equipment manufacturers (OEM), or system integrators.  Although there is no current computer-aided-detection for TB sputum microscopy analysis, which can be identified as competition to Signature MappingTM, there are substitute technologies, which in the long run could compete for sputum specimen analysis.  The dipstick or biomarker approach could be considered a future competitor to Signature MappingTM. Ultimately, competition to our approach will be driven by its cost per procedure, ease-of-use, sensitivity and specificity, and ability to be used by non-trained or lightly trained personnel in the point of care environment. These emerging tests are Polymerase Chain Reaction, TB Breathalyzer, Q-Beta Replicase Assay, Transcription-Medicated Amplification, Ligase Chain Reaction, Strand Displacement Amplification, Nucleic Acid Sequence-Based Amplification and Branched DNA and Cepheid Systems GeneXpert® System.  LIQUIDITY AND CAPITAL RESOURCES  The following table presents a summary of our net cash provided by (used in) operating, investing and financing activities:          Year Ended December 31Category20102009Net cash provided (used) in operating activities$ (1,230,527)$ (2,320,209)Net cash provided (used) in investing activities(79,926)(37,514)Net cash provided by financing activities1,306,2302,283,454Effect of exchange rates on cash and cash equivalents3902,199Net increase (decrease) in cash$ (3,833)$ (72,070)   Net Cash Used in Operations  Net cash used in operating activities for the fiscal year ended December 31, 2010, was $1,230,527, compared with net cash used in operating activities of $2,320,209 during the same period for 2009, or a decrease in the use of cash for operating activities of $1,089,682 (47.0%). The decrease in the use of cash is due to: (i) lower operating costs of $1,851,931 (38.3%), including but not limited to an increase in revenue of $18,995 (20.8%), a decrease in cost of sales of $56,811 (55.7%), decreases in selling, general and administrative costs (other than depreciation and amortization, and stock based compensation) of $1,039,347 (25.2%), and a decrease in net interest income and expense (other than noncash items) of $736,781 (100.0%); and (ii) offset by a net decrease in components of operating assets and liabilities of $762,249 (30.3%).  Net Cash Used in Investing Activities  Net cash used in investing activities of $79,926 was for the net purchase of equipment and costs for patent applications for the year ended December 31, 2010. This compares with net cash used for the same activities of $37,514 for 2009, or an increase of $42,412, or 113.1%. The net increase is comprised of higher equipment costs for the TBDx project of $41,576 (1163.6%), and increased patent costs of $836 (2.5%). The Company anticipates it will continue to incur equipment costs during the current fiscal year ending December   55  31, 2011, as we design add-on features that extend our current products into other areas, and ongoing patent costs related to further protection of our PinPointTM and Signature MappingTM products.  Net Cash Provided by Financing Activities  Net proceeds from financing activities were $1,306,230 for the year ended December 31, 2010, compared with $2,283,454 for the same period in 2009, or a decrease of $977,224 (42.8%). Of the 2010 proceeds from financing activities, $1,115,280 (85.4%) was from the issuance of a new equity financing, $262,500 (20.1%) from the exercise of stock purchase warrants, $37,350 (2.9%) from the exercise of employee stock options, and $108,900 (8.4%) use of cash for the reduction of short-term note payable from an executive of the Company. The decrease in the net cash provided by financing activitiesis due to (i) a reduction of $725,000 (100.0%) from short-term convertible notes, (ii) a reduction of $443,174 (28.4) from the issuance of new equity financings, (iii) an increase in use of funds of $108,900 to reduce short-term note payable from an executive of the Company, (iv) an increase in funds of $262,500 (100%) from the exercise of common stock purchase warrants, and (v) an increase in funds of $37,350 from the exercise of employee stock options. Management is seeking, and expects to continue to seek to raise additional capital through equity or debt financings or bank borrowings, including through one or more equity or debt financings or bank borrowings to fund its operations, repay or repurchase its debentures, and pay amounts due to its creditors and employees. However, there can be no assurance that the Company will be able to raise such additional equity or debt financing or obtain such bank borrowings on terms satisfactory to the Company or at all.  Cash and Cash Equivalents  Our cash and cash equivalents decreased during fiscal year ended December 31, 2010 by $3,833, compared to a decrease in cash and cash equivalents during the same period in 2009 of $72,070. As outlined above, the decrease in cash and cash equivalents for the current fiscal period was the result of; (i) cash used in operating activities of $1,230,527, (ii) cash used for the net purchase of equipment and patent costs of $79,926, (iii) an increase in cash by $1,306,230 from financing activities, and (iii) $390 from the favorable effect of currency exchange rates. The net change in cash and cash equivalents for the twelve months ending December 31, 2010, as compared to the same period in 2009, was $68,237 (94.7%), and is the result of a decrease in cash used in operating activities of $1,089,682 (47.0%), an increase from the net purchase of equipment and patent costs of $42,412 (113.1%), a decrease of 1,809 (82.3%) from the negative effect of currency exchange rates, and offset by a reduction of $977,224 (42.8%) from financing activities.  Working Capital Information - The following table presents a summary of our working capital at the end of each fiscal year:                        As of December 31Category20102009Cash and cash equivalents$ 4,874$ 8,707Current assets93,68242,300Current liabilities10,822,31813,398,581Working capital (deficit)$ (10,728,636)$ (13,356,281)   At December 31, 2010, we had a working capital deficit of $10,728,636, compared with a working capital deficit at December 31, 2009 of $13,356,281, a decrease in working capital deficit of $2,627,645 (19.7%). For 2010, overall current assets increased $51,382 (121.4%), including (i) decrease in cash and cash equivalents of $3,833, (ii) increase in accounts receivable of $57,655, and (iii) decrease in prepaid expenses of $2,440. Current liabilities decreased $2,576,263 (19.2%), with specific decreases in liabilities of $5,373,943, including: i) $3,808 in deferred revenue, ii) deferred rent of $9,132, (iii) $36,482 of accrued interest on short-term notes converted for stock, iv) $108,900 in note payable, related party, v) $219,400 for conversion of accounts payable for stock, vi) $265,600 for the reduction of derivative liabilities (beneficial conversion feature) due to conversions of debentures, vii) $402,742 for waiver by the debenture holders of additional interest and late fees, viii) $427,500 for conversion of debentures for stock, ix) $638,163 for conversion of regular interest on debentures for stock, (x) a decrease in short-term promissory notes of $675,000 that were converted for stock, and xi) waiver of prior years default provision by the debenture holders of $2,587,216, and specific increases in current liabilities of $2,797,680, including: (i) $405,439 in other trade payables, ii) $1,139,980 for the revaluation of derivative liabilities (beneficial conversion feature) related to the convertible debentures, and iii) $1,252,261 for the continued accrual and unpaid wages and related expenses for all employees.  As of December 31, 2010, the Company had cash and cash equivalents of $4,874 as compared to $8,707 on December 31, 2009. The decrease in cash is the net result of our operating, investing and financing activities outlined above. Our revenue generating activities during the period, as in previous years, have not produced sufficient funds for profitable operations, and we have incurred operating losses since inception. Accordingly, we have continued to utilize the cash raised in our financing activities to fund our operations. In addition to raising cash through additional financing activities, we may supplement our future working capital needs   56  through the extension of trade payables and increases in accrued expenses. In view of these matters, realization of certain of the assets in the accompanying balance sheet is dependent upon our continued operations, which in turn is dependent upon our ability to meet our financial requirements, raise additional financing, and the success of our future operations.  Other Liabilities  2009 Convertible Promissory Notes  During the period of June through August 2009, at a series of closings, Applied Visual Sciences, Inc. issued six-month convertible promissory notes to a total of 12 accredited investors in the aggregate principal amount of $725,000. The six-month notes accrued interest at a rate of 10% per annum. The notes were convertible, at the holders option, into shares of common stock at a conversion price of $0.25 per share. If converted, each holder is entitled to receive Class M common stock purchase warrants for the right to purchase an equal number of shares and they are exercisable at a price of $0.25 per share, contain certain anti-dilution and other customary provisions, and expire sixty (60) months from the date the warrants were issued. On December 31, 2009, the Company had an aggregate principal amount outstanding of $675,000 from eleven (11) note holders.  During the year ended December 31, 2010, all note holders converted an aggregate principal amount of $675,000 and $71,999 of accrued interest into an aggregate of 2,987,995 shares of common stock, and 2,987,995 Class M Warrants.  The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  2006 and 2007 Series A Debentures and Series D Common Stock Purchase Warrants  Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. The Company issued an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants at a first closing held on November 8, 2006 and, due to the price reset conversion feature embedded in the notes and the warrants, the transaction was recognized as a liability under generally accepted accounting principles. We also issued an aggregate of 623,520 common stock purchase warrants to the placement agent in such financing which were upon terms substantially similar to the Series D Warrants. Due to milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was indeterminable as of December 31, 2007. The Company issued an additional $2,575,000 in principal amount of the Series A Debentures at a second closing held on April 12, 2007, following the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. The Company allocated proceeds from the second closing to the embedded conversion features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. One-half of the Series D Warrants became exercisable on November 8, 2006 (2,226,854 warrants), and the remaining one-half became exercisable on April 12, 2007 (2,226,855 warrants). The Series D Warrants and the placement agents warrants issued as compensation in the offering to Midtown Partners & Co., LLC, may be exercised via a cashless exercise if certain conditions are met. The Company considered ASC 815-40 (formerly EITF 00-19, relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock), and concluded that there were insufficient shares to share settle the contracts. The Series D Warrants that became exercisable at the first closing will expire on November 8, 2011, and those related to the second closing will expire in April 12, 2012. On April 1, 2007, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agents Warrants issued as compensation to Midtown Partners & Co., LLC, were reset to a price $0.7453 per share, to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. As a result of a June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,281,109 Series D warrants. Our outstanding Series A convertible debentures became due on November 7, 2008.  During the twelve months ended December 31, 2010, our debenture holders converted an aggregate of $427,500 in principal amount, and $638,163 of accrued interest into an aggregate of 4,262,653 shares of our common stock. As of December 31, 2010, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of December 31, 2010, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted, and 4,995,222 Series D Warrants remain unexercised. Proceeds of the two offerings were used for the purpose of hiring new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO.  As of the date of the filing of this report, approximately 13,566,734 warrants (excluding the warrants exercisable by the debenture holders) may be exercised pursuant to the cashless exercise provisions of such warrants, which may be subsequently resold as   57  restricted securities under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Companys common stock could cause the market price of the Companys common stock to drop.  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and the Company was considered in default for nonpayment of principal and unpaid interest and late fees.  The holders though had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures. During 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock. The Company has and may in the future seek to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although the Company has not reached any agreement with our debenture holders with regard to any such repayment, repurchase or extension.  The Companys ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance.  Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures.  Also under the Debenture amendment agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures.  Such a forced conversion may only be effected once every 90 days and the ability of the Company to force any such conversion is subject to certain equity conditions, which conditions were amended under the terms of the Debenture Amendment Agreement in accordance with the following:  · if the variable weighted average price for the Companys common stock (VWAP) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for the Companys common stock during such period equals or exceeds $50,000, the Company may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; · if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, the Company may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; · if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, the Company may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.  The Company did not make timely payment of the interest due under our Series A 10% Senior Convertible Debentures on July 1, 2008, through October 1, 2010, which may be deemed to be events of default under the debentures.  The debentures provide that any default in the payment of interest, which default is not cured within five trading days of the receipt of notice of such default or ten trading days after we become aware of such default, will be deemed an event of default. The Company has not maintained the registration of the shares underlying the debentures and Series D Warrants to permit the reoffer and resale of such shares as required under the terms of our agreements with the holders of the debentures which also may have been deemed an event of default under the Debentures.  Failure to pay the principal, unpaid interest and certain late fees under the Debentures when due may have constituted an event of default under the debentures and failure to remit payment of the debentures and all late fees may have resulted in enforcement of the debenture holders rights and remedies under the debentures and applicable law, although the holders did not seek to enforce their rights under the debentures.  We did not maintain the registration of the shares underlying the debentures and Series D Warrants in order to permit the reoffer and resale of such shares as required under the terms of our agreements, which also may be deemed an event of default under the debentures.  If an event of default occurs under the debentures, the debenture holders could elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, plus accrued but unpaid interest, or (b) the outstanding principal amount plus accrued but unpaid interest divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in   58  full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. Also, interest under the debentures accrued at a rate of 18% per annum or the maximum amount allowed under the law and we may be subject to a late fee equal to the lesser of 18% per annum or the maximum rate permitted by law. In the event the debenture holders had made such a demand, the Company had insufficient funds to meet such demand. In anticipation of such election by the debenture holders, due to the late payment of the January 1, 2008 interest payment made on April 8, 2008, we measured the default on December 31, 2007 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense.  We remeasured the default amount as of December 31, 2009 at approximately $2,587,216, and on September 30, 2010 at approximately $2,541,739. This default amount was recognized as interest expense in Fiscal 2007 of approximately $645,641, an additional $76,658 during Fiscal 2008, $1,864,917 during Fiscal 2009, and a net reduction of interest expense during Fiscal 2010 of $45,477. On October 15, 2010, the two remaining Series A Debenture holders waived all defaults and default amount of $2,541,739, which the Company reversed to interest expense.  Prior to the Debenture amendment agreement and absent a default, the Debentures bore interest at the rate of 10% per annum due on the first day of each calendar quarter, upon conversion or redemption of the Debentures as to the principal amount converted or redeemed, or on the maturity date of the Debentures. We could elect to pay interest due under the Debentures in cash or registered shares of our common stock. If we elected to pay the interest due in shares of our common stock, the number of shares to be issued in payment of interest is determined on the basis of 85% of the lesser of the daily volume weighted average price of our common stock as reported by Bloomberg LP (VWAP) for the five trading days ending on the date that is immediately prior to (a) date the interest is due or (b) the date such shares are issued and delivered to the holder. We could pay interest in shares of our common stock only if the equity conditions, described below, have been met during the 20 consecutive trading days prior to the date the interest is due and through the date the shares are issued.  We may redeem some or all of the Debentures at any time after the effective date of the registration statement covering the shares to be issued upon conversion or exercise of the Debentures or Series D Warrants, if for 20 consecutive trading days the closing price of our common stock exceeds $1.7345 (a redemption measurement period). Upon a redemption, we are required to pay to the holder an amount equal to 110% of the principal amount redeemed as well as any accrued but unpaid interest and liquidated damages.  If we decide to redeem a Debenture, we are required to provide notice to a holder within one trading day of the end of the redemption measurement period and to redeem the Debenture 20 trading days after the date we deliver the notice. We may only redeem the Debentures if the equity conditions, described below, have been met on each trading day from the date of the notice to the date we redeem the Debentures, and the trading volume requirement is met during the redemption measurement period through the date we redeem the shares. Before a holder receives payment for the redemption from us, the holder may voluntarily convert the Debenture at the then current conversion price.  As discussed above, the payment of interest in shares of our stock, the redemption of the Debentures and the occurrence of certain other events, was subject to a requirement that certain equity conditions (equity conditions) were met, as follows: (i) we have honored all conversions and redemptions of a Debenture by the holder, (ii) we have paid all liquidated damages and other amounts due to the holder, (iii) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a holder to utilize the registration statement to resell its shares, (iv) our stock is traded on the OTC Bulletin Board or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of our common stock to cover the issuance of the shares upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holders 4.99% or 9.99% ownership restriction cap, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control of the Company may occur and the transaction has not been consummated, (ix) the holder is not in possession of material public information regarding us, and (x) the daily trading volume of our shares for 20 consecutive trading days prior to the applicable date exceeds 100,000 shares.  Under the terms of the Debenture Amendment Agreement, (A) the equity condition in (iii) above was amended to provide that such condition is met if, in the alternative, the shares issuable upon conversion of the Debentures may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered to a holder an opinion of the Companys counsel that such resale may legally be made and provided the holder has furnished a representation letter reasonable acceptable to the Companys counsel that the holder is not an affiliate for purposes of Rule 144; (B) the equity condition in (vi) above was amended to except an event of default that has previously been waived; and (C) the equity condition in (x) above was amended to except circumstances where another volume condition is applicable.  The Debentures contain a limitation on the amount of Debenture that may be converted at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the Debenture. This limitation may be waived upon 61 days notice to us by the holder of the Debenture permitting the holder to change such limitation to 9.99%.    59  We have agreed to compensate a holder of a Debenture in the event our transfer agent fails to deliver shares upon conversion of the Debentures within three trading days of the date of conversion, and the holders broker is required to purchase shares of our common stock in satisfaction of a sale by a holder. If certain events of default occur under the Debentures, holders could accelerate the due date of the interest and principal due under the Debentures, and we may become obligated to pay all costs, expenses and liquidated damages due under the Debenture plus an amount equal to the greater of (i) 120% of the principal and interest due under the Debenture and (ii) the outstanding principal amount of the Debenture and accrued interest divided by the conversion price on the date the amount is due or paid, whichever is higher, multiplied by the VWAP for our shares on the date of demand or payment, whichever is higher.  An event of default may occur under the Debentures if (a) the Company defaults in the payment of interest, liquidated damages or principal, (b) the Company fails to materially observe or perform a covenant or agreement in the Debentures, (c) a default or event of default occurs under any other transaction document related to the financing or in any other material agreement to which the Company is a party that results in a material adverse effect on the Company, (d) any representation or warrant the Company made to investors in the transaction documents related to the financing is materially untrue or incorrect, (e) a bankruptcy event occurs with regard to the Company, (f) the Company defaults on any other loan, mortgage, or credit arrangement that involves an amount greater than $150,000 and results in the obligation becoming declared due prior to the due date, (g) the Companys common stock is not eligible for quotation on the OTC Bulletin Board or other exchange on which the Companys shares are traded, (h) a transaction occurs in which the control of the Company changes, the Company effects a merger or consolidation, the Company sells substantially all of the assets, a tender offer is made for the Companys shares, the Company reclassify their shares or a compulsory share exchange, or the Company agrees to sell more than 33% of the assets, unless the Company receives the consent of holders of 67% of then outstanding principal of the Companys Debentures, (i) the registration statement has not been declared effective within 240 days of the first closing, (j) the registration statement lapses for more than 20 consecutive trading days or more than 40 trading days in a 12 month period, or 60 consecutive trading days and 90 non-consecutive trading days in the event of a material merger or acquisition, (k) the Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (l) the Company has a judgment against them for more than $150,000.  If certain events of default occur under the Debentures, holders could accelerate the due date of the interest and principal due under the Debentures, and we may become obligated to pay all costs, expenses and liquidated damages due under the Debenture plus an amount equal to the greater of (i) 120% of the principal and interest due under the Debenture and (ii) the outstanding principal amount of the Debenture and accrued interest divided by the conversion price on the date the amount is due or paid, whichever is higher, multiplied by the VWAP for our shares on the date of demand or payment, whichever is higher.  The Series D Warrants are exercisable at the same price as the conversion price of the debentures outlined above.  If certain milestones are not met, the conversion price of the Debentures and exercise price of the Series D Warrants may be and were re-set. Also, the exercise price may be adjusted under anti-dilution and other price re-set provisions contained in the Series D Warrants. One-half of the Series D Warrants became exercisable on the date of the first closing on November 8, 2006, and the remaining one-half of the Series D Warrants became exercisable on the date of the second closing on April 12, 2007. The original conversion price was $1.1563 per share, but has been reset to $0.4089 effective May 20, 2008 (the final milestone reset provision).  As a result of the June 2009 financing, in which the Company issued shares of common stock and warrants, the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) would be increased to an aggregate of 6,889,848 shares.  The Series D Warrants contain a cashless exercise provision in the event (i) at any time after one year following the date the Series D Warrants are first exercisable there is no registration statement effective covering the resale of the shares underlying the Series D Warrants or (ii) at any time after four years following the date the Series D Warrants were issued.  The Series D Warrants contain a limitation on the amount of Series D Warrants that may be exercised at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the warrants. This limitation may be waived upon 61 days notice to us by the holder of the Series D Warrants permitting the holder to change such limitation to 9.99%.  The conversion price of the Debentures and the exercise price of the Series D Warrants or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants are subject to adjustment in the event of a stock dividend, stock split, subdivision or combination of our shares of common stock, reclassification, sales of our securities below their then conversion or exercise price, a subsequent rights offering, or a reclassification of our shares. Also, if we effect a merger or consolidation with another company, we sell all or substantially all of our assets, a tender offer or exchange offer is made for our shares, or we effect a reclassification of our shares or a compulsory share exchange, a holder that subsequently converts its Debenture will be entitled to receive the same kind and amount of securities, cash or property as if the shares it is entitled to receive on the conversion had been issued and outstanding on the date immediately prior to the date any such transaction occurred.  Except as discussed above, no such events have occurred through the date of this report.    60  We are not required to make an adjustment to the conversion or exercise price or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants under the anti-dilution provisions related to an exempt issuance, which is defined as: (A) any stock or options that are issued under our stock option plans or are approved by a majority of non-employee directors and issued (i) to employees, officers or directors or (ii) to consultants, but only if the amount issued to consultants does not exceed 400,000 shares in a 12 month period, (B) securities issued under the Debentures or Series D Warrants, (C) shares of common stock issued upon conversion or exercise of, or in exchange for, securities outstanding on the date we entered into the securities purchase agreement, (D) the issuance of the Midtown placement agents warrants or the shares underlying the placement agents warrants, or (E) the issuance of securities in an acquisition or strategic transaction approved by our disinterested directors.   Under the Debenture Amendment Agreement, commencing October 15, 2010, Debenture holders agreed that an exempt issuance shall also include the issuance of stock or common stock equivalents authorized and approved in advance by the Companys disinterested directors at a price per share or at a conversion or exercise price per share equal to or greater than $0.25.  Under the terms of a Registration Rights Agreement we entered into with each purchaser at the closing of the sale of our Debentures and Series D Warrants (purchasers), we agreed we would use our best efforts to file a registration statement under the Securities Act within 45 days of the first closing to permit the public resale by purchasers of the shares that may be issued upon conversion of the Debentures and upon exercise of the Series D Warrants, including the shares of our common stock underlying the Debentures to be issued at the second closing. We are required to keep the registration statement effective until the earlier of either the date all shares underlying the Debentures and Series D Warrants have been sold or such shares are eligible for resale under Rule 144(k), but no later than four years after the effective date of the registration statement. The initial registration became effective on April 9, 2007. We were required to register a number of shares of our common stock equal to 130% of the shares underlying the Debentures and the Series D Warrants.At any time after the effective date of the registration statement covering the resale of the shares to be issued upon conversion or exercise of the Debentures and Series D Warrants, we may call for cancellation up to 75% of the Series D Warrants if: (i) the closing bid or closing sale price of the common stock for 20 consecutive trading days (the measurement period) exceeds $2.89, (ii) the daily trading volume during the measurement period exceeds 100,000 shares per trading day, and (iii) the holder is not in possession of material nonpublic information regarding us. We are required to give notice of cancellation to the holders within one trading day of the end of the measurement period. The Series D Warrants covered by the call notice will be cancelled effective 30 trading days after the date of the call notice, subject to certain conditions, including that the holder shall have the right to exercise the Series D Warrant during the measurement period. As not all of these conditions are met, the Debentures and Series D warrants are not yet cancelable.  On April 28, 2008, the Company filed a new Form S-1 Registration Statement with the Securities and Exchange Commission (SEC), to register additional shares for resale by certain holders (Registered Shares) of the Series A Convertible Debentures and Series D Warrants upon conversion or exercise thereof at a lower conversion price due to the reset provisions of the agreements, and to carry forward in such registration statement certain unsold shares from our Form S-1 Registration Statement that became effective April 9, 2007 (Registration Statement), in a combined prospectus under applicable SEC Rules. On June 5, 2008, Applied Visual Sciences filed a Post-Effective Amendment No. 1 to the Registration Statement (Post-Effective Amendment No. 1) to de-register 1,157,971 shares of Common Stock issuable in lieu of interest accrued through December 22, 2006, which became effective on June 6, 2008. On July 25, 2008, the Company filed a Post-Effective Amendment No. 2 to the Registration Statement (Post-Effective Amendment No. 2) to de-register an aggregate of an additional 4,208,495 of the Registered Shares. This amount includes: (i) an aggregate of 2,465,460 Registered Shares previously registered under the Registration Statement for resale by certain of the holders of the Companys Series A 10% Senior Convertible Debentures (the Debentures) upon conversion thereof; and (ii) an aggregate of 1,743,035 Registered Shares previously registered under the Registration Statement that represent additional shares registered under the Registration Statement for resale by certain of the holders of the Debentures and Series D Common Stock Purchase Warrants upon conversion or exercise thereof, which was approved by the SEC on August 6, 2008. On August 11, 2008, the Company filed a Post-Effective Amendment No. 3 to the Registration Statement to de-register the remaining unsold shares under the Registration Statement, which became effective August 13, 2008. On August 11, 2008, and in view of the Companys current financing requirements, the Company filed a request with the SEC to withdraw the April 28, 2008 Form S-1 Registration which withdrawal request was approved by the SEC.  Under the terms of the Debenture amendment agreement, the remaining Debenture holders agreed to terminate the Registration Rights Agreement with each such holder; however, the Company continues to be obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture but continues to hold Series D Warrants.  We also granted to each purchaser of the Debentures and Series D Warrants the right to participate in any offering by us of common stock or common stock equivalents until the later of (i) 12 months after the effective date of the registration statement and (ii) the date a purchaser holds less than 20% of the principal amount of the Debenture the purchaser originally agreed to purchase, except for an exempt issuance or an underwritten public offering of our common stock.  Purchasers may participate in such an offering up to the lesser of 100% of the future offering or the aggregate amount subscribed for under the securities purchase agreement by all purchasers. Although such common stock offerings have occurred, the original purchasers have not yet elected to participate in any such offerings through the date of the filing of this report, and have notified the Company that they do not want to participate in any future financings.   61   The securities purchase agreement also contained representations and warranties of both us and purchasers, conditions to closing, certain indemnification provisions, and other customary provisions.  Also the Debenture Amendment Agreement amended certain provisions covering events of default under the Debentures, contained certain representations and warranties of the Company, a reaffirmation of certain of the representations and warranties in the securities purchase agreement, contained certain conditions to closing, and certain other customary provisions.  We were prohibited from effecting a reverse or forward stock split or reclassification of our common stock except as may be required to comply with the listing standards of any national securities exchange.  Midtown Partners & Co., LLC acted as placement agent for the financing pursuant to the terms of a Placement Agent Agreement, dated July 14, 2006, between us and Midtown. At the first closing, we paid or issued the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees of $30,000 of which $10,000 was paid prior to closing, (iii) placement agents warrants to purchase an aggregate of 623,520 shares (one half of the Midtown placement agents warrants are exercisable commencing on November 6, 2006 and the remaining one-half become exercisable on the second closing). The second closing took place on April 12, 2007, at which time we paid the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees equal to 1% of the second closing or $25,750, (iii) the placement agents warrants to purchase an aggregate of 311,760 shares (the remaining one-half of the placement agents warrants). The Midtown placement agents warrants are exercisable at a price of $1.15634 per share for a period of five years from the date they become exercisable, the exercise price was re-set as disclosed above for the convertible debentures, contain a piggyback registration right, a cashless exercise provision and are substantially identical to the warrants issued to purchasers in the Debenture and Warrant offering.  As a result of the June 2009 financing, the exercise price of the placement agents warrants were adjusted under the anti-dilution provisions of such warrants to a price of $0.25 per share and the number of shares underlying the placement agents warrants would be increased to an aggregate of 1,019,828 shares.  The securities, including certain securities issued to Midtown, were not registered under the Securities Act of 1933 or any state laws and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.  2006 through 2010 Short-Term Promissory Notes, Related Party  On April 21, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, our Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $200,000. The Company issued a non-negotiable promissory note, dated effective April 21, 2006, to Mr. Trudnak in the principal amount of $200,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition.  In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full.  The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On October 21, 2006, Mr. Trudnak extended the due date of the loan to December 31, 2006. Subsequently, on October 3 and October 18, 2006, Mr. Trudnak loaned the Company $102,000 and $100,000, respectively, on substantially the same terms as the April 21, 2006 loan, except that each loan is due six months after the date thereof. Accordingly, following such additional loans, the Company owed an aggregate of approximately $402,000 to Mr. Trudnak. On November 10, 2006, Mr. Trudnak extended the due dates of such loans to May 31, 2007, except that $100,000 of the April 21, 2006, loan becomes due upon the Company raising $2,500,000 in financing after November 6, 2006, and the remaining amount of $202,000 of such loans become due upon the Company raising an aggregate of $5,000,000 in financing after November 6, 2006, and prior to May 31, 2007. Following the first closing of our Debenture and Series D Warrant financing on November 8, 2006, the Company repaid $100,000 on November 20, 2006, in principal amount of the April 1, 2006 loan, and paid an additional $100,000 to Mr. Trudnak on April 17, 2007 upon the second   62  closing of our Debenture and Series D Warrant financing. On May 31, 2007, Mr. Trudnak extended the due dates of the remaining loans to May 31, 2008. Although, the anticipated payment of $202,000 had not been made, and Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, for total outstanding notes of $226,000.  Subsequently, the maturity date of the outstanding loans was extended to May 31, 2009, and subsequently to May 31, 2010.  On June 1, 2010, the outstanding loans were extended to June 30, 2011.  During 2010, the Company repaid an aggregate of $108,900 of the notes, resulting in an outstanding balance at December 31, 2010, of $117,100. The terms of the above transaction were reviewed and approved by the Companys audit committee and by our Board of Directors.  Additional Capital  To the extent that additional capital is raised through the sale of our equity or equity-related securities of our subsidiaries, the issuance of our securities could result in dilution to our stockholders.  No assurance can be given that we will have access to the capital markets in the future, or that financing will be available on terms acceptable to satisfy our cash requirements, implement our business strategies, and meet the restrictive requirements of the debenture financing described above.  If we are unable to access the capital markets or obtain acceptable financing, our results of operations and financial condition could be materially and adversely affected.  We may be required to raise substantial additional funds through other means. We have not begun to receive material revenues from our commercial operations associated with the software products.  Management may seek to raise additional capital through one or more equity or debt financings or have discussions with certain investors with regard thereto.  We cannot assure our stockholders that our technology and products will be commercially accepted or that revenues will be sufficient to fund our operations.  If adequate funds are not available to us, we may be required to curtail operations significantly or to obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.    Financial Condition, Going Concern Uncertainties and Events of Default  During the year ended December 31, 2010, 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, 2009, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern.  Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.  During the period of June through August 2009, at a series of closings, Applied Visual Sciences, Inc. issued six-month convertible promissory notes to a total of 12 accredited investors in the aggregate principal amount of $725,000. The six-month notes accrued interest at a rate of 10% per annum. The notes were convertible, at the holders option, into shares of common stock at a conversion price of $0.25 per share. If converted, each holder is entitled to receive Class M common stock purchase warrants for the right to purchase an equal number of shares and they are exercisable at a price of $0.25 per share, contain certain anti-dilution and other customary provisions, and expire sixty (60) months from the date the warrants were issued. On December 31, 2009, the Company had an aggregate principal amount outstanding of $675,000 from eleven (11) note holders.  During the year ended December 31, 2010, all note holders converted an aggregate principal amount of $675,000 and $71,999 of accrued interest into an aggregate of 2,987,995 shares of common stock, and 2,987,995 Class M Warrants.  The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and we were considered in default for nonpayment of principal and unpaid interest and late fees.  The holders though had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, we entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, we agreed with two debenture holders: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) we issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that we may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures.  During the year   63  ended December 31, 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock.  As of December 31, 2010, we have outstanding trade and accrued payables of $1,347,819, other accrued liabilities of $454,648, and accrued salaries due to our employees and management of $4,986,115. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $117,100.  From March through September 2010, we sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 4,424,000 shares of common stock and 4,424,000 Class N Warrants for gross proceeds of $1,106,000 (or $1,022,280, net of commission and expenses of $83,720). The Class N 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 five years after the date of issuance.  During November through December 2010, we sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 400,000 shares of common stock and 400,000 Class P Warrants for gross proceeds of $100,000 (or $93,000, net of commission and other expenses of $7,000). The Class P Warrants are exercisable at a price of $0.50 per share; contain piggyback registration rights, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance.  As of December 31, 2010, we had a cash balance of $4,874.  Subsequently and through April 5, 2011, we received $350,000 (or $338,000, net of commissions and expenses of $12,000) from the issuance and sale of common stock and warrants in a private offering.  Included in the subsequent closings is $150,000 under a February 23, 2011, Securities Purchase Agreement executed by the Company with an institutional accredited investor for up to $1,000,000, under certain stock price and volume conditions. Management believes these funds to be insufficient to fund our operations, absent any cash flow from operations or funds from the sale of our equity or debt securities. We are currently 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.  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 and the convertible note, the debenture and convertible note holder do not convert such debt or require payment of principal and interest, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures (excluding convertible notes), 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 Applied Visual Sciences limited revenues to date, we have 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.  The proceeds from our financings are insufficient to fund our operations, pay our trade payables, repay our unconverted debentures, or accrued and unpaid wages to our employees.  Therefore, the debentures holders, our employees or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations.  Also, in the event we are unable to pay our employees, we may suffer employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of our stock, we may have limited or no access to the capital markets.  Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.  During the year ended December 31, 2010, our total stockholders deficit decreased by $2,529,598 to $10,164,515 and our consolidated net loss was $3,650,231 for the year ended December 31, 2010. 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.  CONSOLIDATED RESULTS OF OPERATIONS  The following analysis reflects the consolidated results of operations of Applied Visual Sciences, Inc. and its subsidiaries. Fiscal 2010 as Compared with Fiscal 2009   64  Net Revenues.Net revenues increased by $18,995 or 20.8%, to $110,499. The increase is due to higher revenue form our healthcare product and lower funded research and development and consulting services.  Revenue for fiscal 2010 includes, $90,226 from the sale of our first fully automated Signature Mapping TBDxTM system installed at the South African National Health Laboratory Services (NHLS) to complete the clinical evaluation of TBDxTM, and $20,273 from research activities of our security services for the completion of a 2009 joint initiative between the Department of Homeland Security (DHS) and the National Electrical Manufacturers Association (NEMA) Phase I of the Digital Imaging and Communications in Security (DICOS) project to establish communication standards within the security industry.  Phase II of DICOS is anticipated to begin in March 2011. The revenue from the Signature Mapping TBDxTM system installed at the NHLS of $90,226, includes, $67,670 for software license and $22,556 for equipment.  Fiscal 2009 revenue consisted of $91,504 from research activities of our security services for Phase I of the DICOS project.  Cost of Sales.Cost of sales for Fiscal 2010 was $45,104 (40.1% of net revenue), compared to $101,915 (111.4% of net revenue) during the same period in 2009, a decrease of $56,811, or 299.1% of the increase in net revenue. The decreased costs are the result of: i) lower labor and other costs for the DICOS Phase I project of $87,130, and increased costs due to hardware and related costs for the TBDxTM system of $30,319.  Selling, General and Administrative Expenses.Selling, general and administrative expenses for fiscal 2010, decreased by $864,378 (15.5%) to $4,708,795 for 2010, as compared to $5,573,173 for the same period in 2009. The table below details the components of selling, general and administrative expense, as well as the dollar and percentage changes for the fiscal years ended December 31.                Twelve Months Ended December 3120102009$ Change% ChangePayroll and related costs$ 2,027,183$ 2,470,072$ (442,889)(17.9)Professional fees496,140536,592(40,452)(7.5)Research and development costs157,355489,591(332,236)(67.9)Insurance costs86,02993,622(7,593)(8.1)Rent - building and equipment158,319307,361(149,042)(48.5)Travel and related61,09299,124(38,032)(38.4)Miscellaneous expenses99,328128,431(29,103)(22.7)Depreciation and amortization110,084116,749(6,665)(5.7)Stock-based compensation1,513,2651,331,631181,63413.6Total$ 4,708,795$ 5,573,173$ (864,378)(15.5)   Payroll and related costs, which includes salaries, commissions, taxes and benefits, decreased $442,889 (17.9%), due to four employees being on temporary leave of absence, although two, continue to support the Company on a part-time basis as needed.  Professional fees include legal, accounting, stock transfer agent, SEC filing, and general consulting fees. Professional fees decreased in 2010 versus in 2009 by $40,452 (7.5%) due to: (i) an increase in legal fees of $27,992, (ii) a decrease in general consultants and investor relations services of $28,162, (iii) a decrease in accounting services by $47,931, and (iv) a net increase of $7,649 for various miscellaneous services and fees.  Research and development (R&D) costs decreased in fiscal 2010, compared to fiscal 2009 by $332,236 (67.9%), due to: (i) reduced activities during the period for our PinPointTM product, or a reduction of $137,167 (96.7%), (ii) reduced R&D activities for Signature Mapping TBDxTM project of $195,069 (56.1%) since the focus for TBDxTM during the period was one of refinement than development.  Insurance costs in fiscal 2010 were $86,029 compared to $93,622 during fiscal 2009, a decrease of $7,593 (8.1%). The decrease is attributed to a reduction in commission and service fees to our insurance broker effective March 1, 2009.  Rent decreased by $149,042 (48.5%) to $158,319 in fiscal 2010, as compared to $307,361 in fiscal 2009, due to the Company relocating its office, effective May 1, 2010, to a smaller facility of approximately 3,269 square feet of space, whereas our previous office lease was for approximately 15,253 square feet. The new lease expires April 30, 2011, and takes advantage of better market conditions and adjusts for our anticipated needs over the coming year. The fixed monthly rent of $5,585 reduces our monthly operating costs by approximately $22,648.  Travel and entertainment expense for fiscal 2010 were $61,092 compared to fiscal 2009 of $99,124, or a decrease of $38,032 (38.4%).  The decrease is due to decreased travel costs associated with general business development activities and greater utilization of electronic communication than travel, and we focused travel costs specifically for our Signature MappingTM Tuberculosis sales activities.    65  Miscellaneous expense decreased by $29,103 (22.7%) to $99,328 during fiscal 2010, as compared to fiscal 2009 of $128,431. The net decrease during 2010 is related to: i) a reduction of $6,337 for software maintenance fees (ii) no bad debt expense in 2010 versus $11,800 during 2009, (iii) decrease of $11,884 for lower payment penalties and late fees, (iv) a reduction of $14,325 for overall data and telephone communication costs due to a renegotiated contract with our carrier, (v) a decrease of $3,238 in various miscellaneous expenses not incurred during 2010, (vi) an increase in use and franchise taxes of $4,722, and (vii) an increase of $13,759 for office relocation and maintenance costs to a new facility under a one year lease.  Depreciation and amortization expense in selling, general, and administrative for fiscal 2010 of $110,084 compared to the same period for 2009 of $116,749, or a decrease of $6,665 (5.7%). The decrease in depreciation expense is due to acquired assets that became fully depreciated during the second half of 2009.  Stock-based compensation, which represents a noncash expense category, is the amortization of the estimated fair value of stock-based compensation to employees, non-employee members of our Board of Directors, and consultants in lieu of cash compensation. During fiscal 2010, the Company recognized an expense associated with employee and non-employee directors stock-based compensation of $1,212,663, and $300,602 of consulting expense. During fiscal 2009, the Company recognized stock-based compensation expense for employees and non-employee directors of $1,214,113 and consultants of $117,518.  Stock-based compensation for employees and non-employee directors decreased by $1,450 (0.1%), and stock-based compensation expense for consultants increased by $183,084 (155.8%), which reflects an increased usage of stock-based compensation versus cash compensation for consultants.  Employee stock option expense in 2010 and 2009 represents the amortization of the Black-Scholes fair value as outlined above in accordance with ASC 718-10. ASC 718-10 requires the recognition of all share-based payments to employees or to non-employee directors, as compensation for service on the Board of Directors, as compensation expense in the consolidated financial statements. The amount of compensation is measured based on the estimated fair values of such stock-based payments on their grant dates, and is amortized over the estimated service period to vesting.  Consulting expense for stock-based payments to consultants is based on the fair value of the stock-based compensation at inception and amortized over the estimated service period but, in accordance with ASC 505-50, is remeasured on each reporting date until the performance commitment is complete.  Other Income (Expense).Other income (expense) includes interest income, interest expense and other non-operating income. Other income during fiscal 2010 was $993,169 compared to other expense of $2,949,930 for the same period last year, for a net decrease of $3,943,102 (133.7%).  There was no interest income from interest bearing accounts in fiscal 2010, compared to $3 for the same period in 2009. The decrease of $3 (100.0%) from the same period last year is attributed to a lower average daily cash balance in interest bearing accounts during the course of 2010.  Interest income for fiscal 2010 was $993,169, compared to interest expense of $2,949,933 for fiscal 2009, or a decrease in interest expense of $3,943,102 (133.7%). The activity for fiscal 2010 and the variances to fiscal 2009 include: (i) interest expense of $681,117, or a decrease of $48,663 (6.7%), (ii) no financing costs in 2010 versus an expense of $39,000 in 2009, (iii) an expense of $1,139,980 for the revaluation of beneficial conversion feature of the outstanding debentures, or an increase of $94,995 (9.1%), (iv) income of $2,587,216 for the revaluation (waiver by the debenture holders) of default provision of the convertible debentures, compared to an expense for 2009 of 1,526,404, or a decrease of $4,113,620 (269.4%), (v) $265,600 gain on settlement of debt for the beneficial conversion feature of debentures converted during 2010, compared to $931,391 during 2009, or a change of $665,791 (71.5%), and (vi) an expense of $38,550 for the fair value of warrants as inducement to extend short-term notes or conversion for stock, or a decrease of $502,605 (92.9%). Net non-cash interest income included above for 2010 was $993,169, as compared to interest expense in 2009 of $2,213,153, or a decrease of $3,206,322 (144.9%).  Net Loss and Net Loss per Share.Net loss for fiscal 2010 was $3,650,231, compared to $8,533,514 for fiscal 2009, for a decreased net loss of $4,883,283 (57.2%). Net loss per share for fiscal 2010 was $0.05 compared to $0.16 in fiscal 2009, based on the weighted average shares outstanding of 69,024,431 and 51,739,274, respectively. The decreased net loss for 2010, compared to 2009 arose from the following: (i) increased net revenue of $18,995, (ii) decreased cost of sales of $56,811, (iii) decreased salary and benefit costs of $442,889, (iv) decreased professional fees of $40,452, (v) decreased research and development costs of $332,236, (vi) decreased rent expense of $149,042, (vii) a decrease in insurance costs of $7,593, (viii) a decrease in travel and entertainment costs of $38,032, (ix) a decrease in other operating expenses of  $29,103, (x) a decrease in depreciation and amortization expense of $6,665, (xi) increased stock-based compensation for employees, non-employee members of our Board of Directors and consultants of $181,634, and (xii) a decrease in other net non-operating income and expense of $3,943,099, including a decrease in financing costs of $39,000, an decrease in net interest expense of $48,660, an decrease in fair value of warrants of $502,605, a decrease of $4,113,620 for the revaluation of default provision, an increase of $94,995 for the revaluation of the derivative liabilities for the debentures, and a decrease in the gain on settlement of debt for the beneficial conversion feature of debentures of $665,791.    66  CONTRACTUAL OBLIGATIONS AND COMMITMENTS  The following table summarizes scheduled maturities of our contractual obligations extending beyond one year for which cash flows are fixed and determinable as of December 31, 2010.                                             CategoryPayments Due in FiscalTotal20112012201320142015ThereafterShort-term convertible debentures (1)$ 1,688,205$ 1,688,205$ -$ -$ -$ -$ -Interest payments (2)-------Operating lease commitments (3)22,33822,388-----Unconditional purchase obligations (4)-------Total contractual obligations$ 1,710,543$ 1,710,593$ -$ -$ -$ -$ -(1) Represents the outstanding Series A Convertible Debentures that originally matured November 8, 2008, and were amended October 15, 2010. Under terms of the amendment, the Company and the debenture holders agreed to an extension of the maturity date to June 30, 2011.  Commencing March 3, 2011, the Company may force a conversion of the debentures if certain trading price and volume conditions are met.(2) The outstanding Series A convertible debentures, under the October 15, 2010 amendment, will not bear interest through the new maturity date of June 30, 2011.(3) Represents projected rent cost for the existing office lease, which expires on April 30, 2011.  Total rental expense included in the accompanying consolidated statements of earnings was $158,318 in fiscal 2010, and $307,361 in fiscal 2009.(4) The company currently does not have any outstanding unconditional purchase obligations.  They would though include inventory commitments, future royalty, consulting agreements, other than month-to-month arrangements or those that expire in less then one year, or commitments pursuant to executive compensation arrangements.   In addition to the above obligations, we are conditionally obligated to redeem shares related to the acquisition of intellectual property (IP) from Difference Engines.  As of December 31, 2010, and as more fully disclosed in Note 7, Acquisitions, a conditional redemption value of $98,946 was estimated and recorded.  CRITICAL ACCOUNTING POLICIES  In December 2001 and January 2002, the Securities and Exchange Commission (SEC) requested that all registrants list their three to five most critical accounting policies in the Managements Discussion and Analysis of Financial Condition and Results of Operations.  The SEC defined a critical accounting policy as one which is both important to the portrayal of the companys financial condition and results of operations, and requires managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.  We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.  Revenue Recognition.  Revenues are derived primarily from the sublicensing and licensing of computer software, installations, training, consulting, software maintenance and sales of PACS, RIS and RIS/PACS solutions.  Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognized.  For software arrangements, we recognize revenue according to the ASC 985-605, Software Revenue Recognition,and related amendments.  ASC 985-605 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements.  Revenue from multiple-element software arrangements is recognized using the residual method.  Under the residual method, revenue is recognized in a multiple element arrangement when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement.  We allocate revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately.  Specifically, we determine the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance offered to customers, which is stated in the contract, and fair value of the installation based upon the price charged when the services are sold separately.  If evidence of the fair value cannot be established for undelivered elements of a software sale, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or vendor-specific objective evidence of fair value can be established.  Revenue from sublicenses sold on an individual basis and computer software licenses is recognized upon shipment provided that evidence of an arrangement exists, delivery has occurred and risk of loss has passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured.  Revenue from software usage sublicenses sold through annual contracts and software maintenance is deferred and recognized ratably over the contract period.  Revenue from installation, training, and consulting services is recognized as services are performed.   67   Cost of goods sold incorporates our direct costs of raw materials, consumables, staff costs associated with installation and training services, and the amortization of the intangible assets (developed software) related to products sold.  Research and Development.  Costs incurred in connection with the development of software products that are intended for sale are accounted for in accordance with ASC 985-20,Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.  Costs incurred prior to technological feasibility being established for the product are expensed as incurred.  Technological feasibility is established upon completion of a detail program design or, in the absence, completion of a working model.  Thereafter, as long as no high-risk development issues exist, all software production costs are capitalized and subsequently reported at the lower of unamortized cost or net realizable value.  Capitalized costs are amortized based on current and future revenue for each product with an annual minimum equal to the straight-line amortization over the remaining estimated economic life of the product.  Amortization commences when the product is available for general release to customers.  Stock-Based Compensation. We adopted on January 1, 2006, the provisions of ASC 718-10, which requires recognition of stock-based compensation expense for all share-based payments based on fair value. ASC 718-10, Share-Based Payment defines fair value-based methods of accounting for stock options and other equity instruments.  This method measures compensation costs based on the estimated fair value of the award and recognizes that cost over the service period. We also consider 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.  We relied upon the guidance provided under ASC 505-50 to determine the measurement date and the fair value re-measurement principles to be applied.  Based on these findings, we determined that the unamortized portion of the stock compensation should be re-measured on each interim reporting date and proportionately amortized to stock-based compensation expense for the succeeding interim reporting period until goods are received or services are performed. We recognize 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. We consider voluntary termination behavior as well as trends of actual option forfeitures when estimating the forfeiture rate.  Valuation of Long-Lived Assets Including Acquired Intangibles.  We evaluate 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. Our 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.  On July 27, 2004, the Company completed the acquisition of Wise Systems Ltd.  This transaction has been accounted for as a business combination.  The purchase price for these assets and liabilities assumed were allocated to acquired intangible assets (FlowPointTM software) and goodwill. In conjunction with its net realizable value analysis required by ASC 985-20 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” during June 2007, we determined that its entire investment in Wise Systems was impaired.  This was based on the our determination that the carrying amount of these assets, as reflected on the Companys consolidated balance sheet, exceeded its projected net realizable value; accordingly, we wrote-off the remaining unamortized acquired intangible assets (FlowPointTM software) totaling $998,247.  Impairment of Excess of Purchase Price Over Net Assets Acquired.  We follow 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.  We determine 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.  Based on a net realizable value analysis as of June 30, 2007, it was determined that the asset was fully impaired and we took a $126,875 write-off for the impairment of goodwill.  OFF-BALANCE SHEET ARRANGEMENTS  We did not have any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities as of December 31, 2010, and 2009.    68  RECENT ACCOUNTING PRONOUNCEMENTS  In December 2010, the Financial Accounting Standards Board (FASB) amended its authoritative guidance related to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more-likely-than-not that goodwill impairment exists.  In determining whether it is more-likely-than-not that goodwill impairment exists, consideration should be made as to whether there are any adverse qualitative factors indicating that an impairment may exist.  The adoption of this standard is not expected to have a material impact on the Companys consolidated financial statements.  In December 2010, the FASB amended its authoritative guidance related to business combinations entered into by an entity that are material on an individual or aggregate basis.  These amendments clarify existing guidance that if an entity presents comparative financial statements that include a material business combination, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period.  The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  This guidance becomes effective prospectively for business combinations for which the acquisition date is on or after the first day of the Companys fiscal 2012.  This disclosure-only guidance will not have a material impact on the Companys results of operations, financial position or cash flows.  In May 2010, the Financial Accounting Standards Board (FASB) amended its authoritative guidance related to foreign currency issues that were discussed at the FASBs Emerging Issues Task Force (EITF) meeting in March 2010 where the staff of the U.S. Securities and Exchange Commission (SEC) announced temporary guidance on certain exchange rate issues.  Prompted by the use of multiple currency exchange rates in Venezuela, the use of different rates for remeasurement and translation purposes has caused reported balances for financial reporting purposes and the actual U.S. dollar denominated balances to be different.  The SEC staff indicated that any differences between the amounts reported for financial reporting purposes and actual U.S. dollar denominated balances that may have existed prior to the application of highly inflationary accounting requirements on January 1, 2010 should be recognized in the income statement upon adoption, unless the issuer can document that the difference was previously recognized as a cumulative translation adjustment (CTA), in which case the difference should be recognized as an adjustment to CTA.  The adoption of this guidance, effective March 31, 2010, did not have a material impact on the Companys consolidated financial statements.  In February 2010, the Financial Accounting Standards Board (FASB), issued ASU No. 2010-09, Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements, whereby it amended its authoritative guidance related to subsequent events to alleviate potential conflicts with current United States Securities and Exchange Commission (SEC) guidance.  Effective immediately, these amendments remove the requirement that an SEC filer disclose the date through which it has evaluated subsequent events.  The adoption of this guidance did not have a material impact on the Companys consolidated financial statements.  In January 2010, the Company adopted FASB ASU No. 2010-06, Fair Value Measurement and Disclosures (Topic 820)- Improving Disclosures about Fair Value Measurements (ASU 2010-06). These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require new disclosures of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. These new disclosures are effective beginning with the first interim filing in 2010. The disclosures about the rollforward of information in Level 3 are required for the Company with its first interim filing in 2011. The Company does not believe this standard will impact their financial statements.  Effective July 1, 2009, the Company adopted FASB ASU No. 2009-05, Fair Value Measurement and Disclosures (Topic 820) (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, Fair Value Measurements and Disclosures  Overall, for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted market price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required for Level 1 fair value measurements. Adoption of ASU 2009-05 did not have a material impact on the Companys results of operations or financial condition.  In June 2008, ASC 470-20-65, Transition Guidance for Conforming Changes to Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios (ASC 470-20-65) was issued. ASC470-20-65 is effective for years ending after December 15, 2008. The overall objective of ASC 470-20-65 is to provide for consistency in application of the accounting for convertible securities. The Company has computed and recorded a beneficial conversion feature in connection with certain of its prior financing arrangements and does not believe that ASC 470-20-65 has a material effect on that accounting.   69   In June 2008, ASC 815-40, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (ASC 815-40) was issued. The objective of ASC 815-40 is to provide guidance for determining whether an equity-linked financial instrument (or Embedded Feature) is indexed to an entitys own stock and it applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative in ASC 815, Accounting for Derivative Instruments and Hedging Activities, for purposes of determining whether that instrument or embedded feature qualifies for the first part of the scope exception as noted in ASC 815. ASC 815-40 also applies to any freestanding financial instrument that is potentially settled in an entitys own stock. The Company has determined ASC 815-40 does not have a material impact on its consolidated financial position, results of operations and cash flows.  In May 2008, ASC 470-20-25, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (ASC 470-20-25) was issued. ASC 470-20-25 specifies that issuers of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) should separately account for the liability and equity components in a manner that will reflect the entitys nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. ASC 470-20-25 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal periods; early adoption is not permitted. The Company does not believe that the provisions of ASC 470-20-25 have a material impact on the consolidated financial statements.  In April 2008, ASC 350 dealing with the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset was issued. The Company was required to adopt the provisions of ASC 350 on October 1, 2008. The Company does not believe that ASC 350 has materially impacted its consolidated financial position, results of operations or cash flows.  In March 2007, ASC 815-10-65 was issued since the use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Accordingly, ASC 815-10-65 requires enhanced disclosures about an entitys derivative and hedging activities and thereby improves the transparency of financial reporting. ASC 815-10-65 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. ASC 815-10-65 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company does not believe ASC 815-10-65 has a material impact on its consolidated financial statements and disclosures for the fiscal and interim periods beginning January 1, 2009.  In February 2007, ASC 825-10 The Fair Value Option for Financial Assets and Financial Liabilities (ASC 825-10), was issued whichpermits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value, and also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.  ASC 825-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of ASC 825-10, effective for the fiscal year ended December 31, 2008, did not have a material impact on consolidated financial condition or results of operations.  In September 2006, ASC 820, "Fair Value Measurements" ("ASC 820") was issued to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). ASC 820 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). ASC 820 becomes effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of ASC 820, effective for the fiscal year ended December 31, 2008, did not have a material impact on the Companys consolidated financial condition or results of operations.  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.         ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  Our market risk is confined to changes in foreign currency exchange rates and potentially adverse effects of differing tax structures. There were no international revenues in the twelve-month period ended December 31, 2010 from Wise Systems, our subsidiary located in the United Kingdom, or other international activities.  International operations were mostly from our foreign subsidiary and are typically denominated in British pounds, although the activities of Wise have remained dormant since 2009. We may be exposed to foreign exchange rate fluctuations as the Company continues to pursue revenue opportunities outside the United States.  As exchange   70  rates vary, results when translated may vary from expectations and adversely impact overall expected profitability. As of December 31, 2010, the Companys foreign currency exposure is related to accounts payable trade in the amount of $30,371.        ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA  See our Consolidated Financial Statements, which incorporates the supplementary data beginning on page 100.         ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Effective February 23, 2009, upon the recommendation of Applied Visual Sciences, Inc.s Audit Committee, Applied Visual's board of directors approved the engagement of KBL, LLP to serve as Applied Visual Sciences, Inc.'s independent registered public accountants and to be the principal registered public accountants to conduct the audit of Applied Visual Sciences, Inc.'s financial statements for the fiscal year ended December 31, 2008, replacing the firm of Goodman & Company, L.L.P. On January 12, 2010, KBL, LLP was reaffirmed by the Audit Committee as Applied Visual Sciences, Inc.'s independent registered public accountants and to be the principal registered public accountants to conduct the audit of Applied Visual Sciences, Inc.'s financial statements for the fiscal year ended December 31, 2010.         ITEM 9A.  CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures  As of the end of the period covered by this Report, the Chief Executive Officer and Chief Financial Officer of the Company (the Certifying Officers) conducted evaluations of the Companys disclosure controls and procedures. As defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure the information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions (SEC) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuers management, including the Certifying Officers, to allow timely decisions regarding required disclosure.  Based on this evaluation, the Certifying Officers determined that, as of the end of the period covered by this Report, the Companys disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms and to ensure that information required to be disclosed by the Company in the Reports that it files or submits under the Exchange Act is accumulated and communicated to the Companys management, including the Companys principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding disclosure.  Although the Certifying Officers have determined that our disclosure controls and procedures were effective, management continues to believe that a refinement to our disclosure controls is an ongoing process. The Audit Committee believes the Company should continue the following activities: (a) additional education and professional development for the Companys accounting and other staff on new and existing applicable SEC filing requirements, certain applicable SEC disclosure requirements, and the timing of the filing thereof, and (b) reviewing disclosure requirements, including Form 8-K and Regulation S-K disclosure requirements, SEC staff guidance and interpretations related thereof.  Managements Annual Report on Internal Control Over Financial Reporting  Management of Applied Visual Sciences, Inc. (including its subsidiaries) (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules13a-15(f) of the Securities Exchange Act of 1934, as amended).  The Companys internal control over financial reporting is a process designed by, and under the supervision of, its principal executive and principal financial officers, or person performing similar functions, and effected by the Companys board of directors, management and other personnel,  to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of   71  records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Companys assets that could have a material effect on the financial statements.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  Under the supervision of and with the participation of the Chief Executive Officer and the Chief Financial Officer, the Companys management conducted an assessment of the effectiveness of the Companys internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, the Companys management has concluded that, as of December 31, 2010, the Companys internal control over financial reporting was effective.  This annual report does not include an attestation report of the Companys registered independent public accounting firm regarding internal control over financial reporting.  Managements report was not subject to attestation by the Companys registered independent public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only managements report in this Annual Report on Form 10-K.  Changes in Internal Controls  There were no changes in the Companys internal controls over financial reporting during the period covered by the Report that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting.         ITEM 9B.  OTHER INFORMATION On October 26, 2010, in accordance with an outstanding capital raise, four executives and a consultant/director of the Company converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation in an aggregate of $1,267,706, for a total of 5,070,825 shares of Common Stock, and an aggregate of 5,070,825 Class N Common Stock Purchase Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.                 PART III        ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE  The following table sets forth the current directors and executive officers of Applied Visual Sciences, Inc.:  NameAgeTitleMichael W. Trudnak58Chairman of the Board, Chief Executive Officer, Secretary, Director - Class IIIWilliam J. Donovan59President, Chief Operating Officer and Director - Class IIICharles T. Nash60Director - Class IJoseph C. Brothers51Director - Class IKeith S. Kelly47Director - Class IHenry A. Grandizio54Director - Class IISean W. Kennedy61Director - Class IIGregory E. Hare57Chief Financial Officer, Treasurer Under Applied Visual Sciences, Inc.s Certificate of Incorporation, the board of directors is divided into three classes and, if the board consists of seven directors, the first class shall consist of three directors to hold office for a term of one year from the date of the ratification of their election by stockholders at the next meeting of stockholders held to consider such matter, the second class shall consist of two directors to hold office for a term of two years from the date of the ratification of his election by stockholders at the next meeting of stockholders held to consider such matter, and the third class shall consist of two directors to hold office for a term of three years from   72  the date of the ratification of their election by stockholders at the next meeting of stockholders held to consider such matter.  At each succeeding annual meeting of stockholders, the successors to the class of directors whose terms shall then expire shall be elected to hold office for a term expiring at the third succeeding annual meeting. Biographical information with respect to the present executive officers and directors of Applied Visual Sciences, Inc. are set forth below. There are no family relationships between any present executive officers or directors.  Michael W. Trudnak, Chairman of the Board, Chief Executive Officer, Secretary, and Director.Mr. Trudnak was appointed Chairman of the Board, Secretary, and Chief Executive Officer and became a Class III director in June 2003.  From March 2003 and until the present, Mr. Trudnak has been Chairman of the Board, Chief Executive Officer, Secretary, Treasurer and a director of RJL. From October 2002 to March 2003, Mr. Trudnak was a consultant to certain telecommunications services companies. From April 2002 to October 2002, Mr. Trudnak was Chief Operating Officer and subsequently President, Chief Executive Officer and a director of Advanced Data Centers, Inc., a privately held telecommunications services company. From July 2001 to March 2002, Mr. Trudnak served as Vice President of Mid-Atlantic Sales for Equant N.V, a leading provider of global IP and data services to multinational companies. Prior to Equant's acquisition of Global One, Inc., in July 2001, Mr. Trudnak served as an Executive Director for South East Region Sales for Global One from June 1998 to July 2001, and from January 1996 to June 1998, served as Managing Director of Global One's sales and operations in France and Germany. From November 1989 through December 1995, Mr. Trudnak served as director of facilities engineering and then Senior Group Manager for Sprint International, a global telecommunications services provider. Mr. Trudnak has over twenty-five years of diversified executive management, sales, business operations, technical and administrative experience in the telecommunications industry. Mr. Trudnak served in the Marine Corps from April 1972 through January 1976.  William J. Donovan, President, Chief Operating Officer and Director. Mr. Donovan became a Class III director in August 2006. Mr. Donovan has been President and Chief Operating Officer since November 21, 2005. Also, from August 18, 2003, until January 30, 2006, Mr. Donovan was Chief Financial Officer. From January 2003 until August 2003, Mr. Donovan was an independent consultant to an affiliate of American Express Small Business Services. From September 1999 through December 2002, Mr. Donovan was CFO of Streampipe.com, Inc., a privately held streaming communications media company.  From October 1996 to August 1999, Mr. Donovan was Chief Operating and Financial Officer for TDI, Inc., a privately held international wireless telecommunications services company.   From October 1986 to October 1996, Mr. Donovan was Chief Financial Officer, Secretary, Treasurer and a director at Riparius Corporation, a privately held holding company with operating subsidiaries in the areas of real estate development, property management, general contracting, government contracting, and telecommunications engineering.  From October 1980 to October 1986, Mr. Donovan was the Controller for McCormick Properties, Inc., a publicly held commercial real estate subsidiary of McCormick & Company.  From July 1973 to October 1980, Mr. Donovan was the Controller for AMF Head Sports Wear, Inc., a privately held international sporting goods manufacturer and a subsidiary of AMF, Inc., a publicly held company.  Mr. Donovan received a Bachelor of Arts in History in 1973, from the University of Maryland, an MBA from the Sellinger School of Business, Loyola College, Baltimore, Maryland in 1982, and a Certificate in Accounting from the University of Maryland in 1978.  Mr. Donovan has been a Certified Public Accountant since 1982.  He is also a Certified Business Valuation & Transfer Agent, Business Brokers Network, 2002.  He has been on the Advisory Board for Nogika Corporation, a privately held software company, since 2001.  Gregory E. Hare, Chief Financial Officer, and Treasurer.Mr. Hare was appointed Chief Financial Officer on January 30, 2006.  From May 2001 through January 2006, Mr. Hare served as a financial executive of Jane Cosmetics, a national mass market cosmetics manufacturing and distribution company headquartered in Baltimore, Maryland. There he served three years as Director of Finance for the wholly owned subsidiary of The Estee Lauder Companies, Inc. and the last two years as CFO/Controller of the privately held Jane & Company, LLC.  Prior to that, Mr. Hare held positions including CFO/Controller for a privately held hospitality company LFB Enterprises, with locations in and around Baltimore and Washington, DC; Manager, Pricing Group for the Industrial Division of McCormick & Company, a publicly held international spice company headquartered in Hunt Valley, Maryland; and CFO/Controller for Acordia Collegiate Benefits, Inc., a for-profit subsidiary of Blue Cross and Blue Shield of Indiana. Mr. Hare received a Bachelor of Science in Accounting from the University of Baltimore, and an MBA from the Sellinger School of Business of Loyola College, Baltimore, Maryland in 1984. Mr. Hare has been a Certified Public Accountant since 1979.  Charles T. Nash, Director.Mr. Nash became a Class I director of Applied Visual Sciences, Inc. in June 2004. Mr. Nash has over 25 years of military experience and more than 10 years of leadership experience in emerging technology in the private sector.  Since October 2000, Mr. Nash has been President of Emerging Technologies International, Inc. (ETII), a privately held consulting company. ETII works to get high level technologies developed by small commercial companies inserted quickly, efficiently and inexpensively into applications/tools for immediate military use. The company also works with government laboratories and acquisition agencies to facilitate speedy and effective lab to fleet technology interchanges and discussions. From April 1998 to October 2000, Mr. Nash was vice president of Emerging Technology Group of Santa Barbara Applied Research, Inc., a privately held defense consulting and emerging technology marketing company.  Prior to that, Mr. Nash served in various military leadership positions, including: head of Strike/Anti-Surface Unit Warfare and Air to Air/Strike Support section on the staff of the Chief of Naval Operations, overseeing budget planning of approximately $18 billion; executive assistant to the Deputy Commander in Chief, U.S. Naval Forces Europe; and executive and   73  commanding officer, Strike Fighter Squadron 137.  Mr. Nash retired from the U.S. Navy in 1998 with the rank of Captain U.S.N.  Mr. Nash is a frequent guest military and aviation analyst for Fox News Channel, and several regional radio stations.  Mr. Nash earned a BS Aeronautics degree in 1973 from the Parks College of Aeronautical Technology, Saint Louis University, Cahokia, Illinois.  Joseph C. Brothers, Director.Mr. Brothers became a Class I director of Applied Visual Sciences, Inc. on April 26, 2010. Since September 1997, Mr. Brothers has been President of The Joseph Brothers Company, Inc., a privately-held ERP (Enterprise Resource Planning) and SAP (Systems, Applications and Products) consulting services company.  Since October 2009, Mr. Brothers has been the Principal Research Scientist for University of Alabama Enterprise Resource Planning Advisor, supporting the Army Chief Information Office and Office of the Deputy Chief of Staff of the Army.  From December 2006 to October 2009, Mr. Brothers was U.S. Army ERP Functional Integration Advisor, Enterprise Integration Office, Business Transformation Agency, United States Department of Defense. From March 2003 to December 2006, Mr. Brothers was a SAP Implementation Functional Integration Lead with Northrop Grumman Mission Systems.  Mr. Brothers has over fourteen years of SAP project/program management, configuration, and functional architecture and business modernization experience for the United States Department of Defense, United States Army, commercial manufacturing, media, and state government environments. Also, he has over twelve years of operational accounting and financial accounting experience in the commercial environment. As an ERP project leader, he has solid knowledge of U.S Army tactical logistical requirements as it relates to SAP functionality.  Mr. Brothers received a Bachelor of Science Degree in Business Administration from the University of Arizona, and a Master of Science Degree in Management from the Krannert Graduate School of Management at Purdue University.  Mr Brothers is a certified public accountant.  Keith S. Kelly, Director.  Mr. Kelly became a Class I director of Applied Visual Sciences, Inc. on April 26, 2010. Since December 2008, has been Chairman and CEO of Mortgage Harmony Corporation (formerly, Lending Annuity Group), a privately-held financial engineering company, where he developed patented mortgage compensation systems and methods, including the introduction of the Harmony Loan, a closing-cost savings platform.  From August 2006 to December 2008, Mr. Kelly was President of Modified Lending, Inc., a privately-held marketing company. From May 1999 to August 2006, Mr. Kelly was Division Manager of National City Mortgage, a publicly-held mortgage company. During these periods, Mr. Kelly also held loan officer positions with MetLife Home Loans, SunTrust Mortgage, National City, and manager positions with Megastar Financial, Access National Bank and Flagstar Bank.  Mr. Kelly is an entrepreneur in the mortgage industry who has created and patented certain mortgage compensation systems and methods, including the platform that enabled the introduction of the Harmony Loan. As a seasoned retail mortgage banking executive, Mr. Kelly has been an advocate for proper homeowner education for nearly two decades, focusing on strategies to avoid paying closing costs and his closing-cost savings platform has been featured in Money, The Washington Post, Time, New York Times, Womans World, CNBC and a host of other national publications. He is also a host of MyMortgageWatchDog (a mortgage educational talk show) in Washington, D.C.  Mr. Kelly received a Bachelor of Science Degree from James Madison University in 1985.  Henry A. Grandizio, Director.  Mr. Grandizio became a Class II director of Applied Visual Sciences, Inc. on September 17, 2007.  Since 2006 to present, Mr. Grandizio has been the managing partner at Grandizio, Wilkins, Little & Matthews, LLP, a certified public accounting firm.  From 1986 until 2006, Mr. Grandizio was shareholder and vice president of Scheiner, Mister, & Grandizio, P.A.  From 1978 to 1986, Mr. Grandizio was an audit and accounting manager for McGrow, Pridgeon and Company, P.A.  Mr. Grandizio received a Masters in Science, Taxation from the University of Baltimore and a Bachelor of Arts in Accounting from Loyola College.  Sean W. Kennedy, Director. Mr. Kennedy became a Class II director in July 2003 and a consultant to the Company since May 27, 2008.  From January 2001 to the present, Mr. Kennedy has been President and Chief Executive Officer of BND Software, Inc. a privately held software development company.  On May 27, 2008, the Company entered into a consulting agreement with BND pursuant to which it agreed to provide certain consulting services to the Company including managing the research, development and information systems activities of the Company. From October 1999 to December 2000, Mr. Kennedy was divisional Vice President of Votenet Solutions, a Web development and consultant for trade associations, political parties and related organizations. From April 1994 to October 1999, Mr. Kennedy was President and CEO of Raintree Communications Corporation, a privately held telecommunications services company, focused on providing technology tools for legislative lobbying to Trade Associations and Fortune 500 companies. From June 1989 to April 1994, Mr. Kennedy was President and CEO of Electronic Funds Transfer Association, a trade association for the electronic payments systems industry.  Mr. Kennedy is a graduate of Mount Saint Marys College in Emmitsburg, Maryland.  Each officer is appointed by the board of directors and holds his office at the pleasure and discretion of the board of directors or until his earlier resignation, removal or death.  There are no material proceedings to which any director, officer or affiliate of Applied Visual Sciences, Inc., any owner of record or beneficially of more than five percent of any class of voting securities of Applied Visual Sciences, Inc., or any associate of any such director, officer, affiliate of Applied Visual Sciences, Inc. or security holder is a party adverse to Applied Visual Sciences, Inc. or any of its subsidiaries or has a material interest adverse to Applied Visual Sciences, Inc. or any of its subsidiaries.  Independent Directors   74  Our board of directors has adopted the definition of independence as defined in Section 803A of the NYSE Amex LLC Company Guide.  Based upon such definition, the board of directors has determined that the following directors are independent: Joseph C. Brothers, Henry A. Grandizio, Keith S. Kelly, and Charles T. Nash, and that a majority of our directors are independent.  The board of directors maintains an audit committee, compensation committee, and nominating committee.  We may also establish special or other committees from time to time to consider matters at the request of the Board. The current members of such committees as of the date of the filing of this report are as follows:  Audit - Henry A. Grandizio, Chairman Joseph C. Brothers Keith S. Kelly  Compensation - Charles T. Nash, Chairman Henry A. Grandizio Keith S. Kelly  Nominating - Joseph C. Brothers, Chairman Charles T. Nash  The Board of Directors The Board oversees the business affairs of Applied Visual Sciences, Inc. and monitors the performance of management. During the year ended December 31, 2010, the Board held four meetings and handled certain other business through unanimous written consents of its board in accordance with its by-laws and applicable Delaware law. Messrs. Donovan, Grandizio, Kennedy, Nash and Trudnak attended all of such meetings of the Board, and Messrs. Brothers and Kelly attended two of such meetings that were held after their appointment to the Board. Applied Visual Sciences, Inc. has a policy of requesting all directors to attend annual meetings of stockholders.  On April 24, 2010, the Company reduced the number of members required for the board of directors from nine to seven members. Currently, the Board has four committees, an Audit, Compensation, Nominating, and Special Committee. The membership and functions of such committees are described below.  Currently, Mr. Trudnak serves as our Chairman and Chief Executive Officer.  Mr. Donovan serves as our President and Chief Operating Officer. A majority of our directors are independent and each of our Board committees consists of independent directors, including each of the Chairs of such committees. We do not have a lead independent director to preside at our Board meetings, but may do so in the future.  For a company of our size, we believe that the CEO is in the best position to focus the independent directors attention on the issues of greatest importance to the company and its stockholders, and we believe that splitting such roles may have the consequence of making our management and governance processes less effective than they are today through duplication and a blurring of the lines of accountability and responsibility for matters.  Our senior management is responsible for overseeing, assessing and managing our exposures to risk on a day-to-day basis, including the creation of appropriate management programs and policies. We do not maintain a separate committee of our Board responsible for managing and overseeing our exposure to risk. Our Board is responsible for overseeing management in the execution of this responsibility and for assessing our approach to risk management. Our Board exercises this responsibility at its periodic Board meetings and at meetings of our Board committees, each of which has a defined area of responsibility. Our Boards role in risk management is consistent with our leadership structure, with our CEO and President having responsibility for assessing and managing our risk exposure and the Board and its committees providing oversight in connection with those efforts.  Audit Committee The Audit Committee consists of three members, Henry A. Grandizio, Joseph C. Brothers, and Keith S. Kelly.  Charles T. Nash was a member of the committee until his resignation on April 24, 2010, when the Board elected Messrs. Brothers and Kelly to the committee. Mr. Grandizio was appointed as chairman of the committee on September 17, 2007. The Audit Committee held four meetings during 2010, and Mr. Grandizio attended all of such committee meetings, Messrs. Brothers and Kelly attended three of such committee meetings, and Mr. Nash attended one meeting of the committee. The board of directors determined that Messrs. Grandizio, Brothers, Kelly and Nash are deemed independent within the definition of independence set forth in Section 803A of the NYSE Amex LLC Company Guide.  The board of directors has adopted a written charter for the Audit Committee which provides that the Audit Committee's primary functions are to (a) oversee the integrity of Applied Visual Sciences, Inc.s financial statements and Applied Visual Sciences, Inc.s compliance with legal and regulatory reporting requirements, (b) appoint a firm of certified public accountants whose duty it is to audit Applied Visual Sciences, Inc.s financial records for the fiscal year for which it is appointed, (c) evaluate the qualifications and independence of the independent auditors, (d) oversee the performance of Applied Visual Sciences, Inc.s internal audit function and independent auditors, and (e) determine the compensation and oversee the work of the independent auditors. It is not the duty of the Audit   75  Committee to plan or conduct audits or to determine that Applied Visual Sciences, Inc.s financial statements are complete and accurate and are prepared in accordance with generally accepted accounting principles in the United States.  Management is responsible for preparing Applied Visual Sciences, Inc.s financial statements, and the independent auditors are responsible for auditing those financial statements.  Compensation Committee The Compensation Committee consists of three members, including Charles T. Nash, Henry A. Grandizio, and Keith S. Kelly. Mr. Nash was appointed chairman of the committee on April 21, 2009.  Mr. Sean W. Kennedy was a member of the committee until his resignation on April 24, 2010, when the Board elected Mr. Kelly to the committee. The Compensation Committee held four meetings during 2010, and Messrs. Nash and Grandizio attended all of such committee meetings, and Mr. Kelly attended three of such committee meetings, and Mr. Kennedy attended one meeting of the committee.  The Compensation Committee's primary functions are to: · evaluate the performance of the CEO and determine the CEOs total compensation and individual elements thereof; · determine the compensation level of the CEO and President and review and approve corporate goals and objectives relevant to senior executive compensation (including that of the CEO), evaluate senior management's performance in light of those goals and objectives, and determine and approve senior management's compensation levels based on their evaluation; · evaluate the performance of other executive officers and determine their total compensation and individual elements thereof; · make all grants of restricted stock or other equity based compensation to executive officers; · administer Applied Visual Sciences, Inc.'s compensation plans and programs; · recommend to the board for approval equity based plans and incentive compensation plans; · review management development and succession programs; and · review appropriate structure and amount of compensation for board members.  The board of directors has determined that all members of the Compensation Committee currently are independent within the meaning of independence set forth in Section 803A of the NYSE Amex LLC Company Guide.  Nominating Committee The Nominating Committee consists of two members, Joseph C. Brothers, and Charles T. Nash.  Mr. Sean W. Kennedy and Mr. Henry A. Grandizio were also members of the committee until their resignation on April 24, 2010, when the Board elected Mr. Brothers to the committee. Mr. Brothers was also elected chairman of the committee on April 24, 2010. The Nominating Committee held two meetings during 2010, and Messrs. Nash, Grandizio, and Kennedy attended all of such meetings, and Mr. Brothers did not attend such meeting as they were held prior to his appointment to the committee.  The board has adopted a written charter for the Nominating Committee.  The Nominating Committee's primary functions are to: · consider, recommend and recruit candidates to serve on the board and to recommend the director nominees selected by the Committee for approval by the board and the stockholders of Applied Visual Sciences, Inc.; · recommend to the board when new members should be added to the board; · recommend to the board the director nominees for the next annual meeting; · when vacancies occur or otherwise at the direction of board, actively seek individuals whom the Committee determines meet the criteria and standards for recommendation to the board; · consider recommendations of director nominees by stockholders and establish procedures for shareholders to submit recommendations to the Committee in accordance with applicable SEC rules and applicable listing standards; · report, on a periodic basis, to the board regarding compliance with the Committees Charter, the activities of the Committee and any issues with respect to the duties and responsibilities of the Committee; · establish a process for interviewing and considering a director candidate for nomination to the board; · recommend to the board guidelines and criteria as to the desired qualifications of potential board members; · provide comments and suggestions to the board concerning board committee structure, committee operations, committee member qualifications, and committee member appointment; · review and update the Committees charter at least annually, or more frequently as may be necessary or appropriate; and · perform such other activities and functions related to the selection and nomination of directors as may be assigned from time to time by the board of directors including, but not limited to, preparing or causing to be prepared any reports or other disclosure required with respect to the Committee by any applicable proxy or other rules of the SEC or as required by the rules and regulations of any exchange or over-the-counter market on which our securities may then be listed or quoted.   76   The Committee will consider all stockholder recommendations for candidates for the Board, which should be sent to the Nominating Committee, c/o Michael W. Trudnak, Secretary, 250 Exchange Place, Suite H, Herndon, Virginia 20170. The information required to be included is set forth in Article III, Section 2 of our Bylaws.  We believe that directors should possess the highest personal and professional ethics, integrity and values, and be committed to representing the long-term interests of stockholders. We believe that the following attributes are important to board membership: experience as a leader of a business firm or institution; mature and practical judgment; the ability to comprehend and analyze complex matters; objectivity and perspective; effective communications skills; and strong character and integrity. The Committees evaluation of director nominees takes into account their ability to contribute to the diversity of background and experience represented on the Board, and the Committee reviews its effectiveness in balancing these considerations when assessing the composition of the Board. The Board also considers candidates recommended by current directors, company officers, employees and others.  The Committee evaluates all nominees for director in the same manner regardless of the source of the recommendation.  Director Communication Policy We have established a policy whereby anyone who has a concern about our conduct or about our accounting, internal accounting controls, or auditing matters, may communicate that concern directly to the Board of Directors, the Chairman of our Audit Committee or any other non-employee director or the Audit Committee. All such concerns will be forwarded to the appropriate directors for their review, and all concerns related to audit or accounting matters will be forwarded to the Audit Committee. All reported concerns will be simultaneously reviewed and addressed by our CEO or his designee (unless he or she is alleged to be involved in the matter at issue). The status of all outstanding concerns addressed to the Board, the non-employee directors, or the Audit Committee will be reported to the Board or the Audit Committee (as applicable) on a quarterly basis. The Board or any Board committee may direct special treatment, including the retention of outside advisors or counsel, for any concern addressed to them. Our corporate policies prohibit retaliatory action against any employee who raises concerns or questions in good faith about these matters.  Stockholders wishing to communicate with the board of directors, any non-employee director, or the Audit Committee may do so by writing to the Company's Corporate Secretary at 250 Exchange Place, Suite H, Herndon, Virginia 20170. Our Secretary will forward any communications as directed by the stockholder.  ADVISORY BOARD  On November 7, 2007, we established an advisory board to advise and make non-binding recommendations to our board of directors and management regarding the strategic positioning of our new products, future product development, industry trends, and potential research collaborations with third parties.  Members serve for a term of one year.  The advisory board consisted of two members, and their service agreements expired on or before November 8, 2008.  The Company anticipates reestablishing the Advisory Board during 2011.  Each member of the Advisory Board of the Corporation (other than the Chairman of the Advisory Board) to be paid or provided as annual compensation an aggregate of 15,000 non-qualified stock options to purchase common stock, $.001 par value per share, of the Corporation pursuant to the Plan, each such option to be exercisable at a price equal to the fair market value of the Common Stock on the date of grant, such options to be exercisable immediately following the date of grant and for a term of ten (10) years thereafter (unless terminated earlier in accordance with the terms of the Plan).  Such compensation was recommended by the compensation committee, and approved by the board of directors of the Company.  AUDIT COMMITTEE EXPERT We have designated Mr. Henry A. Grandizio as our audit committee financial expert. CODE OF ETHICS On August 29, 2003, we adopted a Code of Ethics for our chief executive officer, chief financial officer, principal accounting officer or controller, and persons performing similar functions.  A copy of the Code of Ethics has been posted to our website.  Our website address is www.appliedvs.com.  SECTION 16(a) COMPLIANCE AND REPORTING  Under the securities laws of the United States, the Companys directors, executive officers, and certain securities holders of the Companys common stock are required to report their initial ownership of the Companys common stock and any subsequent changes in that ownership to the SEC.  Specific due dates for these reports have been established and the Company is required to disclose any failure to file by these dates.   77   Based on our review of Forms 3, 4 and 5 submitted to us pursuant to Rule 16a-3 under the Exchange Act by our executive officers and directors with respect to our most recent fiscal year ended December 31, 2010, there were no known (1) late reports, (2) transactions that were not reported, or (3) known failures to file a required report by such executives officers and directors.        ITEM 11.   EXECUTIVE COMPENSATION  Compensation Discussion and Analysis  Overview  The material principles underlying our goals for executive compensation policies and decisions are intended to:  · implement compensation packages, which are competitive with comparable organizations and allow us to attract and retain the best possible executive talent; · relate annual and long-term and stock incentives to achievement of measurable corporate and individual performance objectives; · appropriately balance mix of cash and noncash short and long-term compensation; · encourage integrity in business dealings through the discretionary portion of our compensation package; and · align executives incentives with long-term stockholder value creation.  We determine the appropriate levels of total executive compensation, including for our named executive officers, and each compensation element, based on several factors, such as an informal benchmarking of our compensation levels to those paid by comparable companies, our overall performance, each individual executive officers performance, the desire to maintain level equity and consistency among our executive officers, and other considerations that we deem to be relevant.  In an effort to assist the Compensation Committee in the evaluation process, in August 2005, we engaged an independent compensation consultant to evaluate certain aspects of our compensation practices and to assist in developing our executive compensation program. To this end, the consultant developed a competitive peer group and performed benchmarking analyses of competitive compensation levels, and used the following companies as a source of the analysis: Merge eFilm, IDX Systems Corporation, DexCom, Inc, NeuStar Inc, Sybari Software, Inc, Technology Spectrum, Inc, Optio Software, Inc, and RadView Software, Ltd.  However, we have not implemented any formal or informal policy for allocating compensation between long-term and short-term, between cash and noncash or among the different forms of noncash compensation.   We did not engage a compensation consultant during fiscal years subsequent to 2005.  Our Compensation Committee reviews and approves all of our compensation policies.   Our Compensation Committee is responsible for evaluating the performance of all our named executive officers, their compensation levels, criteria for grants of stock options, and reviewing and evaluating the terms of their employment agreements.  Our Compensation Committee performs such tasks periodically and solicits the input of our executive officers.  The compensation levels for our named executive officers are based upon management recommendations, including the recommendations of our CEO.  Our executive compensation program during 2010 consisted of three principal elements: base salary, stock options, and severance and change in control benefits.  We also provided to two employees a car allowance. Except for Mr. Borrelli, we compensate our named executive officers according to the terms of their employment agreements with us. Mr. Borellis salary was determined based on market levels at the time of employment, individual responsibilities, performance, and experience. We made no change to Mr. Borrellis salary at the time he became a named executive officer. Our ability to provide any cash incentive compensation, plan or non-plan has been constrained by our limited cash resources. Accordingly, our executive compensation arrangements have been relatively straight forward.  Moreover, due to our limited available cash, during 2006, a significant portion of four of our then named executive officers base salaries were and continue to be unpaid.  During 2007, three of our named executives had a small portion of their base salaries unpaid and the amount continued to be unpaid during 2010.  Additionally, during 2009 and 2010, significant portions of our four named executive officers base salaries were unpaid.  As of December 31, 2010, the Company has an aggregate unpaid salary of its named executives of approximately $2,304,205. We continue to accrue the salaries for our Principal Executive Officers and named executive officers, however, there is substantial uncertainty that we will be able to pay such amounts to our officers.On October 26, 2010, in accordance with an outstanding capital raise, four executives and a consultant/director of the Company converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation in an aggregate of $1,267,706, for a total of 5,070,825 shares   78  of Common Stock, and an aggregate of 5,070,825 Class N Common Stock Purchase Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance. The Company also issued to such executives and consultant/director, an aggregate of 1,000,000 shares of common stock, and such issuance was previously authorized for all employees as compensation for the hardship of not regularly receiving their salaries, wages, or other compensation that was due during June 2008 through January 2009, and the continued or continuing nonpayment of such amounts by the Company. The issuance of the Common Stock was not in lieu of the payment of such compensation which remained accrued and unpaid.  Elements of Compensation  The principal elements of our compensation package for our named executive officers, may include following, although we have not provided cash based compensation other than for base salary. We may consider in the future other cash based compensation once we become able to do so.  · base salary; · annual cash incentive bonuses; · long-term incentive plan awards using stock options; · severance benefits; · change in control benefits; · 401(k) savings plans; · retirement benefits; and · perquisites and other compensation.  Base Salary  The amount of base salary paid or payable to our named executive officers is used to recognize the experience, skills, knowledge and responsibilities required of all our employees, including our named executive officers. When establishing base salaries for the executives, the Compensation Committee and management consider a number of factors, including the seniority of the individual, the functional role of the position, the level of the individuals responsibility, the ability to replace the individual, the base salary of the individual at his prior employment and various qualified candidates to assume the individuals role. Generally, we believe our executives base salaries should be targeted near the median of the range of salaries for executives in similar positions at comparable companies.  Except for Mr. Borelli, the base salary of each of our named executive officers is determined on the basis of such officers employment agreement with us.  Our Compensation Committee is to review annually each executive officers base salary during our performance review. Base salaries may be adjusted from time to time to realign salaries with market levels after taking into account individual responsibilities, performance, experience and the our cash position.  During 2010, we did not increase the base salary of any of Messrs. Trudnak, Donovan, Hare or Borrelli, and the Committee has not made a determination for 2011.  Also, as discussed above, and due to our limited available cash, during 2006, a significant portion of four of our then named executive officers base salaries were and continue to be unpaid.  During 2007, three of our named executives had a small portion of their base salaries unpaid and the amount continued to be unpaid during 2010.  Additionally, during 2009 and 2010, significant portions of our four named executive officers base salaries were unpaid.  As of December 31, 2010, the Company had an aggregate accrued but unpaid salary due to its named executives of approximately $2,304,205.  Annual Cash Incentive Bonus  Due to the limited cash available to us, we currently do not have a bonus plan and, during 2010, we did not make any annual cash incentive award to our employees, including our named executive officers.  Long-Term Incentive Plan Awards  We believe our long-term performance is fostered by a compensation methodology which compensates all employees, including our named executive officers, through the use of stock-based awards that foster a continuing stake of each employee in our long-term success.    We currently utilize stock options, restricted stock rights or other awards and other rights to receive compensation based on the value of our stock. Currently, we do not have a plan requiring us to make any grant or award of stock options or other equity based awards, except for certain annual awards to members of our board of directors who are also independent, discussed under Director Compensation and Benefits, below.    79  Amended and Restated 2003 Stock Incentive Plan  The Board of Directors adopted the 2003 Stock Incentive Plan on August 29, 2003. 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 shareholders on February 13, 2004.  Under the 2003 Plan, we may grant stock-based compensation in the form of options.  The 2003 Plan authorizes the issuance of up to an aggregate of 30,000,000 shares of the Companys common stock.  The 2003 Plan terminates on August 29, 2013. 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 aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if our outstanding shares are increased, decreased or exchanged through merger or similar transaction. The Plan provides for options which qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986, as well as the issuance of Non-Qualified Options, which do not so qualify. Pursuant to the terms of the 2003 Plan, the Company, as determined by the Board of Directors or a committee appointed by the Board, may grant Non-Qualified Stock Options (NQSOs) to its executive officers, non-employee directors, or consultants of the Company and its subsidiaries at any time, and from time to time.  The 2003 Plan also provides for Incentive Stock Options (ISOs) to be granted to any officer or other employee of the Company or its subsidi­aries at any time, and from time to time, as determined by the Board or selected by the committee appointed by the Board.  Such stock options granted allow a grantee to purchase a fixed number of shares of the Companys common stock at a fixed exercise price provided that such price may not be less than the fair market value (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. Also, the Compensation Committee, based on managements recommendation and discussions with the Committee, may grant stock options to new employees.  New employees were granted stock options in prior years, but no such stock options were issued during 2010 since there were no new employees hired during the year.  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 Applied Visual Sciences, Inc. 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.  During 2010, the Compensation Committee granted 1,069,560 stock options under the 2003 Plan.  As of December 31, 2010, the Company has reserved under the 2003 Plan, 16,394,681 shares to be issued upon exercise of outstanding options, and 11,812,819 shares   80  were available for future awards.  Compensation expense for stock options granted is recognized over the requisite service period, which is typically the period over which the stock-based compensation awards vest. In anticipation of implementation of SFAS 123R, we accelerated the vesting of the outstanding options in December 2005, prior to adopting SFAS 123R.  We applied the guidance of SAB 107 in conjunction with the adoption of SFAS 123R.  This acceleration was for all employees, including the named executive officers.  On April 24, 2010, the Companys Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options to purchase an aggregate of 10,552,921 shares of common stock, $.001 par value per share (Common Stock), of the Company previously granted to officers, directors, employees and consultants of the Company (the Outstanding Options) pursuant to the Companys Amended and Restated 2003 Stock Incentive Plan. The Compensation Committee re-priced the Outstanding Options to a price equal to the mean between the closing bid and asked quotations for the Companys Common Stock on April 26, 2010, as reported on the OTC Bulletin Board, the quotation service for the Companys shares of Common Stock, namely, $0.30 per share. The Outstanding Options had been issued with exercise prices ranging from $0.43 to $5.27 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant. The Compensation Committee re-priced the Outstanding Options as compensation for the hardship of each optionee not regularly receiving his or her salary, wages, or other compensation due during the period April 6, 2006, through and including the present and ongoing, and the continued or continuing non-payment of such amounts by the Company.  The Compensation Committee determined that such action was in the best interest of the Company and its stockholders.  The following is a brief summary of the principal income tax consequences of awards under the 2003 Plan. This summary is based on current federal income tax laws and interpretations thereof, all of which are subject to change at any time, possibly with retroactive effect.  This summary is not intended to be exhaustive.  · Non-Qualified Options.  A participant who receives Non-Qualified Stock Options does not recognize taxable income upon the grant of an option, and Applied Visual Sciences, Inc. is not entitled to a tax deduction.  Applied Visual Sciences, Inc. is generally entitled to tax a deduction in an amount equal to the amount taxable to the participant as ordinary income in the year the income is taxable to the participant (generally when the option is exercised).  Any appreciation in value after the time of exercise will be taxable to the participant as capital gain (assuming it is a capital asset) and will not result in a deduction by Applied Visual Sciences, Inc.  · Incentive Options.  A participant who receives an Incentive Stock Option does not recognize taxable income upon the grant or exercise of the option and Applied Visual Sciences, Inc. is not entitled to a tax deduction.  The difference between the option price and the fair market value of the option shares on the date of exercise, however, will be treated as an item of adjustment for purposes of determining the alternative minimum tax liability, if any, of the participant in the year of exercise.  · A participant will recognize gain or loss upon the disposition of shares acquired from the exercise of ISOs.  The nature of the gain or loss depends on how long the option shares were held.  If the option shares are not disposed of pursuant to a disqualifying disposition (i.e., no disposition occurs within two years from the date the option was granted or one year from the date of exercise), the participant will recognize long-term capital gain or capital loss depending on the selling price of the shares.  If the option shares are sold or disposed of as part of a disqualifying disposition, the participant must recognize ordinary income in an amount equal to the lesser of the amount of gain recognized on the sale or the difference between the fair market value of the option shares on the date of exercise and the option price.  Any additional gain will be taxable to the participant as a long-term or short term capital gain, depending on how long the option shares were held.  Applied Visual Sciences, Inc. is generally entitled to a deduction in computing its federal income taxes for the year of disposition in an amount equal to any amount taxable to the participant as ordinary income.  2009 Stock Compensation Plan  On June 4, 2009, the Board of Directors adopted the 2009 Stock Compensation Plan (2009 Plan) which provides for the grant or issuance of up to an aggregate of 20,000,000 shares of the Companys common stock pursuant to non-qualified stock options (NQSOs), restricted stock awards (RSAs), restricted stock rights (RSRs), or common stock awards (Common Stock Awards) (a NQSO, RSA, RSR or Common Stock Award, individually, an Award; collectively, Awards). The exercise price of NQSOs may not be less than 100% of the fair market value of the stock on the date of the option grant, and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement, but may not be exercised after ten years from the date on which it was granted.  RSAs and RSRs consist of a specified number of shares of the Companys Common Stock that are, or may be, subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Committee. Generally, unless the Committee determines otherwise, once the restricted stock vests, the shares of Common Stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions, under a RSA (but not a RSR), a participant   81  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.    During 2010, we issued 1,725,000 stock awards under the 2009 Stock Compensation Plan to employees as compensation for the hardship of not regularly receiving their salaries, wages, or other compensation that was due during June 2008 through January 2009, and the continued or continuing nonpayment of such amounts by the Company. The issuance of the stock awards was not in lieu of the payment of such compensation which remains accrued and unpaid.  We also issued 40,000 stock awards to an employee upon conversion of accrued and unpaid wages, and 871,108 stock awards to consultants as compensation in lieu of cash payments for services rendered. As of December 31, 2010, there were 15,929,563 shares available for future awards under the 2009 Stock Compensation Plan.  The purpose of the 2009 Plan is to foster our success and the success of our subsidiaries and affiliates by providing incentives to employees, directors, officers and consultants to promote our long-term financial success.  The Plan complements our 2003 Amended and Restated Stock Incentive Plan (the 2003 Plan) and provides greater flexibility to us in that it permits us to compensate and award employees, directors, officers and consultants through the issuance of certain options, RSAs, RSRs, and stock awards in addition, or as an alternative, to the incentive and non-qualified stock options that may be awarded under the 2003 Plan. The 2009 Plan terminates on June 4, 2019, and no award may be made after that date, however, awards made before that date may extend beyond that date. If an award under the 2009 Plan is cancelled, expires, forfeited, settled in cash or otherwise terminates without being exercised in full, the shares of common stock not acquired pursuant to the award will again become available for issuance under the 2009 Plan.  Our Board of Directors has delegated its authority to administer the 2009 Plan to the Compensation Committee.  Subject to the provisions of the 2009 Plan, the committee has the power to:  · Prescribe, amend, and rescind rules and regulations relating to the 2009 Plan and to define terms not otherwise defined therein; · Determine which persons are eligible to participate, to which of such participants, if any, awards shall be granted, and the timing of any such awards; · Grant awards to participants and determine the terms and conditions thereof, including the number of shares subject to awards and the exercise or purchase price of such shares and the circumstances under which awards become exercisable or vested or are forfeited or expire; · Establish any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any award; · Prescribe and amend the terms of the agreements or other communications evidencing awards made under the 2009 Plan (which need not be identical) and the terms or form of any document or notice required to be delivered to us by participants under the 2009 Plan; · Determine the appropriate adjustment, if any, required as a result of any reorganization, reclassification, combination of shares, stock split, reverse stock split, spin-off or dividend (other than regular, quarterly cash dividends), or other changes in the number or kind of outstanding shares or any stock or other securities into which such shares shall have been exchanged; · Interpret and construe the 2009 Plan, any rules and regulations under the 2009 Plan and the terms and conditions of any award granted thereunder, and to make exceptions to any such provisions in good faith and for the benefit of the Company; and · Make all other determinations deemed necessary or advisable for the administration of the 2009 Plan.  Unless the Board expressly provides otherwise prior to a change of control or in an award agreement, in the event of a change of control of the Company, all outstanding options under the 2009 Plan vest and become exercisable on the date immediately before the change of control and all restrictions under RSAs and RSRs shall lapse or be deemed satisfied on the date immediately prior to the change of control.  A change of control is deemed to have occurred upon the occurrence of one of the following events: (i) any person or group of persons becomes the beneficial owner of shares of the Company to which 50% or more of the total number of votes for the election of directors may be cast; (ii) as a result of a cash tender offer, exchange offer, merger or other business combination, sale of assets or contested election, persons who were directors immediately prior to the event cease to constitute a majority of the board; (iii) stockholders approve an agreement providing either that the Company will cease to be an independent publicly owned corporation or for sale or other disposition of all or substantially all the assets of the Company; or (iv) a tender offer or exchange offer is made for shares of our common stock (other than one made by us) and shares of common stock are acquired.    82  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 RSRs 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.  Severance and Change in Control Benefits  Three of our four named executive officers are covered by employment agreements which specify payments in the event the executives employment is terminated. The type and amount of payments vary by executive level and the nature of the termination. These termination benefits are payable if and only if the executives employment terminates as specified in the applicable employment agreement.  Also, two of our named executive officers, Mr. Donovan and Mr. Hare, have employment agreements that require us to make certain payments in the event of a change in control and upon the occurrence of certain other material events.  Our primary reason for including termination and change in control benefits in compensation packages is to attract and retain the best possible executive talent. We believe our termination benefits are competitive with general industry packages. For a further description of these severance benefits, see Employment Agreements and Severance and Change in Control Benefits below.  In addition, our 2003 Stock Incentive Plan provides that in the event of our change in control, the Compensation Committee may otherwise determine the status of unvested options or restricted stock, including, without limitation, whether the successor corporation will assume or substitute an equivalent award, or portion thereof, for each outstanding award under the plan or, if there is no assumption or substitution of unvested outstanding awards, such unvested awards may be canceled.   83   401(k) Savings Plan  We maintain a tax-qualified retirement plan that provides eligible employees with an opportunity to save for retirement on a tax advantaged basis. Eligible employees are able to participate in the 401(k) plan as of the first day of the month following 90 days of employment. The 401(k) plan permits us to make profit sharing contributions to eligible participants, although we currently do not match contributions. Pre-tax contributions are allocated to each participants individual account and are then invested in selected investment alternatives according to the participants directions. All employee contributions are 100% vested. The 401(k) plan is intended to qualify under Sections 401(a) and 501(a) of the Internal Revenue Code. As a tax-qualified retirement plan, contributions to the 401(k) plan and earnings on those contributions are not taxable to the employees until distributed from the 401(k) plan. We believe that offering a 401(k) retirement plan fosters our ability to attract and retain the best possible executive talent.  Deferred Compensation and Pension Plans  Currently, we do not have a company sponsored deferred compensation or pension plan for any or all employees, including our named executive officers.  Perquisites and Other Compensation  During the each of the two fiscal years ended December 31, 2010, two of our named executive officers received reimbursement of up to $6,000 annually for automobile expenses as required under the terms of their employment agreements. See below Employment, Severance and Change in Control Arrangements.  Currently, we do not provide short or long term disability or life insurance coverage for employees, including our named executive officers, as a result of our current cash position.  We do provide health care benefits to all employees including our named executive officers, and such benefits are contributory.  We intend to continue to maintain executive benefits and perquisites for officers, however, the Compensation Committee may in its discretion revise, amend or increase named executive officers perquisites as it deems advisable. We believe these benefits and perquisites are currently not above median competitive levels for comparable companies and are beneficial in attracting and retaining executive talent.  Equity Ownership Guidelines  Currently, we do not have any equity ownership guidelines for our executive officers or directors.  Role of Executive Officers in Executive Compensation  The Compensation Committee considers managements recommendation and other factors mentioned above in determining the compensation payable to each of the named executive officers as well as the compensation of the members of the board of directors.  Summary Compensation Table  The following Summary Compensation Table sets forth the compensation earned or awarded to our CEO, President and COO, CFO and other named executive officers during each of the two fiscal years ended December 31, 2010:     84                                              Name and principal positionYearCompensationSalaryBonusStock awards (1)Options awards (1)All other (2)TotalMichael W. Trudnak (3)2009$ 275,000$ -$ -$ 96,633$ 6,000$ 377,633Chairman, CEO2010275,000-61,000488,229422,7011,246,930William J. Donovan (4)2009265,000--93,0966,000364,096President/COO2010265,000-61,000543,292273,0981,142,390Gregory E. Hare (5)2009200,000--70,254-270,254Chief Financial Officer2010200,000-61,000264,402210,322735,724Richard F. Borrelli (6)2009160,000--56,187-216,187Vice President2010160,000-61,000110,49078,868410,358(1) Reflects the grant date fair value of stock and/or options estimated using option-pricing models calculated in accordance with ASC 718-10. See Note 2 "Significant Accounting Policies" to the Consolidated Financial Statements for a discussion of the relevant assumptions used in calculating the grant date fair value pursuant to ASC 718-10.  For 2010, the amount reflects the incremental fair value for repricing of previously issued options to $0.30, which was the maket price on the date repriced.  See Grants of Plan-Based Awards disclosure below for additional information related to the repricing of stock options.(2) All Other Compensation consists of monthly automobile allowance expenses of $6,000 for Messrs Trudnak and Donovan.  2010 also includes interest on accrued and unpaid wages, which was converted to stock on October 26, 2010, under terms of the Company's then current private offering.  The purchase price of the stock and execrise price of the warrants issued in the offering were under the same terms and conditions to all investors participating in the offering of $0.25 per share, while the market price on the date of purchase was $0.305 per share.(3) For Mr. Trudnak, includes accrued and unpaid salary of $281,058 in 2010, and $211,708 in 2009, for a cumulative deferral as of December 31, 2010 of $922,292.(4) For Mr. Donovan, includes accrued and unpaid salary of $207,496 in 2010, and $184,881 in 2009, for a cumulative deferral as of December 31, 2009 $571,133.(5) For Mr. Hare, includes accrued and unpaid salary $144,150 in 2010, and $128,839 in 2009, for a cumulative deferral as of December 31, 2009 of $495,455.(6) For Mr. Borrelli, includes accrued and unpaid salary of $121,133 in 2010, and 95,731 in 2009, for a cumulative deferral as of December 31, 2009 of $315,325.  Mr. Borrelli was an officer of the Company through January 10, 2011, but continues as the Vice President of Business Development, Healthcare.    Grants of Plan-Based Awards Table  The following table sets forth information regarding stock option awards to our named executive officers under our 2003 Stock Incentive Plan during the fiscal year ended December 31, 2010:    85                                                                                   NameGrant Date (1)Estimated future payouts under non-equity incentive plan awardsEstimated future payouts under equity incentive plan awardsAll other stock awards: Number of shares of stock or units (#)All other option awards: Number of securities underlying options (#)Exercise or base price of option awards ($/Share)Grant date fair value of stock and option awardsMichael W. Trudnak (2)4/26/10$ -$ --1,627,430$ 0.30$ 488,229William J. Donovan (2)4/26/10---1,810,9720.30543,292Gregory E. Hare (2)4/26/10---881,3400.30264,402Richard F. Borrelli (2)4/26/10---368,3000.30110,490(1) Two year vesting period with 50% vested after year one, and 50% vested after year two, except repriced options that were fully vested.(2) On April 24, 2010, the Company*s Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options previously granted to officers, directors, employees and consultants of the Company, pursuant to the Company*s Amended and Restated 2003 Stock Incentive Plan. The Committee repriced 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, namely, $0.30 per share.  The outstanding options for the above named officers were issued with exercise prices ranging from $0.36 to $4.10 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant. The Compensation Committee repriced the outstanding options as compensation for the hardship of each optionee not regularly receiving his or her salary, wages, or other compensation due during the period April 6, 2006, through and including April 26, 2010, and the continued non-payment of such amounts by the Company.  The Committee determined that such action was in the best interest of the Company and its stockholders.   Outstanding Equity Awards at Fiscal Year-End Table  The following table sets forth information for each named executive officer regarding the number of shares subject to exercisable and unexercisable stock options as of December 31, 2010.    86                                                       NameOption awards (1)Stock awardsNumber of securities underlying unexercised options (#)Equity incentive plan awards: number of securities underlying unexercised unearned options (#)Option exercise price (1)Option Expiration DateNumber of shares or units of stock that have not vested (#)Market value of shares or units of stock that have not vested (#)Equity incentive plan awards: number of unearned shares, units or other rights that have not vested (#)Equity incentive plan awards: market or payout value of unearned shares, units or other rights that have not vestedExercisableUnexercisableMichael W. Trudnak450,000--$ 0.30(2)2/18/2014---$ -10,000--0.30(2)2/18/2014----125,000--0.30(2)1/14/2017----707,530--0.30(2)10/8/2017----334,900--0.30(2)1/8/2018----178,950178,950-0.304/21/2019----William J. Donovan200,000--0.30(2)8/18/2013----600,000--0.30(2)2/18/2014----10,000--0.30(2)2/18/2014----200,000--0.30(2)11/21/2015----125,000--0.30(2)1/14/2017----353,372--0.30(2)10/8/2017----322,600--0.30(2)1/8/2018----172,400172,400-0.304/21/2019----Gregory E. Hare200,000--0.30(2)1/16/2016----125,000--0.30(2)1/14/2017----312,840--0.30(2)10/8/2017----243,500--0.30(2)1/08/2018----130,250130,250-0.304/21/2019----Richard F. Borrelli100,000--0.30(2)9/3/2014----20,000--0.30(2)10/3/2015----112,000--0.30(2)1/14/2017----136,300--0.30(2)1/8/2018----104,050104,050-0.304/21/2019----(1) Two year vesting periods with 50% vested after year one, and 50% after year two.(2) On April 24, 2010, the Company*s Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options previously granted to officers, directors, employees and consultants of the Company, pursuant to the Company*s Amended and Restated 2003 Stock Incentive Plan. The Committee repriced 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, namely, $0.30 per share.  The outstanding options for the above named officers were issued with exercise prices ranging from $0.36 to $4.10 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant. The Compensation Committee repriced the outstanding options as compensation for the hardship of each optionee not regularly receiving his or her salary, wages, or other compensation due during the period April 6, 2006, through and including April 26, 2010, and the continued non-payment of such amounts by the Company.  The Committee determined that such action was in the best interest of the Company and its stockholders.   Option Exercises and Stock Vested Table    87  The following table sets forth information for each named executive officer regarding the number of shares acquired upon the exercise of stock options during the year ended December 31, 2010, and the aggregate dollar value realized upon the exercise of the option. We have not issued stock appreciation rights (SARs) or restricted stock awards (RSAs) under our 2009 Stock Compensation Plan.                                 NameOption awardsStock awardsNumber of shares acquired on exerciseValue realized on vesting (1)Number of shares acquired on vestingValue realized on vesting (1)Michael W. Trudnak-$ --$ -William J. Donovan----Gregory E. Hare----Richard F. Borrelli----(1) Represents the difference between the market price on date of exercise and the exercise price.   Employment, Severance and Change in Control Arrangements   The employment agreements for each named executive officer (except for Mr. Borrelli with whom we have not entered into any employment agreement) are multiple years in duration and automatically renew unless terminated by either party in accordance with its terms. Each of the named executive officers employment agreement provides for an annual base salary and a discretionary annual incentive cash bonus and/or equity awards.  In subsequent years, the amount of annual incentive cash and/or equity award bonus is subject to determination by our board of directors without limitation on the amount of the award. Each of the agreements provides for a severance payment over a prescribed term in the event the named executive is terminated without cause, including for Mr. Donovan and Mr. Hare, if their duties are materially changed in connection with a change in control. Each agreement also provides that no severance payment is due in the event of termination for cause, which includes termination for willful misconduct, conviction of a felony, dishonesty or fraud. Each agreement further contains an agreement by the named executive officer not to compete with us for a defined term equal in length to the applicable severance payment in the respective employment agreement, which we feel is reasonable and consistent with industry guidelines.  Michael W. Trudnak.Mr. Trudnak serves as Chairman of the Board, Secretary, and Chief Executive Officer and a Class III director.  The Company entered into an employment agreement with Mr. Trudnak, which commenced on January 1, 2003.  The Company amended his agreement effective December 10, 2004. The amended agreement is for a three year term commencing June 26, 2003, and is renewable for one year terms.  The employment agreement provides for annual compensation to Mr. Trudnak of $275,000 and a monthly automobile allowance of $500.  The agreement provides for incentive compensation and/or bonuses as determined by Applied Visual Sciences, Inc., participation in the Companys stock option plan, and participation in any of its employee benefit policies or plans.  The employment agreement may be terminated upon the death or disability of the employee or for cause, in which event Applied Visual Sciences, Inc.s obligation to pay compensation shall terminate immediately.  In the event the agreement is terminated by us other than by reason of the death or disability of the employee or for cause, the employee is entitled to payment of his base salary for one year following termination.  The employee may terminate the agreement on 30 days prior notice to Applied Visual Sciences, Inc. The employee has entered into an employee proprietary information, invention assignment and non-competition agreement, pursuant to which the employee agrees not to disclose confidential information regarding Applied Visual Sciences, Inc., agrees that inventions conceived during his employment become the property of Applied Visual Sciences, Inc., agrees not to compete with the business of Applied Visual Sciences, Inc. for a period of one year following termination of employment, and agrees not to  solicit employees or customers of the Company following termination of employment.  William J. Donovan.Mr. Donovan serves as President and Chief Operating Officer of Applied Visual Sciences, Inc., and previously served as Chief Financial Officer.  The Company entered into a new employment agreement with Mr. Donovan on November 18, 2005, which superseded his previous employment agreement with Applied Visual Sciences, Inc., dated effective August 18, 2003.  The new employment agreement is for a term of three years unless earlier terminated, and is automatically renewable for one year terms.  The employment agreement provides for an annual salary of $265,000.  The agreement provides for annual performance bonuses based on goals established by Applied Visual Sciences, Inc. and agreed to by Mr. Donovan, a monthly automobile allowance of $500, participation in our stock option and other award plans (which options or awards shall immediately vest upon a change in control), and participation in any benefit policies or plans adopted by us on the same basis as other employees at Mr. Donovans level.    88  The employment agreement may be terminated by Mr. Donovan on 30 days prior written notice.  The employment agreement may be terminated by us by reason of death, disability or for cause.  In the event the agreement is terminated for death or disability of the employee, our obligation to pay compensation to the employee shall terminate immediately; provided that if the Company does not maintain disability insurance for the employee, he is entitled to be paid his base salary for one year following his disability.  In the event that he is terminated other than by reason of his death, disability, for cause, or change in control, Mr. Donovan is entitled to payment of his base salary for one year following termination.  Further if Mr. Donovan terminates his employment for the following material reasons (each a material reason): written demand by us to change the principal workplace of the employee to a location outside of a 50-mile radius from the current principal address of Applied Visual Sciences, Inc.; a material reduction in the number or seniority of personnel reporting to employee or a material reduction in the frequency or in nature of matters with respect to which such personnel are to report to employee, other than as part of a company-wide reduction in staff; an adverse change in employees title; a material decrease in employees responsibilities; or a material demotion, Mr. Donovan is entitled to be paid the greater of the base salary remaining under the employment agreement or twelve months base salary.  In the event of a change in control of Applied Visual Sciences, Inc. and, within 12 months of such change of control, employees employment is terminated or one of the events in the immediately preceding sentence occurs, Mr. Donovan is entitled to be paid his base salary for 18 months following such termination or event.  A change in control would include the occurrence of one of the following events:  · the approval of the stockholders for a complete liquidation or dissolution of Applied Visual Sciences, Inc.;  · the acquisition of 20% or more of the outstanding common stock of Applied Visual Sciences, Inc. or of voting power by any person, except for purchases directly from Applied Visual Sciences, Inc., any acquisition by Applied Visual Sciences, Inc., any acquisition by a Applied Visual Sciences, Inc. employee benefit plan, or a permitted business combination;  · if two-thirds of the incumbent board members as of the date of the agreement cease to be board members, unless the nomination of any such additional board member was approved by three-quarters of the incumbent board members;  · upon the consummation of a reorganization, merger, consolidation, or sale or other disposition of all or substantially all of the assets of Applied Visual Sciences, Inc., except if (i) all of the beneficial owners of Applied Visual Sciences, Inc.s outstanding common stock or voting securities who were beneficial owners before such transaction own more than 50% of the outstanding common stock or voting power entitled to vote in the election of directors resulting from such transaction in substantially the same proportions, (ii) no person owns more than 20% of the outstanding common stock of Applied Visual Sciences, Inc. or the combined voting power of voting securities except to the extent it existed before such transaction, and (iii) at least a majority of the members of the board before such transaction were members of the board at the time the employment agreement was executed or the action providing for the transaction.  Also, Mr. Donovan has entered into a proprietary information, invention assignment and non-competition agreement (non-competition agreement), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to solicit our employees or customers following termination of his employment.  The employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.  Gregory E. Hare.Mr. Hare serves as our Chief Financial Officer, and Treasurer. The Company entered into an employment agreement with Mr. Hare commencing on January 30, 2006. The employment agreement is essentially the same as the agreement the Company entered into with Mr. Donovan, except that the agreement is for a term of two years unless earlier terminated and shall automatically renew for successive one year terms unless terminated prior thereto.  The employment agreement provides for a base salary of $200,000 per annum and no automobile allowances. The agreement provides for annual performance bonuses based on goals established by the Company and agreed to by Mr. Hare, participation in the Companys stock option and other award plans, and participation in any company benefit policies or plans adopted by us on the same basis as other employees at Mr. Hares level.  The Company agreed to grant to Mr. Hare, subject to approval of our Compensation Committee, stock options to purchase 200,000 shares of our common stock pursuant to our 2003 Stock Incentive Plan, one-half of which options will vest on the one year anniversary of the commencement of his employment and the remaining options vesting on the two year anniversary of the commencement of his employment.  Also, Mr. Hare has entered into a proprietary information, invention assignment and non-competition agreement (non-competition agreement), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to  solicit our employees or customers following termination of his employment.  The   89  employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.  Richard F. Borrelli. Mr. Borrellis employment as Vice President and Officer for the Company is at-will, and thus has not entered into employment agreements.  Therefore, there is no employment, severance or change of control arrangements.  Potential Payments upon Termination or Change in Control  As described under Employment, Severance and Change in Control, above, we are required to make certain severance payments to all of our named executive officers and provide certain change in control benefits to Mr. Donovan and Mr. Hare.  In the event of the occurrence of such events, such named executive officer, as applicable, would be entitled to (a) cash payments of any unpaid base salary through the date of termination and any accrued vacation pay and severance pay and (b) in certain cases, the accelerated vesting of outstanding stock options and restricted stock.  Healthcare benefits would be continued at the individuals election and cost through the COBRA plan.  Perquisites would be discontinued upon termination.  Cash Severance and Change in Control Payments  The following table summarizes the potential payments and benefits payable to each of our named executive officer upon termination of employment or change in our control assuming our named executive officers were terminated on December 31, 2010:         NameOther Than Death, Disability, or Cause (1)Disability (1)Material Reason (1)Change in Control (2)Michael W. Trudnak$ 275,000$ -$ 0$ 0William J. Donovan265,000265,000265,000397,500Gregory E. Hare200,000200,000200,000300,000(1) Represent 12 months salary, and does not include accrued and unpaid salary, nor earned and unused vacation.(2) Represent 18 months salary, and does not include accrued and unpaid salary, nor earned and unused vacation.    Acceleration o f Vesting of Option Awards  If our named executive officers were terminated on December 31, 2010, the applicable officer is entitled to automatically and immediately vest in his or her outstanding stock options, as described in the table below:                       Name/CircumstancesDescription of Equity AwardsMichael W. Trudnak (Change of Control)357,900 options were granted on April 21, 2009, of which 178,950 became exercisable on April 21, 2010, and the balance of 178,950 would immediately vest and become exercisable in full at a total exercise value of $53,685 (average of $0.30 per share).William J. Donovan (Change of Control, Death, or Disability)344,800 options were granted on April 21, 2009, of which 172,400 became exercisable on April 21, 2010, and the balance of 172,400 would immediately vest and become exercisable in full at a total exercise value of $51,720 (average of $0.30 per share).Gregory E. Hare (Change of Control, Death, or Disability)260,200 options granted were on April 21, 2009, of which 130,100 became exercisable on April 21, 2010, and the balance of 130,100 would immediately vest and become exercisable in full at a total exercise value of $39,030 (average of $0.30 per share).    Pension Benefits  None of our named executive officers participate in or have account balances in qualified or non-qualified defined benefit plans sponsored by us.  Non-Qualified Deferred Compensation    90  None of our named executive officers participate in or have account balances in non-qualified defined contribution plans or other deferred compensation plans by us. The Compensation Committee may elect to provide our officers and other employees with non-qualified defined contribution or deferred compensation benefits if the Compensation Committee determines that doing so is in our best interests.  Director Compensation and Benefits  On December 6, 2007, based upon the recommendation of the Compensation Committee, the Board adopted an Amended Policy Regarding Compensation of Independent Directors, pursuant to which we will furnish the following compensation to our independent directors effective July 1, 2009.  We furnished compensation to our independent directors in accordance with the following policy during 2010:  · At the beginning of each calendar year, each independent director will receive annual compensation in the form an award of non-qualified options to purchase 150,000 shares of common stock, an annual retainer for attending Board meetings of non-qualified options to purchase 24,000 shares of common stock, non-qualified options to purchase 3,000 shares of common stock for each board committee of which he or she is a member, and non-qualified options to purchase 2,000 shares of common stock for each board committee of which he or she is a chairperson of the Compensation, Nominating, and Special Committees, and non-qualified options to purchase 70,000 shares of common stock for the Audit Committee chairperson, or a pro rata portion of such number if a director is elected after the beginning of the year. · We reimburse our independent directors for out of pocket expenses in connection with travel to and attending board and committee meetings.  All of the options we issue to independent directors are pursuant to our 2003 Stock Incentive Plan.  The options are exercisable for a period of ten years and at a price equal to the fair market value of Applied Visual Sciences, Inc.s common stock on the date of grant.  The board, at its discretion, may grant additional awards of options, restricted stock and/or cash compensation to its independent directors as it may determine from time to time.  Our Policy may be amended, altered or terminated at the election of the board, provided no amendment, alteration or terminations shall have a retroactive effect or impair the rights of an independent director under any option grant theretofore granted. Our directors who are also officers of or employed or engaged as consultants by Applied Visual Sciences, Inc. or any of its subsidiaries are not additionally compensated for their board activities.  The following table sets forth compensation to our independent directors for the fiscal year ended December 31, 2010. Currently, our independent directors as a group only receive stock option awards as compensation for their services on the Board and do not receive any cash compensation other than reimbursement of expenses for such activities.      91                                                                          NameFiscal YearFees Earned or Paid in CashStock Awards ValueOption Awards Value (1)Value of Non-Equity Incentive Plan CompensationChange in Pension Value and Nonqualified Deferred Compensation EarningsValue of All Other CompensationTotal ValueCharles T. Nash (2)2010$ -$ -$ 59,059$ -$ -$ -$ 59,059Henry A. Grandizio (2)2010--72,682---72,682Joseph C. Brothers2010--35,483---35,483Keith S. Kelly2010--35,099---35,099Sean W. Kennedy (2)(3)2010--59,810--208,000267,810(1) The options granted are for the same year as the Board activities. The issuances were consistent with the then current "Policy Regarding Compensation of Independent Directors" outlined above. Reflects the grant date fair value estimated using option-pricing models calculated in accordance with ASC 718-10. See Note 2 "Significant Accounting Policies" to the Consolidated Financial Statements for a discussion of the relevant assumptions used in calculating the grant date fair value pursuant to ASC 718-10.(2) On April 24, 2010, the Company*s Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options previously granted to officers, directors, employees and consultants of the Company, pursuant to the Company*s Amended and Restated 2003 Stock Incentive Plan. The Committee repriced 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, namely, $0.30 per share.  The outstanding options for the above directors were previously issued with the exercise prices ranging from $0.45 to $3.60 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant.  Includes the aggregate fair value of the options on the repricing date for Messrs. Nash, Grandizio, and Kennedy of $34,050, $20,756, and $36,150, respectively.(3) Mr. Kennedy provides consulting services through BND Software, Inc., a corporation that he owns and controls. The consulting services provided include managing the research, development and information systems activities of the Company. We paid or agreed to pay BND Software, Inc. an aggregate of $208,000 during 2010.  As of December 31, 2010, the Company has accrued and unpaid fess due BND Software, Inc. of $325,796.   Other Arrangements  We maintain a claims made officers and directors liability insurance policy with coverage limits of $5,000,000 and a maximum $200,000 deductible amount for each claim.       ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS  The following table shows, as of March 30, 2011, the beneficial ownership of our common stock by (i) any person we know who is the beneficial owner of more than 5% of our common stock, (ii) each of our directors and executive officers, and (iii) all of our directors and executive officers as a group.  As of March 30, 2011 there were 84,763,958 shares of our common stock issued and outstanding.       92                        Name of Beneficial Owner (1)Number of Shares Beneficially Owned (1)% of Common Stock Beneficial OwnershipMichael W. Trudnak10,190,988(2)11.6%William J. Donovan4,493,572(3)5.1%Gregory E. Hare2,624,712(4)3.0%Sean W. Kennedy1,971,824(5)2.3%Charles T. Nash490,500(6)*Henry A. Grandizio649,187(7)*Joseph C. Brothers1,600,000(8)1.9%Keith S. Kelly320,777(9)*All executive officers and directors as a group (8 individuals)22,341,560(10)23.1%* Represents less than 1%   (1)Beneficial ownership is determined in accordance with Rule 13d-3 under the Exchange Act, and is generally determined by voting powers and/or investment powers with respect to securities.  Unless otherwise noted, all shares of common stock listed above are owned of record by each individual named as beneficial owner and such individual has sole voting and dispositive power with respect to the shares of common stock owned by each of them.  Such person or entitys percentage of ownership is determined by assuming that any options or convertible securities held by such person or entity which are exercisable within 60 days from the date hereof have been exercised or converted as the case may be.  All addresses, except as noted, are c/o Applied Visual Sciences, Inc., 250 Exchange Place, Suite H, Herndon, Virginia 20170.(2)Mr. Trudnak - includes 1,806,380 shares underlying options and 1,666,804 warrants to purchase shares of common stock which are currently exercisable. Does not include shares underlying 178,950 options that are not currently exercisable.(3)Mr. Donovan - includes 1,983,372 shares underlying options and 1,600,000 warrants to purchase shares of common stock which are currently exercisable. Does not include 172,400 shares underlying options that are not currently exercisable.(4)Mr. Hare  includes 1,011,440 shares underlying options and 900,136 warrants to purchase shares of common stock which are currently exercisable.  Does not include shares underlying 130,100 options that are not currently exercisable.(5)Mr. Kennedy - includes 566,950 shares underlying options and 588,412 warrants to purchase shares of common stock which are currently exercisable. Does not include underlying 82,450 options that are not currently exercisable. Includes 10,550 shares of common stock owned by Mr. Kennedys wife with respect to which Mr. Kennedy disclaims beneficial ownership.(6)Mr. Nash - includes 483,500 shares underlying options to purchase shares of common stock which are currently exercisable. Does not include underlying 3,425 options that are not currently exercisable.(7)Mr. Grandizio  includes 649,187 shares underlying options to purchase shares of common stock which are currently exercisable. Does not include underlying 2,055 options that are not currently exercisable.(8)Mr. Brothers  includes 800,000 shares underlying warrants to purchase shares of common stock which are currently exercisable. Does not include underlying 126,725 options that are not currently exercisable.(9)Mr. Kelly  does not include underlying 125,355 options that are not currently exercisable.(10)All executive officers and directors as a group (8 individuals) - includes shares underlying options to purchase an aggregate of 1,806,380, 1,983,372, 1,011,440, 566,930, 483,500, 649,187, 0, and 0 shares of common stock which are currently exercisable that have been granted to Messrs. Trudnak, Donovan, Hare, Kennedy, Nash, Grandizio, Brothers, and Kelly, respectively.  Also includes shares underlying warrants to purchase an aggregate of 1,666,804, 1,600,000, 900,136, 588,412, 0, 0, 800,000, and 0 shares of common stock which are currently exercisable that have been issued to Messrs. Trudnak, Donovan, Hare, Kennedy, Nash, Grandizio, Brothers, and Kelly, respectively.  Does not include shares underlying options to purchase an aggregate of 178,950, 172,400, 130,100, 82,450, 3,425, 2,055, 126,725, and 125,355 shares of common stock that are not currently exercisable that have been granted to Messrs. Trudnak, Donovan, Hare, Kennedy, Nash, Grandizio, Brothers, and Kelly, respectively.         ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE  In addition to the executive and director compensation arrangements, including employment and change in control arrangements discussed above under Item 11 - Executive Compensation, the following is a description of transactions since January 1, 2008, to which we have been a party in which the amount involved in the transaction exceeded or will exceed the lesser of $120,000 or one percent of the average of our total assets as at the year end for the last two completed fiscal years, and in which any of our directors, executive officers or beneficial holders of more than 5% of our capital stock, or any immediate family member of, or person sharing the household with, any of these individuals, had or will have a direct or indirect material interest.    93  Loans from Our Chief Executive Officer  On April 21, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, the Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $200,000. The Company issued a non-negotiable promissory note, dated effective April 21, 2006, to Mr. Trudnak in the principal amount of $200,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition.  In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full.  The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On October 21, 2006, Mr. Trudnak extended the due date of the loan to December 31, 2006. Subsequently, on October 3 and October 18, 2006, Mr. Trudnak loaned the Company $102,000 and $100,000, respectively, on substantially the same terms as the April 21, 2006 loan, except that each loan is due six months after the date thereof. Accordingly, following such additional loans, the Company owed an aggregate of approximately $402,000 to Mr. Trudnak. On November 10, 2006, Mr. Trudnak extended the due dates of such loans to May 31, 2007, except that $100,000 of the April 21, 2006, loan becomes due upon the Company raising $2,500,000 in financing after November 6, 2006, and the remaining amount of $202,000 of such loans become due upon the Company raising an aggregate of $5,000,000 in financing after November 6, 2006, and prior to May 31, 2007. Following the first closing of our Debenture and Series D Warrant financing on November 8, 2006, the Company repaid $100,000 on November 20, 2006, in principal amount of the April 1, 2006, and paid an additional $100,000 to Mr. Trudnak on April 17, 2007 upon the second closing of our Debenture and Series D Warrant financing. On May 31, 2007, Mr. Trudnak extended the due dates of the remaining loans to May 31, 2008. Although, the anticipated payment of $202,000 had not been made, and Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, for total outstanding notes of $226,000.  Subsequently, the maturity date of the outstanding loans was extended to May 31, 2009, and subsequently to May 31, 2010.  On June 1, 2010, the outstanding loans were extended to June 30, 2011.  During 2010, the Company repaid an aggregate of $108,900 of the notes, resulting in an outstanding balance at December 31, 2010, of $117,100. The terms of the above transaction were reviewed and approved by the Companys audit committee and by our Board of Directors.  Consulting Agreement with BND Software, Principal Owner Sean Kennedy, a Director of the Company  On July 15, 2008, Applied Visual Sciences, Inc. entered into a consulting agreement with BND Software, Inc. (BND), a corporation that is owned and controlled by Mr. Sean W. Kennedy, a director of the Company. BND agreed to provide certain consulting services to the Applied Visual including managing the research, development and information systems activities of the Company. The agreement is for a term of one year commencing on May 27, 2008, and expires on May 31, 2009. The agreement provided for an extension of a twelve (12) month period upon mutual agreement by both parties. The agreement may be terminated upon 60 days prior written notice by one party to the other party. The agreement also provided for an annual compensation of $216,000. The Company did not renew the agreement with BND, although Mr. Kennedy continues to provide management services for the research, development and information systems activities.  We paid or agreed to pay BND an aggregate of $208,000 during 2010, and $216,000 during 2009, of which $325,796 is accrued and unpaid as of December 31, 2010.         ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES  To ensure the independence of Applied Visual Sciences, Inc.s independent auditor and to comply with applicable securities laws, the Audit Committee is responsible for reviewing, deliberating and, if appropriate, pre-approving all audit, audit-related, and non-audit services to be performed by Applied Visual Sciences, Inc.s independent registered public accountants.  For that purpose, the Audit Committee has established a policy and related procedures regarding the pre-approval of all audits, audit-related, and non-audit services to be performed by Applied Visual Sciences, Inc.s independent accountants (the "Policy").   94   The Policy provides that Applied Visual Sciences, Inc.s independent accountant may not perform any audit, audit-related, or non-audit service for Applied Visual Sciences, Inc., subject to those exceptions that may be permitted by applicable law, unless (1) the service has been pre-approved by the Audit Committee, or (2) Applied Visual Sciences, Inc. engaged the independent registered public accountant to perform the service pursuant to the pre-approval provisions of the Policy. In addition, the Policy prohibits the Audit Committee from pre-approving certain non-audit services that are prohibited from being performed by Applied Visual Sciences, Inc.s independent accountant by applicable securities laws. The Policy also provides that the Chief Financial Officer will periodically update the Audit Committee as to services provided by the independent auditor. With respect to each such service, the independent registered public accountant provides detailed back-up documentation to the board and the Chief Financial Officer.  Pursuant to its Policy, the Audit Committee has pre-approved certain categories of services to be performed by the independent registered public accountant and a maximum amount of fees for each category. The Board annually re-assesses these service categories and the associated fees. Individual projects within the approved service categories have been pre-approved only to the extent that the fees for each individual project do not exceed a specified dollar limit, which amount is re-assessed annually. Projects within a pre-approved service category with fees in excess of the specified fee limit for individual projects may not proceed without the specific prior approval of the Audit Committee. In addition, no project within a pre-approved service category will be considered to have been pre-approved by the Board if the project causes the maximum amount of fees for the service category to be exceeded, and the project may only proceed with the prior approval of the Audit Committee to increase the aggregate amount of fees for the service category.  The Audit Committee of the Board of Directors of the Company has appointed the firm of KBL, LLP, to serve as independent auditors of the Company for the fiscal year ending December 31, 2010.  KBL, LLP was first appointed on February 23, 2009 for the fiscal year ending December 31, 2008 audit. The London office of Moore Stephens International performs an audit of Wise Systems, in accordance with the statutory requirements of the United Kingdom, and also provides related tax services.  For the fiscal years ended December 31, 2010, and 2009, the Company paid (or will pay) the following fees for services rendered during the year or for the audit in respect of those years:                       Fee Type20102009Audit Fees (1)$ 60,500$ 68,000Audit Related Fees (2)-2,757Tax Fees (3)8,5006,500All Other Fees (4)--Total$ 69,000$ 77,257(1) Represents fees for professional services rendered in connection with the audit of the annual financial statements, and review of the quarterly financial statements for each fiscal year.  Fiscal 2010 fees include approximately $60,500 for KBL, LLP.  Fiscal 2009 fees include approximately $58,000 for KBL, LLP, and $10,000 for Moore Stephens.(2) Represents fees for professional services that principally include due diligence in connection with acquisitions or dispositions, accounting consultantations, and assistance with internal control documentation and information systems audits. The assurance and related services reasonably related to the performance of the audit or review of the Company's financial statements, such as SEC filings. No such services for Fiscal 2010 were approved nor rendered.  Fiscal year 2009 reflects fees to KBL, LLP of $0, and $2,757 for Goodman & Company, L.L.P.(3) Represents fees for tax compliance services.  Fiscal 2010 disclosure represent amounts estimated to be paid to KBL, LLP of $3,500, and to Moore Stephens for Wise Systems of $5,000.  Fiscal 2009 disclosure represent amounts paid to KBL, LLP of $2,500, and to be paid to Moore Stephens for Wise Systems of $4,000.(4) Represents fees for professional services other than those described above.  No other such services for Fiscal 2010 and 2009 were approved nor rendered pursuant to the de minimis exception provided in Rule 2-01 (7) (i)(C) of Regulation S-X.          PART IV            95  ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES  FINANCIAL STATEMENTS The financial statements of the Company for the fiscal years covered by this Annual Report are located on page 100 of this Annual Report.  (a) The following financial statements and those financial statement schedules required by Part IV, Item 15 hereof are filed as part of this report:  1. Financial Statements Report of Independent Registered Public Accounting Firm, Consolidated Balance Sheets as of December 31, 2010 and 2009, Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2010, and 2009, Consolidated Statements of Stockholders Equity (Deficit) and Comprehensive Income (Loss) for the years ended December 31, 2010, and 2009, Consolidated Statements of Cash Flows for the years ended December 31, 2010, and 2009, Notes to Consolidated Financial Statements.  2. Financial Statement Schedules:  The financial statements are set forth under Part IV, Item 15 of this Annual Report on Form 10-K.  Financial statement schedules have been omitted since they are not required, not applicable, or the information is otherwise included.  (b) The following exhibits are filed as part of this Annual Report on Form 10-K:  EXHIBITS  Incorporated by Reference FromExhibit No.Exhibit DescriptionFormFiling DateFiled Herewith2.1Amended and Restated Agreement and Plan of Reorganization dated effective June 12, 2003, by and among the Company, RJL Marketing Services, Inc., and the shareholders of RJL Marketing Services, Inc.8-K06/27/20033.1Certificate of Incorporation10-KSB04/15/20043.2Articles of Amendment to Certificate of Incorporation10-KSB04/15/20043.3Certificate of Designation of Rights and Preferences of Series A Convertible Preferred Stock.10-QSB08/15/20033.4Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock.10-QSB08/15/20033.5Certificate of Designations, Preferences and Rights of Series C Convertible Preferred Stock, dated September 24, 2003.10-QSB11/14/20033.6Certificate of Amendment to Certificate of Designation of Preferences and Rights of Series B Convertible Preferred Stock, dated October 27, 2003.10-QSB11/14/20033.7Certificate of Amendment to Certificate of Designations of Rights and Preferences of Series A Convertible Preferred Stock, dated November 24, 20043.8By-Laws10-KSB04/15/2004   96   4.1Form of Common Stock Certificate, on file at company10.1Employment Agreement, dated August 18, 2003, between the Registrant and William J. Donovan.10-QSB11/14/200310.2Asset Purchase Agreement, dated October 23, 2003, between the Registrant, Difference Engines Corporation and Certain Stockholders.10-QSB11/14/200310.3Amended And Restated 2003 Stock Incentive Plan.10-KSB04/15/200410.4Amended Employment Agreement, dated December 10, 2004, between the Registrant and Michael W. Trudnak.8-K12/20/200410.5Form of Incentive Stock Option Award Agreement.10-Q08/12/200510.6Form of Non-Qualified Stock Option Award Agreement.10-Q08/12/200510.7Form of Systems Implementation Agreement.10-Q11/14/200510.8Employment Agreement, dated December 21, 2005, between the Registrant and Mr. Gregory E. Hare8-K01/31/200610.9Loan Agreement, dated April 21, 2006, by and between the Registrant and Mr. Michael W. Trudnak.8-K/A5/25/0610.10Reseller Agreement, dated July 25, 2006, by and between Registrant and Logos Imaging, LLC.10-Q8/11/0610.11Securities Purchase Agreement, dated November 3, 2006, by and among Registrant and Certain purchasers.8-K11/8/0610.12Form of Series A 10% Senior Convertible Debenture, due November 8, 2008.8-K11/8/0610.13Form of Registration Rights Agreement by and among Registrant and Certain Purchasers.8-K11/8/0610.14Form of Series D Common Stock Purchase Warrant Issued to Certain Purchasers.8-K11/8/0610.15Placement Agent Agreement, dated July 14, 2006, by and between Registrant and Midtown Partners & Co., LLC.8-K11/8/0610.16Form of Placement Agents Warrant issued to Midtown Partners & Co., LLC and its designees8-K11/8/0610.17Distribution Agreement, dated August 20, 2006, by and between Registrant and MTS Delft.10-Q11/14/0610.18Distribution Agreement, dated August 20, 2006, by and between Registrant and Calyx (UK) Limited.10-Q11/14/0610.19Amendment Agreement, dated October 21, 2006, by and between Registrant and Mr. Michael W. Trudnak.10-Q11/14/0610.20Amendment Agreement, dated November 10, 2006, by and between Registrant and Mr. Michael W. Trudnak.10-Q11/14/0610.21Collaboration Agreement, dated March 23, 2007, by and between Registrant and Confirma, Inc.10-Q5/18/0710.22Public and Investor Relations Agreement, dated May 8, 2007, by and between Registrant and Trilogy Capital Partners, Inc.10-Q8/17/0710.23Software License Agreement, dated June 26, 2007, by and between Registrant and NAST.10-Q8/17/0710.24Consultant Agreement, dated July 19, 2007, by and between Registrant and Medical Image Informatics.10-Q8/17/0710.25Securities Purchase Agreement, dated August 6, 2007, by and among Registrant and Certain purchasers.8-K8/7/0710.26Form of Series F and G Common Stock Purchase Warrant Issued to Certain Purchasers.8-K8/7/07   97   10.27Form of Non-Qualified Stock Option Award Agreement Issued to Certain Executive Officers Related to Continued Deferral of Salary10-Q11/13/0710.28Strategic Alliance and Joint Development Agreement, dated October 16, 2007, by and between Registrant and with Control Screening, LLC, d/b/a AutoClear.10-K4/16/0810.29Marketing License Agreement, dated November 1, 2007, by and between Registrant and EGC Informatics, Inc., d/b/a International Threat Detection Systems (ITDS).10-K4/16/0810.30Consulting Agreement, dated July 19, 2008, by and between Registrant and BND Software.8-K7/22/0810.312009 Stock Compensation Plan, amended and effective on July 24, 20098-K8/4/0910.32Form of Non-Qualified Stock Option Award Agreement, 2009 Stock Compensation Plan8-K6/22/0910.33Form of Restricted Stock Award Agreement, 2009 Stock Compensation Plan8-K6/22/0910.34Form of Restricted Stock Rights Agreement, 2009 Stock Compensation Plan8-K6/22/0910.35Amended Policy Independent Director Compensation, effective July 1, 20098-K6/25/0910.36Form of Independent Director Non-Qualified Stock Option Award Agreement8-K6/25/0910.372009 Stock Compensation Plan, amended and effective on July 24, 20098-K8/4/0910.38Placement Agent Agreement, dated July 20, 2009, by and between Registrant and Grant Bettingen, Inc.8-K8/4/0910.39Convertible Promissory Note, six month term8-K8/4/0910.40Certificate of Ownership and Merger, and Name Change8-K7/15/1010.41Amendment and Waiver Agreement, dated October 15, 2010, by and between Registrant and Certain Purchasers8-K10/20/1010.42Securities Purchase Agreement, dated February 23, 2011, by and among Registrant and Seaside 88, L.P.8-K3/2/1114.1Code of Ethics for Chief Executive Officer and Senior Financial Officers10-KSB4/15/0421List of Subsidiaries.X23.1Consent of KBL, LLPX31.1Certification 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)X31.2Certification 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)X32.1Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CEO)X32.2Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (CFO)X   98         SIGNATURES  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.   APPLIED VISUAL SCIENCES, INC.By:
/s/ Michael W. Trudnak
Michael W. Trudnak
Chief Executive Officer
(Principal Executive Officer)By:        /s/ Gregory E. Hare
Gregory E. Hare
Chief Financial Officer
(Principal Financial and Accounting Officer)  Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.  SignatureTitleDate/s/ Michael W. Trudnak
Michael W. TrudnakChairman of the Board, Chief Executive Officer and Secretary, Director
(Principal Executive Officer)April 5, 2011/s/ William J. Donovan
William J. DonovanPresident and Chief Operating Officer, DirectorApril 5, 2011/s/ Gregory E. Hare
Gregory E. HareChief Financial Officer, Treasurer
(Principal Financial and Accounting Officer)April 5, 2011/s/ Joseph C. Brothers
Joseph C. BrothersDirectorApril 5, 2011/s/ Henry A. Grandizio
Henry A. GrandizioDirectorApril 5, 2011/s/ Keith S. Kelly
Keith S. KellyDirectorApril 5, 2011/s/ Sean W. Kennedy
Sean W. KennedyDirectorApril 5, 2011/s/ Charles T. Nash
Charles T. NashDirectorApril 5, 2011      99     APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIES   CONSOLIDATED FINANCIAL STATEMENTS TOGETHER WITH THE REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   Board of Directors and Stockholders Applied Visual Sciences, Inc. Herndon, Virginia  We have audited the accompanying consolidated balance sheets of Applied Visual Sciences, Inc. (the Company) as of December 31, 2010 and 2009 and the related consolidated statements of operations, changes in stockholders equity (deficit), and cash flows for the years ended December 31, 2010 and 2009. These consolidated financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform an audit of the Companys internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.  In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Applied Visual Sciences, Inc. as of December 31, 2010 and 2009, and the results of its consolidated statements of operations, changes in stockholders equity (deficit), and cash flows for the years ended December 31, 2010 and 2009 in conformity with U.S. generally accepted accounting principles.  The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.   As discussed in Note 1 to the consolidated financial statements, the Company has sustained significant operating losses and needs to obtain additional financing or restructure its current obligations. These conditions raise substantial doubt about the Companys ability to continue as a going concern.  Managements plans in regard to these matters are also described in Note 1.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.  /s/ KBL, LLP New York, NY April 4, 2011              CONSOLIDATED BALANCE SHEETS  APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSDecember 3120102009ASSETSCurrent AssetsCash and cash equivalents$                4,874$                8,707Accounts receivable69,52711,872Prepaid expenses19,28121,721Total current assets93,68242,300Equipment, net286,772329,657Other AssetsOther noncurrent assets11,12222,244Intangible assets, net365,173352,578Total assets$            756,749$            746,779LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)Current LiabilitiesAccounts payable$          1,766,870$          2,469,674Other accrued liabilities5,021,7123,967,127Note payable and advances, related parties117,100226,000Convertible notes payable-675,000Convertible debentures1,688,2054,702,921Derivative liabilities - embedded conversion feature of debentures2,228,4311,354,051Deferred revenue-3,808Total current liabilities10,822,31813,398,581Common shares subject to repurchase, stated at estimated redemption value; 282,704 shares outstanding at December 31, 2010, and 302,222 shares outstanding at December 31, 200998,94642,311Stockholders' Equity (Deficit)Convertible preferred stock, $0.20 par value; authorized 1,000,000 sharesShares issued and outstanding at December 31, 2010 - noneShares issued and outstanding at December 31, 2009 - none--Common stock, $0.001 par value; authorized 200,000,000 sharesShares issued and outstanding at December 31, 2010 - 82,212,233Shares issued and outstanding at December 31, 2009 - 58,992,88082,21258,993Additional paid-in capital80,242,98774,087,250Accumulated comprehensive income63,35462,481Deficit accumulated(90,553,068)(86,902,837)Total stockholders' equity (deficit)(10,164,515)(12,694,113)Total liabilities and stockholders' equity (deficit)$            756,749$            746,779See notes to consolidated financial statements.              CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)Year Ended December 3120102009Net revenues$           110,499$            91,504Cost of sales45,104101,915Gross profit (loss)65,395(10,411)Selling, general and administrative expense4,708,7955,573,173Operating loss(4,643,400)(5,583,584)Other income (expense)993,169(2,949,930)Net loss$      (3,650,231)$      (8,533,514)Net loss per common share:Basic and diluted$              (0.05)$              (0.16)Weighted average number of common shares usedin computing basic and diluted net loss per share69,024,43151,739,274Other comprehensive incomeComprehensive income - beginning of period$            62,481$            61,450Cumulative translation adjustments8731,031Comprehensive income  - end of period$            63,354$            62,481See notes to consolidated financial statements.              CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (DEFICIT) AND COMPREHENSIVE INCOME (LOSS) APPLIED VISUAL SCIENSES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) AND COMPREHENSIVE INCOME (LOSS)Total Accumulated Comprehensive LossDeferred Stock CompensationOther Comprehensive Income (Loss)Total Stockholders' Equity (Deficit)Common StockAdditionalAccumulated DeficitSharesAmountPaid-In CapitalBalance, December 31, 200847,074,674$          47,075$     69,375,269$          (9,412)$             61,450$ (78,369,323)$   (8,894,941)$   (78,307,873)Remeasurement of stock issued pursuant to consulting agreements--(13,454)13,454----Proceeds from sale of common stock for cash, net5,329,4925,3301,553,124---1,558,454-Exchange commission for common stock148,00014831,852---32,000-Common stock and warrants issued for consulting services309,329309124,191(124,500)----Stock options issued for consulting services--44,523(44,523)----Fair value of warrants in consideration of short-term note--5,671---5,671-Common stock issued to employees1,125,0001,125235,125---236,250-Conversion of interest for common stock161,21016135,320---35,481-Conversion of debentures to common stock4,434,4554,4341,108,066---1,112,500-Conversion of bridge notes to common stock410,720411109,589---110,000-Relative fair value of warrants issued for dilutive issuance of financing--535,484---535,484-Gain (loss) remeasurement of common shares subject to repurchase--12,090---12,090-Amortization of consultants deferred stock based compensation---117,518--117,518-Amortization of employee stock options--977,863---977,863-Foreign currency translation----1,031-1,0311,031Net loss-----(8,533,514)(8,533,514)(8,533,514)Total comprehensive loss-------(8,532,483)Balance, December 31, 200958,992,88058,99374,134,713(47,463)62,481(86,902,837)(12,694,113)(86,840,356)Remeasurement of stock issued pursuant to consulting agreements--4,100(4,100)----Proceeds from sale of common stock for cash, net4,824,0004,8241,110,456---1,115,280-Common stock and warrants issued for consulting services1,121,1081,120306,557(185,070)--122,607-Stock options issued for consulting services--14,000(14,000)----Employee stock options exercised124,50012437,226---37,350-Exercise of common stock purchase warrants1,092,0001,092261,408---262,500-Cashless exercise of common stock purchase warrants420,166420(420)-----Fair value of warrants in consideration extend/convert short-term note--38,550---38,550-Common stock issued to employees or consultant2,765,0002,765579,685---582,450-Conversion of interest for common stock7,033,0187,0331,751,032---1,758,065-Conversion of debentures to common stock1,710,0001,710425,790---427,500-Conversion of convertible notes to common stock2,779,8192,780699,359---702,139-Conversion of accounts payable to common stock759,287760218,731---219,491-Conversion of accrued wages to common stock590,455591147,162---147,753-Reclassification of common shares previously subject to repurchase--2,733---2,733-Gain on remeasurement of common shares subject to repurchase--(59,368)---(59,368)-Amortization of consultants deferred stock based compensation---180,493--180,493-Amortization of employee stock options--641,413---641,413-       Foreign currency translation----873-873873Net loss-----(3,650,231)(3,650,231)(3,650,231)Total comprehensive loss-------(3,649,358)Balance, December 31, 201082,212,233$          82,212$     80,313,127$        (70,140)$             63,354$ (90,553,068)$ (10,164,515)$   (90,489,714)See notes to consolidated financial statements.         CONSOLIDATED STATEMENTS OF CASH FLOWS  APPLIED VISUAL SCIENCES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSYear Ended December 3120102009CASH FLOWS FROM OPERATING ACTIVITIESNet loss$        (3,650,231)$        (8,533,514)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization110,084116,749Stock-based compensation expense1,559,2151,331,631Amortization of bridge notes and debentures discounts-541,155Fair value of warrants issued - derivative instruments38,550-Revaluation of derivative instrument expense (income)(1,447,236)2,571,389Gain on settlement of debt(265,600)(931,392)Noncash broker compensation expense-32,000Other noncash (stock issued in lieu of interest paid)681,11735,481Changes in operating assets and liabilities:Decrease (increase) in accounts receivable(57,655)16,328Decrease in prepaid expenses2,44081,411Decrease in other noncurrent assets11,122-Increase (decrease) in accounts payable406,092864,425Increase in accrued expenses1,385,3831,560,163Decrease in deferred revenue(3,808)(6,035)Net cash flows used in operating activities(1,230,527)(2,320,209)CASH FLOWS FROM INVESTING ACTIVITIESPurchase of equipment(45,149)(3,573)Investment in patents(34,777)(33,941)Net cash flows used in investing activities(79,926)(37,514)CASH FLOWS FROM FINANCING ACTIVITIESProceeds from issuance of common stock, net1,115,2801,558,454Proceeds from exercise of employee stock options37,350-Proceeds from exercise of stock warrants262,500-Proceeds from short-term convertible notes payable0725,000Reduction of short-term note payable, related party(108,900)-Net cash flows provided by financing activities1,306,2302,283,454Effect of exchange rate changes on cash and cash equivalents3902,199Net decrease in cash and cash equivalents(3,833)(72,070)Cash and cash equivalents at beginning of the year8,70780,777Cash and cash equivalents at end of the year$                4,874$                8,707Supplemental disclosure of cash flow information:Remeasurement of common stock subject to repurchase$             (59,368)$              12,090Reclassification of common stock previously subject to repurchase2,733-Conversion of short-term convertible notes to common stock675,000-Conversion of convertible debenture to common stock427,5001,112,500Conversion of accounts payable and other accrued liabilities to stock894,085-Conversion of accrued wages to common stock207,002-Interest paid during the period in cash-450See notes to consolidated financial statements.             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS         NOTE 1.    BASIS OF PRESENTATION AND GOING CONCERN CONSIDERATIONS 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” (“3iTM”) engine that is capable of extracting embedded knowledge from digital images, and has the capacity to analyze and detect image anomalies. The technology is not limited by type of digital format. It can be deployed across divergent digital sources such as still images, x-ray images, video and hyper-spectral imagery. To date, the technology has been tested in the area of threat detection for baggage scanning at airports, for bomb squad applications and the detection of tuberculosis by analyzing digital images of stained sputum slides captured through a photo microscopy system. Varying degrees of research and development have been conducted in the areas of detection for cargo scanning, people scanning, military target acquisition in a hyper-spectral environment, satellite remote sensing ground surveys and mammography CAD products and radiologists diagnostic imaging tools. Product development in these areas is ongoing, and while there can be no assurance, we believe that the technology should produce results equal to or greater than those currently achieved in baggage scanning.  On July 19, 2010 we announced that we had expanded ours organizational structure to better reflect our business operations and to provide an enhanced operational structure to capitalize on domestic and international business and joint product development opportunities.  We changed our name to Applied Visual Sciences, Inc. (APVS) and our common stock began to be quoted on the OTC Bulletin Board under symbol APVS. APVS serves as the holding company and IT development organization for the group.  The Company has achieved certain significant corporate life cycle milestones that necessitated a more diverse corporate structure.  The purpose of the structure is to segregate distinct business operations into separate corporate entities, all under a single umbrella organization. Our two wholly-owned operating subsidiaries are: Guardian Technologies International, Inc. - the homeland security/defense technology entity, and Signature Mapping Medical Sciences, Inc. - the healthcare technology entity.  APVS will maintain ownership of all existing and in-process patents, as well as any future patentable technology developed by its research and development staffs, or developed as a tangential application of its core patented technologies.  Our subsidiaries will be the business operations focused on new product development, marketing, and sales for their respective markets. By structuring in this manner, as a means to conduct business, we expect to realize the following benefits: · Creation of autonomous business units with defined measurable goals and objects; · Alignment of risk characteristics to the specific product, line of business or foreign market; · Provide a level of legal risk insulation to the core assets, the patents & intellectual property; · Flexibility to maximize tax benefits, both domestic & foreign activities; · Flexibility and ease in negotiating and structuring mergers, acquisitions, joint ventures, or joint development partnerships; · Facilitate the potential spin-off of one of the subsidiary entities; · Facilitate the potential sale of part of the company; and, · Attract investment from investors that focus on specific industries.  Currently, we are focused on providing technology solutions and services in two primary markets, healthcare and aviation/homeland security. However, as new or enhanced solutions are developed, we expect to expand into other markets such as military and defense utilizing hyper-spectral technology, and imaging diagnostics for the medical industry. We may also engage in one or more acquisitions of businesses that are complementary to our business.  Further, we may form wholly-owned subsidiaries to operate within defined vertical markets.       Financial Condition, Going Concern Considerations and Events of Default  During the year ended December 31, 2010, the Companys 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, 2009, contains an explanatory paragraph wherein they expressed an opinion that there is substantial doubt about our ability to continue as a going concern.  Accordingly, careful consideration of such opinions should be given in determining whether to continue or become our stockholder.  During the period of June through August 2009, at a series of closings, the Company issued six-month convertible promissory notes to a total of 12 accredited investors in the aggregate principal amount of $725,000. The six-month notes accrued interest at a rate of 10% per annum. The notes were convertible, at the holders option, into shares of common stock at a conversion price of $0.25 per share. If converted, each holder is entitled to receive Class M common stock purchase warrants for the right to purchase an equal number of shares and they are exercisable at a price of $0.25 per share, contain certain anti-dilution and other customary provisions, and expire sixty (60) months from the date the warrants were issued. On December 31, 2009, the Company had an aggregate principal amount outstanding of $675,000 from eleven (11) note holders.  During the year ended December 31, 2010, all note holders converted an aggregate principal amount of $675,000 and $71,999 of accrued interest into an aggregate of 2,987,995 shares of common stock, and 2,987,995 Class M Warrants.  The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and the Company was considered in default for nonpayment of principal and unpaid interest and late fees.  The holders though had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures.  During the year ended December 31, 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock.  As of December 31, 2010, we have outstanding trade and accrued payables of $1,347,819, other accrued liabilities of $454,648, and accrued salaries due to our employees and management of $4,986,115. Also, the Company has an outstanding noninterest-bearing loan from its Chief Executive Officer of $117,100.  From March through September 2010, The Company sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 4,424,000 shares of common stock and 4,424,000 Class N Warrants for gross proceeds of $1,106,000 (or $1,022,280, net of commission and expenses of $83,720). The Class N 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 five years after the date of issuance.  During November through December 2010, the Company sold securities of the Company to certain accredited investors in a series of closings, and issued an aggregate of 400,000 shares of common stock and 400,000 Class P Warrants for gross proceeds of $100,000 (or $93,000, net of commission and other expenses of $7,000). The Class P Warrants are exercisable at a price of $0.50 per share; contain piggyback registration rights, certain anti-dilution and other customary provisions. The warrants expire three years after the date of issuance.  As of December 31, 2010, we had a cash balance of $4,874.  Subsequently and through April 5, 2011, we received $350,000 (or $338,000, net of commissions and expenses of $12,000) from the issuance and sale of common stock and warrants in a private offering.  Included in the subsequent closings is $150,000 under a February 23, 2011, Securities Purchase Agreement executed by the Company with an institutional accredited investor for up to $1,000,000, under certain stock price and volume conditions. Management believes these funds to be insufficient to fund our operations, absent any cash flow from operations or funds from the sale of our equity or debt      securities. We are currently 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.  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 and the convertible note, the debenture and convertible note holder do not convert such debt or require payment of principal and interest, partially convert such debt, or effect the buy-in provision related to the warrants and the debentures (excluding convertible notes), 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 Companys 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.  The proceeds from our financings are insufficient to fund our operations, pay our trade payables, repay our unconverted debentures, or accrued and unpaid wages to our employees.  Therefore, the debentures holders, our employees or trade creditors may seek to enforce payment of amounts due to them, and our results of operations and financial condition could be materially and adversely affected and we may be unable to continue our operations.  Also, in the event we are unable to pay our employees, we may suffer employee attrition. There can be no assurances that we will be successful in our efforts to raise any additional financing, any bank borrowing, and research or grant funding. Moreover, in view of the current market price of our stock, we may have limited or no access to the capital markets.  Furthermore, under the terms of our agreements with the debenture holders, we are subject to restrictions on our ability to engage in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set. In view of the foregoing, we may be required to curtail operations significantly, or obtain funds through entering into arrangements with collaborative partners or others that may require us to relinquish rights to certain of our technologies or products.  During the year ended December 31, 2010, our total stockholders deficit decreased by $2,529,598 to $10,164,515 and our consolidated net loss was $3,650,231 for the year ended December 31, 2010. Notwithstanding the foregoing discussion of managements expectations regarding future cash flows, the Companys 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.  Basis of Presentation  The consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). 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.  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.           NOTE 2.    SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation 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.       Fair Value of Financial Instruments 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.  Convertible Instruments 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.  Cash Equivalents Cash and cash equivalents are stated at cost, which approximates fair value, and consists of interest and noninterest bearing accounts at a bank.  Balances may periodically exceed federal insurance limits.  The Company does not consider this to be a significant risk.  The Company considers all highly liquid debt instruments with initial maturities of 90 days or less to be cash equivalents.  Accounts Receivable Accounts receivable are customer obligations due under normal trade terms and is stated net of the allowance for doubtful accounts.  The Company records an allowance for doubtful accounts based on specifically identified amounts that the Company believes to be uncollectible.  The outstanding allowance for doubtful accounts as of December 31, 2010 and 2009 was $0 and $0, respectively.  Customer Concentration Risks Approximately 100% of the Companys revenue for the year ended December 31, 2010 was comprised of two customers, one representing 82% and the other 18% of the Companys total revenue. These represent major customers. The Company does not consider this risk to be material.  Straight Line Lease For consolidated financial statement purposes, rent expense is recorded on a straight-line basis over the term of the lease term. The difference between the rent expense incurred and the amount paid is recorded as deferred rent and is being amortized over the term of the lease.  Property and Equipment  Property and equipment are carried at cost less accumulated depreciation and amortization.  For financial statement purposes, depreciation and amortization is provided on the straight-line method over the estimated useful live of the asset ranging from 3 to 10 years.             December 31Asset (Useful Life)20102009Software (3 years)$ 84,224$ 84,224Computer equipment (3 - 5 years)324,991330,094Furniture and fixtures (7 - 10 years)488,239488,239Equipment (7 - 10 years)79,62734,265977,081936,822Less accumulated depreciation and amortization690,309607,165$ 286,772$ 329,657   Depreciation and amortization for property and equipment was $87,903 and $96,286 in the years ended December 31, 2010, and 2009 respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations.  Intangible Assets Intangible assets consist of acquired software and patents. The acquired software is being amortized using the straight-line method over 5 years. Patent acquisition costs pertaining to PinPointTM have been capitalized and are being amortized over the 20-year legal life of the patents. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. Amortization expense for intangible assets was $22,181 and $20,464 in fiscal 2010 and 2009, respectively, and is reflected in selling, general and administrative expenses in the accompanying consolidated statements of operations. The Companys intangible software technology was fully amortized as of December 31, 2010. Therefore, there was no amortization costs associated with software technology during the year ended December 31, 2010. The Company anticipates incurring additional patent acquisition costs during the current fiscal year ending December 31, 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.  Based on a net realizable value analysis as of June 30, 2007, goodwill from the acquisition of Wise Systems Ltd. was determined to be fully impaired.  Therefore, there was no amortization expense of goodwill during fiscal 2010 and 2009.  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. Based on a net realizable value analysis for the period ended June 30, 2007, goodwill and the acquired software (FlowPointTM) from the acquisition of Wise Systems Ltd. was determined to be fully impaired. Therefore, the balance of goodwill at December 31, 2010 and 2009 was $0, respectively.  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.  Foreign Currency Translation The accounts of the Companys foreign subsidiary are maintained using the local currency as the functional currency.  For the subsidiary, assets and liabilities are translated into U.S. dollars at the period end exchange rates, and income and expense accounts are translated at average monthly exchange rates.  Net gains or losses from foreign currency translation are excluded from operating results and are accumulated as a separate component of stockholders equity.  Comprehensive Loss The Company adopted ASC 220-10, Reporting Comprehensive Income, (ASC 220-10). ASC 220-10 requires the reporting of comprehensive income in addition to net income from operations. The comprehensive loss reflects the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.  Comprehensive loss is comprised of net loss and foreign currency translation adjustments.       Revenue Recognition -Revenues are derived primarily from the research activities, and sublicensing and licensing of computer software, installations, training, consulting, third party hardware, and software maintenance.  Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognized.  For software arrangements, the Company recognizes revenue according to ASC 985-605, Software Revenue Recognition, and related amendments. ASC 985-605 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. Revenue from multiple-element software arrangements is recognized using the residual method. Under the residual method, revenue is recognized in a multiple element arrangement when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. The Company allocated revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately.  Specifically, the Company determines the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance offered to customers, which is stated in the contract, and fair value of the installation based upon the price charged when those services are sold separately. If evidence of the fair value cannot be established for undelivered elements of a software sale, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or vendor-specific objective evidence of fair value can be established.  Revenue from sublicenses sold on an individual basis and computer software licenses are recognized upon shipment, provided that evidence of an arrangement exists, delivery has occurred and risk of loss has passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured.  Revenue from software usage sublicenses sold through annual contracts and software maintenance is deferred and recognized ratably over the contract period. Revenue from installation, training, and consulting services is recognized as services are performed. Revenue from research activities, if a fixed price contract, is based on the percentage of completion method.  Cost of goods sold incorporates direct costs of raw materials, consumables, staff costs associated with installation and training services, and the amortization of the intangible assets (developed software) related to products sold.  Research and Development  The Company accounts for its software and solutions research and development costs in accordance with ASC 985-20, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed.During the years ended December 31, 2010, and 2009, the Company expensed $157,355 and $489,591, respectively for such costs.  No amounts were capitalized in these years.  Loss per Common Share -Basic net loss per share is calculated using the weighted-average number of shares of common stock outstanding, including restricted shares of common stock.  The effect of common stock equivalents is not considered as it would be anti-dilutive.  Use of Estimates The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements.  Changes in these estimates and assumptions may have a material impact on the consolidated financial statements.  Certain estimates and assumptions are particularly sensitive to change in the near term, and include estimates of net realizable value for long-lived and intangible assets, the valuation allowance for deferred tax assets and the assumptions used for measuring stock-based payments and derivative liabilities.  Income Taxes The Company accounts for income taxes under the liability method.  Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse.  Valuation allowances are established, when necessary, to reduce tax assets to the amounts more likely than not to be realized.  Uncertainty in Income Taxes In June 2006, ASC 740-10 was established regarding the uncertainty in income taxes.  ASC 740-10 establishes a recognition threshold and measurement for income tax positions recognized in an enterprises financial statements in accordance with accounting for income taxes. ASC 740-10 also prescribes a two-step evaluation process for tax positions.  The first step is recognition and the second step is measurement.  For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position.  If the tax position meets the more-likely-than-not recognition threshold, it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized.  If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of the position is not recognized in the financial statements.      Tax positions that meet the more-likely-than-not recognition threshold, at the effective date of ASC 740-10, may be recognized or, continued to be recognized, upon adoption of ASC 740-10.  The cumulative effect of applying the provision of ASC 740-10 shall be reported as an adjustment to the opening balance of retained earnings for that fiscal year.  ASC 740-10 applies to fiscal years beginning after December 15, 2006 with earlier adoption permitted.  The Company has determined that as of December 31, 2010, no additional accrual for income taxes is necessary.  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 (PinPointTM) and Healthcare (Signature MappingTM Medical Computer Aided Detection (“Medical CAD”)), and operates in two 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 Fiscal 2010 was $110,499, of which $90,226 is from our healthcare product, and $20,273 from research activities of our security product/services, and in Fiscal 2009 of $91,504 was from research activities of our security product/services.  The Company increased efforts and focus in developing the PinPointTM and Signature MappingTM imaging technologies, and discontinued active marketing of the FlowPointTM product in January 2009, whereby the Company’s existing small customer base in England was assigned to Richard Mace Solutions Ltd for the purpose of continuous service to these customers. Accordingly, we entered into two licensing arrangements for a perpetual, nonexclusive and nontransferable license to use, modify, create derivative works from, market and sublicense our FlowPointTM RIS and PACS solutions. Royalties generated from these licensing agreements is not anticipated to be a significant portion of our revenue.                                  Segment and Geographic InformationFiscal Years Ended December 3120102009Net revenues:The Americas:Software licenses$ 67,670$ -Research funding20,27391,504Maintenance and support--Hardware and related22,556-The Americas110,49991,504United Kingdom:Software licenses--Research funding--Maintenance and support--Hardware and related--United Kingdom--Total net revenues$ 110,499$ 91,504Cost of sales:The Americas:Software licenses$ -$ -Research funding14,785101,915Maintenance and support--Hardware and related30,319-The Americas45,104101,915United Kingdom:Software licenses--Research funding--Maintenance and support--Hardware and related--United Kingdom--Total cost of sales$ 45,104$ 101,915Operating (loss):The Americas:Software licenses$ (4,628,322)$ (5,508,609)Research funding1,589(39,253)Maintenance and support--Hardware and related(16,343)-The Americas(4,643,076)(5,547,862)United Kingdom:Software licenses--Research funding--Maintenance and support(324)(35,722)Hardware and related--United Kingdom(324)(35,722)Total operating (loss)$ (4,643,400)$ (5,583,584)Depreciation and amortization:The Americas:Software licenses$ 109,760$ 115,126Research funding--Maintenance and support--Hardware and related--The Americas109,760115,126United Kingdom:Software licenses--Research funding--Maintenance and support3241,623Hardware and related--United Kingdom3241,623Total depreciation and amortization$ 110,084$ 116,749Total assets:The Americas$ 756,749737,545United Kingdom-9,234Total$ 756,749$ 746,779Long-lived assets, net:The Americas$ 651,945675,629United Kingdom-6,606Total$ 651,945$ 682,235Long-lived assets, net: Consists of software, goodwill, patents, property and equipment, and other noncurrent assets.        Stock-Based Compensation – On January 1, 2006, the Company adopted the provisions of ASC 718-10, which requires recognition of stock-based compensation expense for all share-based payments based on fair value. Prior to January 1, 2006, the Company measured compensation expense for its employee stock based compensation plans using the intrinsic value method. Under ASC 718-10, when the exercise price of the Companys employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.  The Company applied the disclosure provisions of ASC 718-10 as if the fair value-based method had been applied in measuring compensation expense for those years.  ASC 718-10 required that the Company provide pro forma information regarding net earnings and net earnings per common share as if compensation expense for its employee stock-based awards had been determined in accordance with the fair value method prescribed therein.  ASC 718-10, Share-Based Payment defines fair value-based methods of accounting for stock options and other equity instruments.  The Company has adopted the method, which measures compensation costs based on the estimated fair value of the award and recognizes that cost over the service period.  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.  Based on these findings, the Company determined that the unamortized portion of the stock compensation should be re-measured on each interim reporting date and proportionately amortized to stock-based compensation expense for the succeeding interim reporting period until goods are received or services are performed. 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.  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 used for the years ended December 31, 2010 and 2009:               Black-Scholes Model Assumptions20102009Risk-free interest rate (1)3.01%1.25%Expected volatility (2)134.3%122.6%Dividend yield (3)0.0%0.0%Expected life (4)6.5 years6.5 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.   Recent Issued Accounting Pronouncements  In December 2010, the Financial Accounting Standards Board (FASB) amended its authoritative guidance related to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more-likely-than-not that goodwill impairment exists.  In determining whether it is more-likely-than-not that goodwill impairment exists, consideration should be made as to whether there are any adverse qualitative factors indicating that an impairment may exist.  The adoption of this standard is not expected to have a material impact on the Companys consolidated financial statements.  In December 2010, the FASB amended its authoritative guidance related to business combinations entered into by an entity that are material on an individual or aggregate basis.  These amendments clarify existing guidance that if an entity presents comparative financial statements that include a material business combination, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period.  The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of      material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  This guidance becomes effective prospectively for business combinations for which the acquisition date is on or after the first day of the Companys fiscal 2012.  This disclosure-only guidance will not have a material impact on the Companys results of operations, financial position or cash flows.  In May 2010, the Financial Accounting Standards Board (FASB) amended its authoritative guidance related to foreign currency issues that were discussed at the FASBs Emerging Issues Task Force (EITF) meeting in March 2010 where the staff of the U.S. Securities and Exchange Commission (SEC) announced temporary guidance on certain exchange rate issues.  Prompted by the use of multiple currency exchange rates in Venezuela, the use of different rates for remeasurement and translation purposes has caused reported balances for financial reporting purposes and the actual U.S. dollar denominated balances to be different.  The SEC staff indicated that any differences between the amounts reported for financial reporting purposes and actual U.S. dollar denominated balances that may have existed prior to the application of highly inflationary accounting requirements on January 1, 2010 should be recognized in the income statement upon adoption, unless the issuer can document that the difference was previously recognized as a cumulative translation adjustment (CTA), in which case the difference should be recognized as an adjustment to CTA.  The adoption of this guidance, effective March 31, 2010, did not have a material impact on the Companys consolidated financial statements.  In February 2010, the Financial Accounting Standards Board (FASB), issued ASU No. 2010-09, Subsequent Events (Topic 855) - Amendments to Certain Recognition and Disclosure Requirements, whereby it amended its authoritative guidance related to subsequent events to alleviate potential conflicts with current United States Securities and Exchange Commission (SEC) guidance.  Effective immediately, these amendments remove the requirement that an SEC filer disclose the date through which it has evaluated subsequent events.  The adoption of this guidance did not have a material impact on the Companys consolidated financial statements.  In January 2010, the Company adopted FASB ASU No. 2010-06, Fair Value Measurement and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements (ASU 2010-06). These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require new disclosures of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standard also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. These new disclosures are effective beginning with the first interim filing in 2010. The disclosures about the rollforward of information in Level 3 are required for the Company with its first interim filing in 2011. The Company does not believe this standard will impact their financial statements.  Effective July 1, 2009, the Company adopted FASB ASU No. 2009-05, Fair Value Measurement and Disclosures (Topic 820) (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, Fair Value Measurements and Disclosures  Overall, for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted market price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required for Level 1 fair value measurements. Adoption of ASU 2009-05 did not have a material impact on the Companys results of operations or financial condition.  In June 2008, ASC 815-40, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (ASC 815-40) was issued. The objective of ASC 815-40 is to provide guidance for determining whether an equity-linked financial instrument (or Embedded Feature) is indexed to an entitys own stock and it applies to any freestanding financial instrument or embedded feature that has all the characteristics of a derivative in ASC 815, Accounting for Derivative Instruments and Hedging Activities, for purposes of determining whether that instrument or embedded feature qualifies for the first part of the scope exception as noted in ASC 815. ASC 815-40 also applies to any freestanding financial instrument that is potentially settled in an entitys own stock. The Company has determined ASC 815-40 does not have a material impact on its consolidated financial position, results of operations and cash flows.  In June 2008, ASC 470-20-65, Transition Guidance for Conforming Changes to Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios (ASC 470-20-65) was issued. ASC470-20-65 is effective for years ending after December 15, 2008. The overall objective of ASC 470-20-65 is to provide for consistency in application of the accounting for convertible securities. The Company has computed and recorded a beneficial conversion feature in connection with certain of its prior financing arrangements and does not believe that ASC 470-20-65 has a material effect on that accounting.  In May 2008, ASC 470-20-25, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (ASC 470-20-25) was issued. ASC 470-20-25 specifies that issuers of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) should separately account for the liability and equity components in a manner that will reflect the entitys nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. ASC      470-20-25 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal periods; early adoption is not permitted. The Company does not believe that the provisions of ASC 470-20-25 have a material impact on the consolidated financial statements.  In April 2008, ASC 350 dealing with the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset was issued. The Company was required to adopt the provisions of ASC 350 on October 1, 2008. The Company does not believe that ASC 350 has materially impacted its consolidated financial position, results of operations or cash flows.  In March 2007, ASC 815-10-65 was issued since the use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Accordingly, ASC 815-10-65 requires enhanced disclosures about an entitys derivative and hedging activities and thereby improves the transparency of financial reporting. ASC 815-10-65 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. ASC 815-10-65 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company does not believe ASC 815-10-65 has a material impact on its consolidated financial statements and disclosures for the fiscal and interim periods beginning January 1, 2009.  In February 2007, ASC 825-10 The Fair Value Option for Financial Assets and Financial Liabilities (ASC 825-10), was issued whichpermits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value, and also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.  ASC 825-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of ASC 825-10, effective for the fiscal year ended December 31, 2008, did not have a material impact on the Companys consolidated financial condition or results of operations.  In September 2006, ASC 820, "Fair Value Measurements" ("ASC 820") was issued to clarify the definition of fair value, establish a framework for measuring fair value and expand the disclosures on fair value measurements. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). ASC 820 also stipulates that, as a market-based measurement, fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability, and establishes a fair value hierarchy that distinguishes between (a) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (b) the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). ASC 820 becomes effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of ASC 820, effective for the fiscal year ended December 31, 2008, did not have a material impact on the Companys consolidated financial condition or results of operations.        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.   NOTE 3.    OTHER ACCRUED LIABILITIES Other accrued liabilities consist of the following:        December 31Classification20102009Deferred rent-9,132Accrued interest-188,544Accrued vacation35,59799,374Accrued salaries4,986,1153,670,077$ 5,021,712$ 3,967,127          NOTE 4.    FINANCING ARRANGEMENTS 2009 Convertible Promissory Notes During the period of June through August 2009, at a series of closings, The Company issued six-month convertible promissory notes to a total of 12 accredited investors in the aggregate principal amount of $725,000. The six-month notes accrued interest at a rate of 10% per annum. The notes were convertible, at the holders option, into shares of common stock at a conversion price of $0.25 per share. If converted, each holder is entitled to receive Class M common stock purchase warrants for the right to purchase an equal number of shares      and they are exercisable at a price of $0.25 per share, contain certain anti-dilution and other customary provisions, and expire sixty (60) months from the date the warrants were issued. On December 31, 2009, the Company had an aggregate principal amount outstanding of $675,000 from eleven (11) note holders.  During fiscal 2010, all note holders converted an aggregate principal amount of $675,000 and $71,999 of accrued interest into an aggregate of 2,987,995 shares of common stock, and 2,987,995 Class M Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  2006 and 2007 Series A Debentures and Series D Common Stock Purchase Warrants Under a securities purchase agreement, dated November 3, 2006, between the Company and certain institutional accredited investors, the Company sold an aggregate of $5,150,000 in principal amount of our Series A Debentures and Series D Common Stock Purchase Warrants to purchase an aggregate of 4,453,709 shares of our common stock. The Company issued an aggregate of $2,575,000 in principal amount of Series A Debentures and 4,453,709 Series D Warrants at a first closing held on November 8, 2006 and, due to the price reset conversion feature embedded in the notes and the warrants, the transaction was recognized as a liability under generally accepted accounting principles. We also issued an aggregate of 623,520 common stock purchase warrants to the placement agent in such financing which were upon terms substantially similar to the Series D Warrants. Due to milestone-related adjustments, the initial exercise price of $1.15634 may be reset and the maximum number of shares to be issued under the debentures was indeterminable as of December 31, 2007. The Company issued an additional $2,575,000 in principal amount of the Series A Debentures at a second closing held on April 12, 2007, following the effectiveness of a registration statement registering the shares of our common stock underlying the Series A Debentures and Series D Warrants. The Company allocated proceeds from the second closing to the embedded conversion features of the Series A Debentures and Series D Warrants that were recognizable as a liability under generally accepted accounting principles. One-half of the Series D Warrants became exercisable on November 8, 2006 (2,226,854 warrants), and the remaining one-half became exercisable on April 12, 2007 (2,226,855 warrants). The Series D Warrants and the placement agents warrants issued as compensation in the offering to Midtown Partners & Co., LLC, may be exercised via a cashless exercise if certain conditions are met. The Company considered ASC 815-40 (formerly EITF 00-19, relating to the provisions for Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock), and concluded that there were insufficient shares to share settle the contracts. The Series D Warrants that became exercisable at the first closing will expire on November 8, 2011, and those related to the second closing will expire in April 12, 2012. On April 1, 2007, the conversion price of the Series A Debentures and the exercise price of the Series D Warrants and Placement Agents Warrants issued as compensation to Midtown Partners & Co., LLC, were reset to a price $0.7453 per share, to $0.6948 effective October 1, 2007, and the final milestone reset of $0.4089 effective April 1, 2008. As a result of a June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) were increased by an aggregate of 2,281,109 Series D warrants. Our outstanding Series A convertible debentures became due on November 7, 2008.  During the year ended December 31, 2010, our debenture holders converted an aggregate of $427,500 in principal amount, and $638,163 of accrued interest into an aggregate of 4,262,653 shares of our common stock. As of December 31, 2010, an aggregate of $3,461,795 in principal amount of the Series A Debentures have been converted into 8,730,037 shares of common stock, an aggregate of $663,043 in interest amount have been converted into 2,675,576 shares of common stock, and an aggregate of 1,779,596 Series D Warrants have been exercised resulting in the issuance of 1,284,964 shares of common stock. Accordingly, as of December 31, 2010, an aggregate of $1,688,205 of principal amount of the debentures remain unconverted, and 4,995,222 Series D Warrants remain unexercised. Proceeds of the two offerings were used for the purpose of hiring new personnel, research and development, registration expenses, for general working capital purposes, and repaying $200,000 in loans made to us by Mr. Michael W. Trudnak, our Chairman and CEO.  As of the date of the filing of this report, approximately 13,566,734 warrants (excluding the warrants exercisable by the debenture holders) may be exercised pursuant to the cashless exercise provisions of such warrants, which may be subsequently resold as restricted securities under the provisions of Rule 144 under the Securities Act. Increased sales volume of the Companys common stock could cause the market price of the Companys common stock to drop.  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and the Company was considered in default for nonpayment of principal and unpaid interest and late fees.  The holders though had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest from July 1, 2010 through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default      Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures. During 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock. The Company has and may in the future seek to re-negotiate the terms of the debentures, including the repayment or repurchase of the debentures and/or seek to extend their maturity date, although the Company has not reached any agreement with our debenture holders with regard to any such repayment, repurchase or extension.  The Companys ability to repay or repurchase the debentures is contingent upon our ability to raise additional financing, of which there can be no assurance.  Also, as a condition to any such extension, debenture holders may seek to amend or modify certain other terms of the debentures.  Also under the Debenture Amendment Agreement, the Debenture holders agreed, commencing March 3, 2011, that the Company may force a conversion of the Debentures.  Such a forced conversion may only be effected once every 90 days and the ability of the Company to force any such conversion is subject to certain equity conditions, which conditions were amended under the terms of the Debenture Amendment Agreement in accordance with the following:  · if the variable weighted average price for the Companys common stock (VWAP) for any five consecutive trading days exceeds $0.50 and the average daily dollar trading volume for the Companys common stock during such period equals or exceeds $50,000, the Company may require a Holder to convert up to 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; · if the VWAP for any five consecutive trading days exceeds $0.75 and the average daily dollar trading volume for the common stock during such period equals or exceeds $75,000, the Company may require a Holder to convert up to an additional 25% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture; · if the VWAP for any five consecutive trading days exceeds $1.00 and the average daily dollar trading volume for the common stock during such period equals or exceeds $100,000, the Company may require a Holder to convert up to 100% of the outstanding principal amount of its Debenture on September 3, 2010, plus any liquidated damages or other amounts owing under the Debenture.  The Company did not make timely payment of the interest due under our Series A 10% Senior Convertible Debentures on July 1, 2008, through October 1, 2010, which may be deemed to be events of default under the debentures.  The debentures provide that any default in the payment of interest, which default is not cured within five trading days of the receipt of notice of such default or ten trading days after we become aware of such default, will be deemed an event of default. The Company has not maintained the registration of the shares underlying the debentures and Series D Warrants to permit the reoffer and resale of such shares as required under the terms of our agreements with the holders of the debentures which also may be deemed an event of default under the Debentures.  Failure to pay the principal, unpaid interest and certain late fees under the Debentures when due may have constituted an event of default under the debentures and failure to remit payment of the debentures and all late fees may have resulted in enforcement of the debenture holders rights and remedies under the debentures and applicable law, although the holders did not seek to enforce their rights under the debentures.  We did not maintain the registration of the shares underlying the debentures and Series D Warrants in order to permit the reoffer and resale of such shares as required under the terms of our agreements, which also may be deemed an event of default under the debentures.  If an event of default occurs under the debentures, the debenture holders could elect to require us to make immediate repayment of the mandatory default amount, which equals the sum of (i) the greater of either (a) 120% of the outstanding principal amount of the debentures, plus accrued but unpaid interest, or (b) the outstanding principal amount plus accrued but unpaid interest divided by the conversion price on the date the mandatory default amount is either (1) demanded or otherwise due or (2) paid in full, whichever has the lower conversion price, multiplied by the variable weighted average price of the common stock on the date the mandatory default amount is either demanded or otherwise due, whichever has the higher variable weighted average price, and (ii) all other amounts, costs, expenses, and liquidated damages due under the debentures. Also, interest under the debentures accrued at a rate of 18% per annum or the maximum amount allowed under the law and we may be subject to a late fee equal to the lesser of 18% per annum or the maximum rate permitted by law. In the event the debenture holders had made such a demand, the Company had insufficient funds to meet such demand. In anticipation of such election by the debenture holders, due to the late payment of the January 1, 2008 interest payment made on April 8, 2008, we measured the default on December 31, 2007 and subsequently on each balance sheet date, which is reflected in the carrying value of the debentures and also recognized as interest expense.  We remeasured the default amount as of December 31, 2009 at approximately $2,587,216, and on September 30, 2010 at approximately $2,541,739. This default amount was recognized as interest expense in Fiscal 2007 of approximately $645,641, an additional $76,658 during Fiscal 2008, $1,864,917 during Fiscal 2009, and a net reduction of interest expense during Fiscal 2010 of $45,477. On October 15, 2010, the two remaining Series A Debenture holders waived all defaults and default amount of $2,541,739, which the Company reversed to interest expense.       Prior to the Debenture Amendment Agreement and absent a default, the Debentures bore interest at the rate of 10% per annum due on the first day of each calendar quarter, upon conversion or redemption of the Debentures as to the principal amount converted or redeemed, or on the maturity date of the Debentures. We could elect to pay interest due under the Debentures in cash or registered shares of our common stock. If we elected to pay the interest due in shares of our common stock, the number of shares to be issued in payment of interest is determined on the basis of 85% of the lesser of the daily volume weighted average price of our common stock as reported by Bloomberg LP (VWAP) for the five trading days ending on the date that is immediately prior to (a) date the interest is due or (b) the date such shares are issued and delivered to the holder. We could pay interest in shares of our common stock only if the equity conditions, described below, have been met during the 20 consecutive trading days prior to the date the interest is due and through the date the shares are issued.  We may redeem some or all of the Debentures at any time after the effective date of the registration statement covering the shares to be issued upon conversion or exercise of the Debentures or Series D Warrants, if for 20 consecutive trading days the closing price of our common stock exceeds $1.7345 (a redemption measurement period). Upon a redemption, we are required to pay to the holder an amount equal to 110% of the principal amount redeemed as well as any accrued but unpaid interest and liquidated damages.  If we decide to redeem a Debenture, we are required to provide notice to a holder within one trading day of the end of the redemption measurement period and to redeem the Debenture 20 trading days after the date we deliver the notice. We may only redeem the Debentures if the equity conditions, described below, have been met on each trading day from the date of the notice to the date we redeem the Debentures, and the trading volume requirement is met during the redemption measurement period through the date we redeem the shares. Before a holder receives payment for the redemption from us, the holder may voluntarily convert the Debenture at the then current conversion price.  As discussed above, the payment of interest in shares of our stock, the redemption of the Debentures and the occurrence of certain other events, was subject to a requirement that certain equity conditions (equity conditions) were met, as follows: (i) we have honored all conversions and redemptions of a Debenture by the holder, (ii) we have paid all liquidated damages and other amounts due to the holder, (iii) the registration statement covering the resale of the shares underlying the Debentures and Series D Warrants is effective permitting a holder to utilize the registration statement to resell its shares, (iv) our stock is traded on the OTC Bulletin Board or other securities exchange and all of the shares upon conversion or exercise of the Debentures and Series D Warrants are listed for trading, (v) we have sufficient authorized but unreserved shares of our common stock to cover the issuance of the shares upon conversion or exercise of the Debentures and Series D Warrants, (vi) there is no event of default under the Debentures, (vii) the issuance of the shares would not violate a holders 4.99% or 9.99% ownership restriction cap, (viii) we have not made a public announcement of a pending merger, sale of all of our assets or similar transaction or a transaction in which a greater than 50% change in control of the Company may occur and the transaction has not been consummated, (ix) the holder is not in possession of material public information regarding us, and (x) the daily trading volume of our shares for 20 consecutive trading days prior to the applicable date exceeds 100,000 shares.  Under the terms of the Debenture Amendment Agreement, (A) the equity condition in (iii) above was amended to provide that such condition is met if, in the alternative, the shares issuable upon conversion of the Debentures may then be resold pursuant to Rule 144 without restriction or limitation and the Company has delivered to a holder an opinion of the Companys counsel that such resale may legally be made and provided the holder has furnished a representation letter reasonable acceptable to the Companys counsel that the holder is not an affiliate for purposes of Rule 144; (B) the equity condition in (vi) above was amended to except an event of default that has previously been waived; and (C) the equity condition in (x) above was amended to except circumstances where another volume condition is applicable.  The Debentures contain a limitation on the amount of Debenture that may be converted at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the Debenture. This limitation may be waived upon 61 days notice to us by the holder of the Debenture permitting the holder to change such limitation to 9.99%.  The principal amount of Debentures issued carry a bring down of representations and warranties, that there shall have been no material adverse effect regarding our financial condition, the legality or validity of our agreements with investors or our ability to perform our obligations under our agreements with investors, that trading in our common stock shall not have been suspended by the SEC or the OTC Bulletin Board, that trading in securities as generally reported by Bloomberg LP shall not have been suspended or limited, that no banking moratorium shall have been declared by either the United States or New York authorities, or that other material adverse changes in the financial markets shall not have occurred.  We have agreed to compensate a holder of a Debenture in the event our transfer agent fails to deliver shares upon conversion of the Debentures within three trading days of the date of conversion, and the holders broker is required to purchase shares of our common stock in satisfaction of a sale by a holder. If certain events of default occur under the Debentures, holders could accelerate the due date of the interest and principal due under the Debentures, and we may become obligated to pay all costs, expenses and liquidated damages due under the Debenture plus an amount equal to the greater of (i) 120% of the principal and interest due under the Debenture and (ii) the      outstanding principal amount of the Debenture and accrued interest divided by the conversion price on the date the amount is due or paid, whichever is higher, multiplied by the VWAP for our shares on the date of demand or payment, whichever is higher.  An event of default may occur under the Debentures if (a) the Company defaults in the payment of interest, liquidated damages or principal, (b) the Company fails to materially observe or perform a covenant or agreement in the Debentures, (c) a default or event of default occurs under any other transaction document related to the financing or in any other material agreement to which the Company is a party that results in a material adverse effect on the Company, (d) any representation or warrant the Company made to investors in the transaction documents related to the financing is materially untrue or incorrect, (e) a bankruptcy event occurs with regard to the Company, (f) the Company defaults on any other loan, mortgage, or credit arrangement that involves an amount greater than $150,000 and results in the obligation becoming declared due prior to the due date, (g) the Companys common stock is not eligible for quotation on the OTC Bulletin Board or other exchange on which the Companys shares are traded, (h) a transaction occurs in which the control of the Company changes, the Company effects a merger or consolidation, the Company sells substantially all of the assets, a tender offer is made for the Companys shares, the Company reclassify their shares or a compulsory share exchange, or the Company agrees to sell more than 33% of the assets, unless the Company receives the consent of holders of 67% of then outstanding principal of the Companys Debentures, (i) the registration statement has not been declared effective within 240 days of the first closing, (j) the registration statement lapses for more than 20 consecutive trading days or more than 40 trading days in a 12 month period, or 60 consecutive trading days and 90 non-consecutive trading days in the event of a material merger or acquisition, (k) the Company fails to deliver certificates for shares to be issued on conversion within seven trading days, (l) the Company has a judgment against them for more than $150,000.  If certain events of default occur under the Debentures, holders could accelerate the due date of the interest and principal due under the Debentures, and we may become obligated to pay all costs, expenses and liquidated damages due under the Debenture plus an amount equal to the greater of (i) 120% of the principal and interest due under the Debenture and (ii) the outstanding principal amount of the Debenture and accrued interest divided by the conversion price on the date the amount is due or paid, whichever is higher, multiplied by the VWAP for our shares on the date of demand or payment, whichever is higher.  The Series D Warrants are exercisable at the same price as the conversion price of the debentures outlined above.  If certain milestones are not met, the conversion price of the Debentures and exercise price of the Series D Warrants may be and were re-set. Also, the exercise price may be adjusted under anti-dilution and other price re-set provisions contained in the Series D Warrants. One-half of the Series D Warrants became exercisable on the date of the first closing on November 8, 2006, and the remaining one-half of the Series D Warrants became exercisable on the date of the second closing on April 12, 2007. The original conversion price was $1.1563 per share, but has been reset to $0.4089 effective May 20, 2008 (the final milestone reset provision).  As a result of the June 2009 financing, in which the Company issued shares of common stock and warrants, the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share and the number of shares underlying the Series D Warrants (including the warrants the Company issued to the placement agent in the financing) would be increased to an aggregate of 6,889,848 shares.  The Series D Warrants contain a cashless exercise provision in the event (i) at any time after one year following the date the Series D Warrants are first exercisable there is no registration statement effective covering the resale of the shares underlying the Series D Warrants or (ii) at any time after four years following the date the Series D Warrants were issued.  The Series D Warrants contain a limitation on the amount of Series D Warrants that may be exercised at any one time in the event the holder owns beneficially more than 4.99% of our common stock without regard to the number of shares underlying the unconverted portion of the warrants. This limitation may be waived upon 61 days notice to us by the holder of the Series D Warrants permitting the holder to change such limitation to 9.99%.  The conversion price of the Debentures and the exercise price of the Series D Warrants or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants are subject to adjustment in the event of a stock dividend, stock split, subdivision or combination of our shares of common stock, reclassification, sales of our securities below their then conversion or exercise price, a subsequent rights offering, or a reclassification of our shares. Also, if we effect a merger or consolidation with another company, we sell all or substantially all of our assets, a tender offer or exchange offer is made for our shares, or we effect a reclassification of our shares or a compulsory share exchange, a holder that subsequently converts its Debenture will be entitled to receive the same kind and amount of securities, cash or property as if the shares it is entitled to receive on the conversion had been issued and outstanding on the date immediately prior to the date any such transaction occurred.  Except as discussed above, no such events have occurred through the date of this report.  We are not required to make an adjustment to the conversion or exercise price or the number of shares to be issued upon conversion or exercise of the Debentures and Series D Warrants under the anti-dilution provisions related to an exempt issuance, which is defined as: (A) any stock or options that are issued under our stock option plans or are approved by a majority of non-employee directors and issued (i) to employees, officers or directors or (ii) to consultants, but only if the amount issued to consultants does not exceed 400,000 shares in      a 12 month period, (B) securities issued under the Debentures or Series D Warrants, (C) shares of common stock issued upon conversion or exercise of, or in exchange for, securities outstanding on the date we entered into the securities purchase agreement, (D) the issuance of the Midtown placement agents warrants or the shares underlying the placement agents warrants, or (E) the issuance of securities in an acquisition or strategic transaction approved by our disinterested directors.   Under the Debenture Amendment Agreement, commencing October 15, 2010, Debenture holders agreed that an exempt issuance shall also include the issuance of stock or common stock equivalents authorized and approved in advance by the Companys disinterested directors at a price per share or at a conversion or exercise price per share equal to or greater than $0.25.  Under the terms of a Registration Rights Agreement we entered into with each purchaser at the closing of the sale of our Debentures and Series D Warrants (purchasers), we agreed we would use our best efforts to file a registration statement under the Securities Act within 45 days of the first closing to permit the public resale by purchasers of the shares that may be issued upon conversion of the Debentures and upon exercise of the Series D Warrants, including the shares of our common stock underlying the Debentures to be issued at the second closing. We are required to keep the registration statement effective until the earlier of either the date all shares underlying the Debentures and Series D Warrants have been sold or such shares are eligible for resale under Rule 144(k), but no later than four years after the effective date of the registration statement. The initial registration became effective on April 9, 2007. We were required to register a number of shares of our common stock equal to 130% of the shares underlying the Debentures and the Series D Warrants.At any time after the effective date of the registration statement covering the resale of the shares to be issued upon conversion or exercise of the Debentures and Series D Warrants, we may call for cancellation up to 75% of the Series D Warrants if: (i) the closing bid or closing sale price of the common stock for 20 consecutive trading days (the measurement period) exceeds $2.89, (ii) the daily trading volume during the measurement period exceeds 100,000 shares per trading day, and (iii) the holder is not in possession of material nonpublic information regarding us. We are required to give notice of cancellation to the holders within one trading day of the end of the measurement period. The Series D Warrants covered by the call notice will be cancelled effective 30 trading days after the date of the call notice, subject to certain conditions, including that the holder shall have the right to exercise the Series D Warrant during the measurement period. As not all of these conditions are met, the Debentures and Series D warrants are not yet cancelable.  On April 28, 2008, the Company filed a new Form S-1 Registration Statement with the Securities and Exchange Commission (SEC), to register additional shares for resale by certain holders (Registered Shares) of the Series A Convertible Debentures and Series D Warrants upon conversion or exercise thereof at a lower conversion price due to the reset provisions of the agreements, and to carry forward in such registration statement certain unsold shares from our Form S-1 Registration Statement that became effective April 9, 2007 (Registration Statement), in a combined prospectus under applicable SEC Rules. On June 5, 2008, the Company filed a Post-Effective Amendment No. 1 to the Registration Statement (Post-Effective Amendment No. 1) to de-register 1,157,971 shares of Common Stock issuable in lieu of interest accrued through December 22, 2006, which became effective on June 6, 2008. On July 25, 2008, the Company filed a Post-Effective Amendment No. 2 to the Registration Statement (Post-Effective Amendment No. 2) to de-register an aggregate of an additional 4,208,495 of the Registered Shares. This amount includes: (i) an aggregate of 2,465,460 Registered Shares previously registered under the Registration Statement for resale by certain of the holders of the Companys Series A 10% Senior Convertible Debentures (the Debentures) upon conversion thereof; and (ii) an aggregate of 1,743,035 Registered Shares previously registered under the Registration Statement that represent additional shares registered under the Registration Statement for resale by certain of the holders of the Debentures and Series D Common Stock Purchase Warrants upon conversion or exercise thereof, which was approved by the SEC on August 6, 2008. On August 11, 2008, the Company filed a Post-Effective Amendment No. 3 to the Registration Statement to de-register the remaining unsold shares under the Registration Statement, which became effective August 13, 2008. On August 11, 2008, and in view of the Companys current financing requirements, the Company filed a request with the SEC to withdraw the April 28, 2008 Form S-1 Registration which withdrawal request was approved by the SEC.  Under the terms of the Debenture Amendment Agreement, the remaining Debenture holders agreed to terminate the Registration Rights Agreement with each such holder; however, the Company continues to be obligated under the terms of the Registration Rights Agreement that the Company entered into with each purchaser that has fully converted its Debenture but continues to hold Series D Warrants.  We also granted to each purchaser of the Debentures and Series D Warrants the right to participate in any offering by us of common stock or common stock equivalents until the later of (i) 12 months after the effective date of the registration statement and (ii) the date a purchaser holds less than 20% of the principal amount of the Debenture the purchaser originally agreed to purchase, except for an exempt issuance or an underwritten public offering of our common stock.  Purchasers may participate in such an offering up to the lesser of 100% of the future offering or the aggregate amount subscribed for under the securities purchase agreement by all purchasers. Although such common stock offerings have occurred, the original purchasers have not yet elected to participate in any such offerings through the date of the filing of this report, and have notified the Company that they do not want to participate in any future financings.  Also, for three years after the date we entered into the securities purchase agreement, we were prohibited from engaging in any transactions in our securities in which the conversion, exercise or exchange rate or other price of such securities is based upon the trading price of our securities after initial issuance or otherwise subject to re-set unless the transaction is (i) approved by purchasers holding at      least 67% of the securities sold in the offering and then outstanding, or (ii) no purchaser then holds more than 20% of the principal amount of the Debentures originally purchased in the offering. This restriction expired on November 7, 2009.  The securities purchase agreement also contained representations and warranties of both us and purchasers, conditions to closing, certain indemnification provisions, and other customary provisions.  Also the Debenture Amendment Agreement amended certain provisions covering events of default under the Debentures, contained certain representations and warranties of the Company, a reaffirmation of certain of the representations and warranties in the securities purchase agreement, contained certain conditions to closing, and certain other customary provisions.  We were prohibited from effecting a reverse or forward stock split or reclassification of our common stock except as may be required to comply with the listing standards of any national securities exchange. Moreover, for one year after April 9, 2007 (the effective date of the registration statement), we agreed to exchange the securities issued in the offering for securities issued in a subsequent offering, except for shares issued in an exempt issuance or an underwritten public offering. No such exchanges have occurred through the date of this report.  Midtown Partners & Co., LLC acted as placement agent for the financing pursuant to the terms of a Placement Agent Agreement, dated July 14, 2006, between us and Midtown. At the first closing, we paid or issued the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees of $30,000 of which $10,000 was paid prior to closing, (iii) placement agents warrants to purchase an aggregate of 623,520 shares (one half of the Midtown placement agents warrants are exercisable commencing on November 6, 2006 and the remaining one-half become exercisable on the second closing). The second closing took place on April 12, 2007, at which time we paid the following compensation to Midtown for its services as placement agent in connection with the offering: (i) sales commissions in the amount of $180,250; (ii) non-accountable expense reimbursement and legal fees equal to 1% of the second closing or $25,750, (iii) the placement agents warrants to purchase an aggregate of 311,760 shares (the remaining one-half of the placement agents warrants). The Midtown placement agents warrants are exercisable at a price of $1.15634 per share for a period of five years from the date they become exercisable, the exercise price was re-set as disclosed above for the convertible debentures, contain a piggyback registration right, a cashless exercise provision and are substantially identical to the warrants issued to purchasers in the Debenture and Warrant offering.  As a result of the June 2009 financing, the exercise price of the placement agents warrants were adjusted under the anti-dilution provisions of such warrants to a price of $0.25 per share and the number of shares underlying the placement agents warrants would be increased to an aggregate of 1,019,828 shares.  The securities, including certain securities issued to Midtown, were not registered under the Securities Act of 1933 or any state laws and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.  2006 through 2010 Short-Term Promissory Notes, Related Party On April 21, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, the Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $200,000. The Company issued a non-negotiable promissory note, dated effective April 21, 2006, to Mr. Trudnak in the principal amount of $200,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition.  In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full.  The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On October 21, 2006, Mr. Trudnak extended the due date of the loan to December 31, 2006. Subsequently, on October 3 and October 18, 2006, Mr. Trudnak loaned the Company $102,000 and $100,000, respectively, on substantially the same terms as the April 21, 2006 loan, except that each loan is due six months after the date thereof. Accordingly, following such additional loans, the Company owed an aggregate of approximately $402,000 to Mr. Trudnak. On November 10, 2006, Mr. Trudnak extended the due dates of such loans to May 31, 2007, except that $100,000 of the April 21, 2006, loan becomes due upon      the Company raising $2,500,000 in financing after November 6, 2006, and the remaining amount of $202,000 of such loans become due upon the Company raising an aggregate of $5,000,000 in financing after November 6, 2006, and prior to May 31, 2007. Following the first closing of our Debenture and Series D Warrant financing on November 8, 2006, the Company repaid $100,000 on November 20, 2006, in principal amount of the April 1, 2006, and paid an additional $100,000 to Mr. Trudnak on April 17, 2007 upon the second closing of our Debenture and Series D Warrant financing. On May 31, 2007, Mr. Trudnak extended the due dates of the remaining loans to May 31, 2008. Although, the anticipated payment of $202,000 had not been made, and Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, for total outstanding notes of $226,000.  Subsequently, the maturity date of the outstanding loans was extended to May 31, 2009, and subsequently to May 31, 2010.  On June 1, 2010, the outstanding loans were extended to June 30, 2011.  During 2010, the Company repaid an aggregate of $108,900 of the notes, resulting in an outstanding balance at December 31, 2010, of $117,100. The terms of the above transaction were reviewed and approved by the Companys audit committee and by our Board of Directors.  2011 Securities Purchase Agreement On February 23, 2011, the Company executed a Securities Purchase Agreement, (the SPA), with an institutional accredited investor for an investment up to $1,000,000, subject to certain stock price and volume conditions.  Subsequently, on February 24, 2011, we sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agents warrants as compensation in connection with the offering.  The placement agents warrants are under the same terms and conditions as those issued to the institutional investor.  In addition, under the SPA, the investor has agreed to provide additional financing to us by purchasing shares of our common stock at seven subsequent closings and in the following amounts; i) at a second closing to be held one month following the first closing, an amount of shares equal to forty percent (40%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a third closing to be held one month following the second closing, an amount of shares equal to thirty percent (30%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a fourth closing to be held one month following the third closing, an amount of shares equal to twenty percent (20%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, and iv) at each of four additional subsequent closings to be held one month following the immediately preceding closing, an amount of shares equal to ten percent (10%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding the subsequent closing. The investor agreed to purchase our shares at each subsequent closing for a price per share equal to the lower of an amount equal to: (a) 60% of the volume weighted average of actual trading prices of the shares for the ten (10) consecutive trading days immediately prior to a date of the applicable closing and (b) 64% of the volume weighted average of actual trading prices of the shares for the trading day immediately prior to the applicable closing date.  If, under this calculation, the price of a share at a subsequent closing does not exceed a floor price of $0.25, the investor will not be obligated to purchase our shares at that closing.  The failure to hold a closing will not impact the holding of the subsequent closings. Also, the investor will not be obligated to purchase shares at a closing if such purchase would cause them to beneficially own in excess of 9.99% of our shares.  We have granted to the investor piggy back registration right with regard to the shares issued in the financing, including the shares underlying the Warrants. The SPA contains representations and warranties of the Company and investor, certain indemnification provisions and customary conditions to each closing.  We may terminate the SPA on ten days prior written notice to the investor, and the investor may terminate the SPA at any time prior to a subsequent financing upon written notice to us if we consummate a reverse stock split or a subsequent financing to which the investor is not a party.  We have agreed to pay the investors counsel with regard to the first closing in the amount of $25,000, $5,000 of which was paid at the first closing and $5,000 will be paid at each of the first four subsequent closings.  We have also agreed to pay additional fees for their counsel for each subsequent closing in the amount of $2,500.  A broker has acted as placement agent for the offering.  Under the terms of a Non-Circumvention and Compensation Agreement, dated January 12, 2011, between the Company and the broker, in connection with the offering, we agreed to pay or issue the broker at a closing a placement fee equal to 6% of the proceeds received by us at the closing and placement agents warrants equal to 6% of the shares sold at the closing (including the shares underlying the Warrants).       NOTE 5.    FAIR VALUE MEASUREMENT The Company determines the fair value of its derivatives that are classified as liabilities, on a recurring basis using significant unobservable inputs.  The fair value measurement of these liabilities is consistent with ASC 820, "Fair Value Measurements"  ASC 820 did not have an impact on the consolidated financial position or results of operations; however, the required disclosure for the year ended December 31, 2010 is as follows:                 Liabilities Measured at Fair ValueConvertible Notes and Debentures, Net of Discount (1)Embedded Conversion Feature of Debentures (2)TotalBeginning balance as of December 31, 2008$ 4,702,921$ 1,354,051$ 6,056,972Revaluation (gain) loss of event of default provision(45,477)1,139,9801,094,503Event of default provision waived by holders(2,541,739)-(2,541,739)Conversions(427,500)(265,600)(693,100)Ending balance as of December 31, 2009$ 1,688,205$ 2,228,431$ 3,916,636Total (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$ (2,587,216)$ 1,139,980$ (1,447,236)(1) The balance as of December 31, 2010 represents the outstanding convertible debentures issued November 8, 2006 and April 12, 2007.  The cumulative provision for the event of default under the debentures of $2,541,739 was waived in full by the holders on October 15, 2010, which was accrued and unpaid during 2007, 2008, and 2009 of $645,641, $76,658, $1,864,917, respectively, and a reduction in the default provision amount during 2010 of $45,477.(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.           NOTE 6.    STOCKHOLDERS EQUITY (DEFICIT) Unless otherwise indicated, fair value is determined by reference to the closing price of the Companys common stock on the measurement date. Prior to January 1, 2006, stock options included in stockholders equity (deficit) reflect only those granted at an exercise price that was less than fair value (the intrinsic value). Subsequently, stock options for employees are recognized and disclosed pursuant to ASC 718-10, Stock-based Payment. Generally, the measurement date for employee stock compensation is the grant date. However, in the case of non-employees, the initial measurement date is the date of binding commitment to perform services for the Company.  This initial-measurement cost is first reflected as deferred compensation in stockholders equity (deficit) and then amortized to compensation expense on a straight-line basis over the period over which the services are performed.  For non-employee grants, the total cost is re-measured at the end of each reporting period based on the fair value on that date, and the amortization is adjusted 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 and, accordingly, recognizes as expense the estimated fair value of such options as calculated using the Black-Scholes model.  Preferred Stock  The Company has the authority to issue 1,000,000 shares of $0.20 par value preferred stock.  The Board of Directors is authorized to issue shares of preferred stock from time to time in one or more series and, subject to the limitations contained in the certificate of incorporation and any limitations prescribed by law, to establish and designate a series and to fix the number of shares and the relative conversion rights, voting rights and terms of redemption (including sinking fund provisions) and liquidation preferences.  The Company has not had any preferred shares outstanding for any of the two years in the period ended December 31, 2010. New issuances of shares of preferred stock with voting rights can affect the voting rights of the holders of outstanding shares of preferred stock and common stock by increasing the number of outstanding shares having voting rights and by the creation of class or series voting rights.  Furthermore, additional issuances of shares of preferred stock with conversion rights can have the effect of increasing the number of shares of common stock outstanding up to the amount of common stock authorized by the articles of incorporation and can also, in some circumstances, have the effect of delaying or preventing a change in control of the Company and/or otherwise adversely affect the rights of holders of outstanding shares of preferred stock and common stock.  To the extent permitted by the certificate of incorporation, a series of preferred stock may have preferences over the common stock (and other series of preferred stock) with respect to dividends and liquidation rights.  Common Stock  The Company has the authority to issue up to 200,000,000 shares of $0.001 par value common stock.  The Board of Directors has the authority to issue such common shares in series and determine the rights and preferences of such shares. As of March 30, 2011, there were approximately 84,763,958 shares of our common stock issued and outstanding and approximately 330 holders of record of the common stock. Each share of common stock entitles the holder thereof to one vote on each matter submitted to our stockholders for a vote. The holders of common stock: (a) have equal ratable rights to dividends from funds legally available therefor      when, as and if declared by the board of directors; (b) are entitled to share ratably in all of our assets available for distribution to holders of common stock upon liquidation, dissolution or winding up of our affairs; (c) do not have preemptive, subscription or conversion rights, or redemption or applicable sinking fund provisions; and (d) as noted above, are entitled to one non-cumulative vote per share on all matters submitted to stockholders for a vote at any meeting of stockholders.  We anticipate that, for the foreseeable future, we will retain earnings, if any, to finance the operations of our businesses.  The payment of dividends in the future will depend upon, among other things, our capital requirements and our operating and financial conditions.  Stock Warrants  The Company has issued warrants as compensation to its placement agent and other consultants, as well as to incentivize investors in each of the Companys private offering financings.  Issuance of Common Stock and Related Common Stock Warrants  On December 16, 2010, the Company agreed to convert a $50,000 outstanding convertible promissory note for 200,000 shares of common stock, and 200,000 Class M common stock purchase warrants. The conversion price of the note was $0.25. The note holder also converted a total of $7,630 accrued and unpaid interest for an aggregate of 30,520 shares of common stock, and 30,520 Class M common stock purchase warrants. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. Common stock was increased by $231 for the par value of the shares and paid-in capital was increased by $57,399.  On December 1, 2010, the Company issued 150,000 shares of common stock and 100,000 common stock purchase warrants to a consultant as compensation for investor relations services. The fair value of the stock and warrants on the date of issuance was $83,000. Common stock was increased by $150 for the par value of the shares, $82,850 to paid-in capital, with an offset to deferred compensation in the amount of $83,000. 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.  As a result, consulting expense of $13,833 was recorded during the month of December 2010 and $5,417 was applied to paid-in-capital for the remeasurement of deferred compensation during the same period.  During November through December 2010, the Company sold to accredited investors an aggregate of 400,000 shares of common stock and 400,000 Class P Warrants for gross proceeds of $100,000 ($93,000, net of commissions and expenses in the amount of $7,000). The warrants are exercisable at a price of $0.50 per shares; contain piggyback registration rights, and certain anti-dilution and other customary provisions. The warrants expire thirty-sixty (36) months from the date of issuance. Common stock was increased by $400 for the par value of the shares and $92,600 to paid-in capital. The Company also issued 28,000 Class P warrants as compensation to a consultant and the fair value of the warrants on their date of issuance was $7,840.  On October 26, 2010, in accordance with an outstanding capital raise, four executives and a consultant/director of the Company converted a portion of their accrued and unpaid wages, outstanding accounts payable, and other related compensation in an aggregate of $1,267,706, for a total of 5,070,825 shares of common stock, and an aggregate of 5,070,825 Class N Common Stock Purchase Warrants. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in sixty (60) months from the date of issuance.  Common stock was increased by $5,071 for the par value of the shares, paid-in capital was increased by approximately $1,262,635, accrued wages and interest due was reduced by $1,195,706, and accounts payable trade was reduced by $72,000.  During July through September 2010, the Company sold to accredited investors an aggregate of 1,340,000 shares of common stock and 1,340,000 Class N Warrants for gross proceeds of $335,000 ($315,500, net of commissions and expenses in the amount of $19,500). The warrants are exercisable at a price of $0.25 per shares; contain a conditional call provision if the market price of each share exceeds $3.00, contain certain anti-dilution and other customary provisions. The warrants expire sixty (60) months from the date of issuance. Common stock was increased by $1,340 for the par value of the shares and $314,160 to paid-in capital. The Company also issued 28,000 Class N warrants as compensation to a consultant and the fair value of the warrants on their date of issuance was $8,540.  During August through September 2010, the Company agreed to convert an aggregate of $575,000 outstanding convertible promissory notes for an aggregate of 2,300,000 shares of common stock, and 2,300,000 Class M common stock purchase warrants. The conversion price of the note was $0.25. The note holders also converted a total of $60,477 accrued and unpaid interest for an aggregate of 241,907 shares of common stock, and 241,907 Class M common stock purchase warrants. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. Common stock was increased by $2,542 for the par value of the shares and paid-in capital was increased by $632,935.  During June, 2010, the Company sold to accredited investors an aggregate of 400,000 shares of common stock and 400,000 Class N Warrants for gross proceeds of $100,000 ($90,000, net of commissions and expenses in the amount of $10,000). The warrants are      exercisable at a price of $0.25 per shares; contain a conditional call provision if the market price of each share exceeds $3.00, contain certain anti-dilution and other customary provisions. The warrants expire sixty (60) months from the date of issuance. Common stock was increased by $400 for the par value of the shares and $89,600 to paid-in capital.  During May, 2010, the Company sold to accredited investors an aggregate of 660,000 shares of common stock and 660,000 Class N Warrants for gross proceeds of $165,000 ($148,950, net of commissions and expenses in the amount of $16,050). The 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, and contain anti-dilution and other customary provisions. The warrants expire sixty (60) months from the date of issuance. Common stock was increased by $660 for the par value of the shares and $148,290 to paid-in capital.  During April, 2010, the Company sold to accredited investors an aggregate of 1,104,000 shares of common stock and 1,104,000 Class N Warrants for gross proceeds of $276,000 ($254,180, net of commissions and expenses in the amount of $21,820). The warrants are exercisable at a price of $0.25 per shares; contain a conditional call provision if the market price of each share exceeds $3.00, contain certain anti-dilution and other customary provisions. The warrants expire sixty (60) months from the date of issuance. Common stock was increased by $1,104 for the par value of the shares and $253,076 to paid-in capital.  During March 2010, the Company accepted direct investments from accredited investors of an aggregate of $230,000 ($213,650, net of commissions and expenses in the amount of $16,350), and issued 920,000 shares of common stock. In addition, the Company issued an aggregate of 920,000 Class N common stock purchase warrants exercisable at a price of $0.25 that contain a conditional call provision if the market price of each share exceeds $3.00, contain anti-dilution and other customary provisions. The warrants expire in March 2015. Common stock was increased by approximately $920 for the par value of the shares and $216,480 to paid-in capital.  On March 12, 2010, the Company agreed to convert a $50,000 outstanding convertible promissory note for an aggregate of 200,000 shares of common stock, and 200,000 Class M common stock purchase warrants. The conversion price of the note was $0.25. The note holder also converted accrued and unpaid interest of $3,892 for 15,568 shares of common stock, and 15,568 Class M common stock purchase warrants. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. Common stock was increased by $216 for the par value of the shares and paid-in capital was increased by $53,676.  On November 19, 2009, the Company agreed to convert a $50,000 outstanding convertible promissory note for an aggregate of 200,000 shares of common stock, and 200,000 Class M common stock purchase warrants. The conversion price of the note was $0.25. The note holder also converted accrued and unpaid interest of $2,252 for 9,007 shares of common stock, and 9,007 Class M common stock purchase warrants. The 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 five years after the date of issuance. Common stock was increased by $209 for the par value of the shares and paid-in capital was increased by $52,043.  On October 5, 2009, the Company agreed to convert a $60,000 outstanding convertible promissory note for an aggregate of 210,720 shares of common stock, and 210,720 Class N common stock purchase warrants. The conversion price of the note was $0.28.5. The note holder also converted accrued and unpaid interest of $8,351 for 29,280 shares of common stock, and 29,280 Class N common stock purchase warrants. The 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 five years after the date of issuance. Common stock was increased by $240 for the par value of the shares and paid-in capital was increased by $68,111.  During the period of October 1, through December 8, 2009, the Company conducted a private placement of units of securities, each unit consisting of 80,000 shares of our common stock and 80,000 Class N Common Stock Purchase Warrants.  At a series of closings we held during this period, we sold an aggregate of 25.63 units, and issued an aggregate of 2,050,000 shares of common stock and 2,050,000 Class N Warrants for gross proceeds to us of approximately $512,500 (or net proceeds of approximately $470,928, after payment of certain commissions and expenses of our placement agent for the offering of approximately $41,572).  The Class N Warrants issued to investors in the offering are exercisable at a price of $0.25 per share, a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire five years after the date of issuance. Newport Coast Securities (formerly Grant Bettingen, Inc) acted as placement agent for the offering on a best efforts basis pursuant to a placement agreement we entered into with Newport Coast Securities.  Also, the Company issued to Newport Coast Securities, placement agents warrants to purchase an aggregate of 205,000 shares of its common stock (subject to adjustment), each warrant exercisable at a price of $0.275 per share for a period of five years from the date of issuance. The Company also issued to its private placement agent 100,000 shares of common stock as additional compensation for the 2009 private placement offering.  On September 2009, the Company issued 200,000 shares of common stock and 250,000 Class M warrants to a consultant as compensation for business advisory services. The fair value of the stock and warrants on the date of issuance was $80,000. Common stock      was increased by $200 for the par value of the shares, $79,800 to paid-in capital, with an offset to deferred compensation in the amount of $80,000. 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.  As a result, consulting expense of $33,334 was recorded during the three month period ending September 30, 2009.  During June through July 2009, the Company sold to accredited investors an aggregate of 1,100,000 shares of common stock and 1,100,000 Class M Warrants for gross proceeds of $275,000 ($265,750, net of expenses of $9,250). The warrants are exercisable at a price of $0.25 per share and expire sixty (60) months from the date of issuance.  Common stock was increased by $1,100 for the par value of the shares and $264,650 to paid-in capital.  During the period of January through April 24, 2009, the Company conducted a private placement of units of securities, each unit consisting of 48,780 shares of our common stock and 97,560 Class L Common Stock Purchase Warrants. At a series of closings we held during the period January 1, 2009 through April 24, 2009, the Company sold an aggregate of 44.68 units, and issued an aggregate of 2,179,490 shares of common stock and 4,358,981 Class L Warrants for gross proceeds of approximately $893,501 (or net proceeds of approximately $821,776, after payment of certain commissions and expenses to the placement agent for the offering of approximately $71,725). The Class L Warrants issued to investors in the offering are exercisable at a price of $0.41 per share; contain a cashless exercise provision, a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire five years after the date of issuance. Newport Coast Securities acted as placement agent for the offering on a best efforts basis pursuant to a placement agreement entered into with the Company. From October 27, 2008 through April 24, 2009, the placement agent received total sales commissions of $89,480 and an expense reimbursement of approximately $17,269. Also, the Company issued to placement agents warrants to purchase an aggregate of 272,826 shares of the Companys common stock (subject to adjustment), each warrant exercisable at a price of $0.45 per share for a period of five years from the date of issuance.  Other Common Stock Issued Including Exercise of Warrants  In October through December 2010, the Company issued to a vendor 374,605 shares of common stock as payment towards an outstanding accounts payable. Common stock was increased by $375 for the par value of the shares, paid-in capital was increased by approximately $117,578, and accounts payable trade was reduced by the fair value of the stock of $117,953.  On October 26, 2010, the Company issued an aggregate of 1,000,000 shares of common stock to four of its executives and a consultant/director, and such issuance was previously authorized for all employees as compensation for the hardship of not regularly receiving their salaries, wages, or other compensation that was due during June 2008 through August 2010, and the continued or continuing nonpayment of such amounts by the Company. The issuance of the common stock was not in lieu of the payment of such compensation, which remains accrued and unpaid. Common stock was increased by $1,000 for the par value of the shares, $304,000 to paid-in capital, and $305,000 to stock-based compensation expense.  On October 18, 2010, the two outstanding debenture holders converted $638,163 of accrued and unpaid interest for 2,552,653 shares of common stock. The conversion price of the interest was $0.25, which was based on the conversion rate per the debenture agreement.  Common stock was increased by $2,553 for the par value of the shares, and paid-in capital was increased by $635,610.  On September 2, 2010, an accredited investor exercised 375,000 Class F and 375,000 Class G common stock purchase warrants for an aggregate of 750,000 warrants for $187,500, and the Company issued 750,000 shares of common stock. Common stock was increased by $750 for the par value of the shares and $186,750 to paid-in capital.  On August 31, 2010, the Company issued to a vendor 96,682 shares of common stock as payment towards an outstanding accounts payable. Common stock was increased by $97 for the par value of the shares, paid-in capital was increased by approximately $29,391, and accounts payable trade was reduced by the fair value of the stock of $29,488.  On July 20, 2010, three holders of our Series D Warrants used the cashless exercise provision of their stock purchase warrants to exchange 864,798 stock purchase warrants for 403,226 shares of common stock.  Common stock was increased by $403 for the par value of the shares and paid-in-capital was decrease by $403.  On July 12, 2010, the Company agreed to convert a $27,139 noninterest bearing convertible note, which was issued for accrued and unpaid wages, for 79,819 shares of common stock. The conversion price of the note was $0.34, which was based on the market price on the date of conversion.  Common stock was increased by $80 for the par value of the shares and paid-in capital was increased by $27,059.       On June 18, 2010, in accordance with the terms of the Companys outstanding Series A Debentures, a debenture holder converted $50,000 in principal amount of its debentures into an aggregate of 200,000 shares of common stock. Common stock was increased by $200 for the par value of the shares and paid-in capital was increased by approximately $49,800.  During June 2010, two accredited investors exercised an aggregate of 300,000 Class M common stock purchase warrants for $75,000, and the Company issued 342,000 shares of common stock. Common stock was increased by $342 for the par value of the shares and $74,658 to paid-in capital.  On May 7, 2010, a holder of our Series D Warrants used the cashless exercise provision of their stock purchase warrants to exchange 50,000 stock purchase warrants for 16,940 shares of common stock.  Common stock was increased by $17 for the par value of the shares and paid-in-capital was decrease by $17.  On March 16, 2010, the Company issued to a consultant, 100,000 shares of common stock as compensation for services rendered. Common stock was increased by $100 for the par value of the shares and $13,900 to paid-in capital.  Stock compensation expense of $14,000 was also recorded.  From January 13  19, 2010, in accordance with the terms of the Companys outstanding Series A Debentures, four debenture holders converted $377,500 in principal amount of their debentures into an aggregate of 1,510,000 shares of common stock. Three of such debenture holders converted their outstanding principal amount in full. Common stock was increased by $1,510 for the par value of the shares and paid-in capital was increased by approximately $375,990.  On January 7, 2010, the Company issued to a 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 and paid-in capital was increased by approximately $22,575. Deferred compensation expense of $22,750 was also recorded.  The shares were subsequently cancelled on June 11, 2010 and the related par value, paid-in-capital and deferred compensation expense were reversed.  From October 5, through December 21, 2009, in accordance with the terms of the Companys outstanding Series A Debentures, six debenture holders converted an aggregate of $880,000 in principal amount of its debenture into an aggregate of 3,520,000 shares of common stock.  Common stock was increased by $3,520 for the par value of the shares and paid-in capital was increased by $876,480. Also, one of the debenture holders also converted approximately $1,892 of accrued and unpaid interest and late fees into an aggregate of 11,828 shares of common stock. Common stock was increased by $12 for the par value of the shares and paid-in capital was increased by $1,880.  On September 29, 2009, the Company issued to its placement agent 100,000 shares of common stock as additional compensation for the 2009 private placement offering. Common stock was increased by $100 for the par value of the shares, $19,800 to paid-in capital, and $20,000 to financing expense.   During August 11, through September 17, 2009, in accordance with the terms of the Companys outstanding Series A Debentures, six debenture holders converted an aggregate of $222,500 in principal amount of its debenture into an aggregate of 890,000 shares of common stock.  The conversion price of the debentures was $0.25. One of the debenture holders also converted approximately $22,986 of accrued and unpaid interest and late fees into an aggregate of 111,095 shares of common stock, for an average conversion price of $0.207. Common stock was increased by $1,001 for the par value of the shares and paid-in capital was increased by $244,485.  On July 2, 2009, the Company issued to its placement agent 48,000 shares of common stock in exchange of commissions for shares. Common stock was increased by $48 for the par value of the shares, $11,952 to paid-in capital, and $20,000 was charged to financing expense. The Company also issued in the transaction 108,000 Class M common stock purchase warrants. The initial fair value of the warrants on the date of issuance was $22,680. The warrants are exercisable at a price of $0.25 per share, contain customary anti-dilution provision, and expire on July 1, 2014.  On February 12, 2009, in accordance with the terms of the Companys outstanding Series A Debentures, a debenture holder converted $10,000 in principal amount of its debenture into an aggregate of 24,455 shares of common stock. The conversion price of the debentures was $0.4089. Common stock was increased by $24 for the par value of the shares and paid-in capital was increased by $9,976.  Other Common Stock Warrants Issued or Forfeited  In December 2010, the Company cancelled an aggregate of 265,005 common stock purchase warrants that expired. The fair value of the warrants on their date of issuance was $1,219,842.       On September 30, 2010, the Company issued to three convertible note holders an aggregate of 78,750 Class M common stock purchase warrants as an inducement to extend and convert the notes.  The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. The fair value of the warrants on the date of issuance was $22,050.  During July through August 2010, the Company cancelled an aggregate of 765,500 common stock purchase warrants that expired. The fair value of the warrants on their date of issuance was $434,703.  On May 29, 2010, the Company cancelled 200,000 Class C common stock purchase warrants that expired. The fair value of the warrants on August 7, 2006, the date of issuance, was $36,000.  On January 1, 2010, the Company issued to a convertible note holder 150,000 Class M common stock purchase warrants as an inducement to extend the note to March 31, 2010. The warrants are exercisable at a price of $0.25 per share; contain certain anti-dilution and other customary provisions. The warrants expire five years after the date of issuance. The fair value of the warrants on the date of issuance was $16,500.  On December 17, 2009, the Company issued to a consultant Class N common stock purchase warrants to purchase an aggregate of 200,000 shares of our Common Stock.  The Warrants are exercisable at a price of $0.25 per share, contain customary anti-dilution provision, and expire sixty (60) months from the date of issuance.  During August and September 2009, the Company reset an aggregate of 3,846,258 warrants to investors as inducement for additional investments made to the Company during 2009. The previous exercise prices of 3,631,973 warrants ranged from $0.4089 to $0.41 were reset to an exercise price of $0.25, and 214,285 warrants that were previously issued at $0.70 were reset to an exercise price of $0.41. All other provisions of the new warrants remained the same as the initial warrants.  During June through August 2009, the Company issued to a consultant common stock purchase warrants to purchase an aggregate of 63,000 shares of our common stock, and the initial aggregate fair value of the warrants on their date of issuance was $13,370. The warrants are exercisable at a price of $0.25 per share, contain customary anti-dilution provision, and expire sixty (60) months from the date of issuance.  As a result of the June 2009 financing in which the Company issued shares of common stock and warrants, the conversion price of our debentures and the exercise price of the Series D Warrants was adjusted under the anti-dilution provisions of such instruments to a price of $0.25 per share, and the number of shares underlying the Series D Warrants would be increased by an aggregate of 2,281,109 warrants to the debenture holders and 396,308 warrants to the placement agent in the financing.  On February 12, 2009, the Company issued to an accredited investor common stock purchase warrants to purchase 18,293 shares of our common stock as an inducement for a short-term loan, and the initial fair value of the warrants on the date of issuance was $5,671.  The warrants are exercisable at a price of $0.41 per share that contains a conditional call provision if the market price of each share exceeds $5.00, and customary anti-dilution provision.  The warrants expire in February 2014.  The table below shows by category, the common stock purchase warrants issued and outstanding at December 31, 2010:   Common Stock Purchase WarrantsNumber of Warrants Outstanding and ExercisableDate Warrants are ExercisableExercise PriceDate Warrants ExpireNote and debenture holders142,652December 20030.75June 201153,334April 20040.75June 2011600,000August 20061.60August 20111,312,056November 20060.25November 20111,362,057April 20070.25April 2012243,666April 20071.60April 201110,000December 20070.70December 201218,293February 20090.41February 20141,140,555June 20090.25November 20111,140,554June 20090.25April 2012150,000January 20100.25January 2015       78,750September 20100.25September 20156,251,917Private placement investors8,000May 20070.75June 2011864,798July 20071.17July 2012312,500August 20070.80December 2011937,500August 20071.75August 20121,500,000February 20080.70February 2013214,285March 20080.75March 20132,142,850April 20080.70April 20132,682,553Sept to December 20080.41Sept to Dec 20134,358,981January to April 20090.41Jan to April 20141,050,000June to July 20090.25June to July 20143,631,973August 20090.25July to Dec 2013214,285September 20090.41December 20122,499,007Oct to Dec 20090.25Oct to Dec 20143,299,568March to June 20100.25March to June 20153,881,907July to September 20100.25July to September 20155,301,345Oct to December 20100.25Oct to December 2015400,000Nov to December 20100.50Nov to December 201333,299,552Placement agents311,760November 20060.25November 2011311,760April 20070.25April 201247,564July 20071.17July 2012198,154June 20090.25November 2011198,154June 20090.25April 2012272,827June 20090.45June 2014108,000July 20090.25July 2014205,000December 20090.28December 20141,653,219Consultants60,000February 20080.54February 2013200,000December 20090.25December 201463,000June to August 20090.25June to August 201414,000August 20100.25August 201514,000September 20100.28September 2015128,000December 20100.50December 2013479,000Total Warrants Issued/Outstanding41,683,688  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 27,742,382 shares remain available for issuance thereunder as of December 31, 2010. 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 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 during the year ended December 31, 2010 of $1,212,663, and $1,214,113 for the same period during 2009. All options granted in the year ended December 31, 2010 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 and, accordingly, recognizes as an expense the estimated fair value of such options as calculated using the Black-Scholes model. However, 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. Total stock-based compensation expense for consultants during the years ended December 31, 2010 and 2009 were $300,602 and $117,518, respectively. All options granted in the year ended December 31, 2010 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 Amended and Restated 2003 Stock Incentive Plan  The Board of Directors adopted the 2003 Stock Incentive Plan on August 29, 2003.  The plan may be modified or terminated at any time, and any such amendment or termination will not affect outstanding options without the consent of the optionee.  The Board of Directors amended and restated the plan on December 2, 2003. The Amended and Restated 2003 Stock Incentive Plan (2003 Plan) was approved by the shareholders on February 13, 2004, pursuant to which it grants stock-based compensation in the form of options, which will result in the issuance of up to an aggregate of 30,000,000 shares of the Companys common stock. The 2003 Stock Incentive Plan terminates on August 29, 2013.  The aggregate number of shares and the number of shares in an award (as well as the option price) may be adjusted if the outstanding shares of the Company are increased, decreased or exchanged through merger or other stock transaction.  The Plan provides for options which qualify as Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986, as well as the issuance of Non-Qualified Options, which do not so qualify. Pursuant to the terms of the 2003 Plan, the Company, as determined by the Board of Directors or a committee appointed by the Board, may grant Non-Qualified Stock Options (NQSOs) to its executive officers, non-employee directors, or consultants of the Company and its subsidiaries at any time, and from time to time.  The 2003 Plan also provides for Incentive Stock Options (ISOs) to be granted to any officer or other employee of the Company or its subsidi­aries at any time, and from time to time, as determined by the Board or selected by the committee appointed by the Board.  Such stock options granted allow a grantee to purchase a fixed number of shares of the Companys common stock at a fixed exercise price not be less than the quoted market price (or 110% thereof for Incentive Stock Options issued to a holder of 10% or greater beneficial ownership) of the shares on the date granted.  The options may vest on a single date or over a period of time, but normally they do not vest unless the grantee is still employed by, or a director of, the Company on the vesting date.  Generally for all employees, the options vest 50% after the first year from the date of grant and the remaining 50% after the second year from the date of grant.  Stock options granted to independent board of directors vest 100% after the service period, which generally is one year from the date of grant.  Factors considered in granting stock options included: (i) the general policy during the past five, and in the foreseeable future, of not increasing base salaries of all employees, (ii) the performance of employees, (iii) the employees increasing responsibilities in a dynamic, and shrinking organization, and (iv) the accomplishments achieved by the Company during the prior year.  The 2003 Plan has been the principal method for our employees and executive officers to acquire equity interests in the Company. We believe that the annual aggregate value of these awards should be set near competitive median levels for comparable companies.  We may provide a greater portion of total compensation to our executives and employees through stock options given the general policy of not increasing base salaries in the foreseeable future. Our Compensation Committee administers the 2003 Plan based on the above factors, and the Committee approved the grant of stock options to all current employees, including its named executives, during 2007 through 2009 as an incentive for continued contributions in moving our product development efforts forward.  Stock options were not granted to employees, including its named executives, during 2010 as the Company did not achieve the desired results in the prior year. Also, the Compensation Committee, based on managements recommendation and discussions with the Committee, may grant stock options to new employees.  New employees were granted stock options in prior years, but no such stock options were issued during 2010 since there were no new employees hired during the year.  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.  During 2010, the Compensation Committee granted under the 2003 Plan, 1,069,560 stock options.  As of December 31, 2010, the Company has reserved under the 2003 Plan, 16,394,681 shares to be issued upon exercise of outstanding options, and 11,812,819 shares were available for future awards.  Compensation expense for stock options granted is recognized over the requisite service period, which is typically the period over which the stock-based compensation awards vest. In anticipation of implementation of SFAS 123R, we accelerated the vesting of the outstanding options in December 2005, prior to adopting SFAS 123R.  We applied the guidance of SAB 107 in conjunction with the adoption of SFAS 123R.  This acceleration was for all employees, including the named executive officers.  On April 24, 2010, the Companys Compensation Committee approved the repricing of fully vested outstanding incentive and non-qualified stock options to purchase an aggregate of 10,552,921 shares of common stock, $.001 par value per share (Common Stock), of the Company previously granted to officers, directors, employees and consultants of the Company (the Outstanding Options) pursuant to the Companys Amended and Restated 2003 Stock Incentive Plan. The Compensation Committee re-priced the Outstanding Options to a price equal to the mean between the closing bid and asked quotations for the Companys Common Stock on April 26, 2010, as reported on the OTC Bulletin Board, the quotation service for the Companys shares of Common Stock, namely, $0.30 per share. The Outstanding Options had been issued with exercise prices ranging from $0.43 to $5.27 per share, which prices represented the fair market value of a share of Common Stock on the date of each such grant. The Compensation Committee re-priced the Outstanding Options as compensation for the hardship of each optionee not regularly receiving his or her salary, wages, or other compensation due during the period April 6, 2006, through and including the present and ongoing, and the continued or continuing non-payment of such amounts by the Company.  The Compensation Committee determined that such action was in the best interest of the Company and its stockholders.  Stock Options Exercised under the 2003 Plan  During 2010, Company employees exercised 124,500 stock options that resulted in the issuance of 124,500 shares of common stock for cash proceeds to the Company of $37,350. Common stock was increased by $124 for the par value of the shares and paid-in capital increased by $37,226.  There were no stock options exercised during 2009.  Summary of stock option activity under the 2003 Plan for the two fiscal years ended December 31, 2010 is as follows:                                 Fiscal Year and ActivityWeighted- Average Exercise PriceNumber of OptionsOutstanding December 31, 2008$ 1.0311,131,221Fiscal 2009 activityGranted ($0.22 - $0.30)0.294,447,300Exercised - None-0Cancelled ($2.45 - $3.60)3.22(30,000)Outstanding December 31, 2009$ 0.8215,548,521Fiscal 2010 activityGranted ($0.13 - $0.28)0.191,069,560Exercised ($0.30)0.30(124,500)Cancelled ($0.43 - $0.46)0.45(98,900)Outstanding December 31, 2010 (1)$ 0.3216,394,681(1) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010.   The following table summarizes additional information about the 2003 Plan stock options outstanding at December 31, 2010:                            Issued and OutstandingExercisableType of Option and Range of Exercise PricesNumber of OptionsWeighted-Average Remaining Contractual Life (Yrs)Weighted-Average Exercise PriceNumber of OptionsWeighted-Average PriceNonqualified Stock Options   $0.30 (1) (5)1,542,0002.9$ 0.301,542,000$ 0.30Nonqualified Stock Options   $0.30 (2) (5)44,0004.10.3044,0000.30Incentive Stock Options         $0.15 - $4.05  (3)802,0424.50.85719,5920.91Incentive Stock Options         $0.15 - $0.30 (4) (5)14,006,6397.80.8410,845,8791.25Total16,394,6817.3$ 0.8213,151,471$ 1.14(1) Issued to employees below fair value and during the period of May 2003 through February 2004.(2) Issued to directors below fair value and during the period of February 2004 through September 2005.(3) Issued to consultants at fair value.(4) Issued to directors and employees at fair value, or above fair value for those individuals with greater than 10% beneficial ownership.(5) The exercise price reflects the repricing of stock options as approved by the Compensation Committee on April 24, 2010.   The 2009 Stock Compensation Plan  On June 4, 2009, the Board of Directors adopted the 2009 Stock Compensation Plan (2009 Plan) which provides for the grant or issuance of up to an aggregate of 20,000,000 shares of the Companys common stock pursuant to non-qualified stock options (NQSOs), restricted stock awards (RSAs), restricted stock rights (RSRs), or common stock awards (Common Stock Awards) (a NQSO, RSA, RSR or Common Stock Award, individually, an Award; collectively, Awards). The exercise price of NQSOs may not be less than 100% of the fair market value of the stock on the date of the option grant, and may only be exercised at such times as may be specified by the Committee and provided for in an award agreement, but may not be exercised after ten years from the date on which it was granted.  RSAs and RSRs consist of a specified number of shares of the Companys Common Stock that are, or may be, subject to restrictions on transfer, conditions of forfeiture, and any other terms and conditions for periods determined by the Committee. Generally, unless the Committee determines otherwise, once the restricted stock vests, the shares of Common Stock specified in the Award will be free of restriction, subject to any applicable lock up period. Prior to the termination of the restrictions, under a RSA (but not a RSR), a participant may vote and receive dividends on the restricted stock unless the Committee determines otherwise, but may not sell or otherwise transfer the shares. Common Stock Awards under the plan may be issued free of restriction and may vest immediately; however, the Committee may impose vesting and other restrictions related to the grant of such common stock Awards.  Compensation expense for these Awards is recognized over the period they vest, although generally Common Stock Awards vest immediately, while the RSAs, RSRs and NQSOs will have a vesting period.       The 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 fiscal year ended December 31, 2010 is as follows:                            Weighted-Average Grant or Exercise Price Per ShareFiscal Year and ActivityNumber of SharesShares reserved for issuance on June 4, 200920,000,000Fiscal 2009 activity:Stock awards$ 0.211,434,329Restricted stock awards--Restricted stock rights--Non-qualified stock options--Issued during Fiscal 20090.211,434,329Fiscal 2010 activity:Stock awards$ 0.182,636,108Restricted stock awards--Restricted stock rights--Non-qualified stock options--Issued during Fiscal 20100.192,636,108Reserved for future issuance as of December 31, 201015,929,563   Common Shares Reserved At December 31, 2010, the activity to date for shares of common stock reserved for future issuance were as follows:               2003 Amended and Restated Stock Incentive Plan:Stock options outstanding16,394,681Stock options available for grant11,812,8192009 Stock Compensation Plan:Stock options or restricted stock rights outstanding0Shares available for grant15,929,563Warrants to purchase common stock41,683,688   Consulting Stock Compensation Issued under the 2009 Plan  During December 2010, the Company issued to two consultants, 65,881 shares of common stock as compensation for services rendered. Common stock was increased by $66 for the par value of the shares and paid-in capital was increased by approximately $22,151.  Stock compensation expense of $22,217 was also recorded.  During November 2010, the Company issued to a consultant, 35,228 shares of common stock as compensation for services rendered. Common stock was increased by $35 for the par value of the shares and paid-in capital was increased by approximately $10,533.  Stock compensation expense of $10,568 was also recorded.  During October 2010, the Company issued to two consultants, 41,994 shares of common stock as compensation for services rendered. Common stock was increased by $42 for the par value of the shares and paid-in capital was increased by approximately $12,776.  Stock compensation expense of $12,818 was also recorded.       During July through September 2010, the Company issued to a consultant, 58,170 shares of common stock as compensation for services rendered. Common stock was increased by $58 for the par value of the shares and paid-in capital was increased by approximately $20,838.  Stock compensation expense of $20,896 was also recorded.  On August 1, 2010, the Company issued to a consultant 56,110 shares of common stock as compensation for services to be rendered during August 1 through October 31, 2010. Common stock was increased by $56 for the par value of the shares and paid-in capital was increased by approximately $20,705. Deferred compensation expense of $19,639 was recorded during the service period and $1,122 was applied to paid-in-capital for the remeasurement of deferred compensation during the same period.  On June 1, 2010, the Company issued to a consultant 30,670 shares of common stock as compensation for services rendered. Common stock was increased by $31 for the par value of the shares and paid-in capital was increased by approximately $10,397. Stock compensation expense of $10,428 was also recorded.  On May 17, 2010, the Company issued to a consultants 79,225 shares of common stock as compensation for services to be rendered during May 1 through July 31, 2010. Common stock was increased by $79 for the par value of the shares and paid-in capital was increased by approximately $22,421. Deferred compensation expense of $24,509 was recorded during the service period and $2,009 was applied to paid-in-capital for the remeasurement of deferred compensation during the same period.  During May 2010, the Company issued to three consultants 93,712 shares of common stock as compensation for services rendered.  Common stock was increased by $94 for the par value of the shares and paid-in capital was increased by approximately $32,416. Stock compensation expense of $32,510 was also recorded.  On April 19, 2010, the Company issued an aggregate of 40,000 shares of common stock as compensation for services rendered. The fair value of the stock was $11,200, resulting in an increase in common stock by $40 for the par value of the shares, $11,160 to paid-in capital, and $11,200 to stock-based compensation expense.  On April 1, 2010, the Company issued to a consultant 23,698 shares of common stock as compensation for services rendered.  Common stock was increased by $24 for the par value of the shares and paid-in capital was increased by approximately $3,294. Stock compensation expense of approximately $3,318 was also recorded.  On May 3, 2010, the Company issued to a consultant 79,225 shares of common stock as compensation for services to be rendered during May 1 through July 31, 2010. Common stock was increased by $79 for the par value of the shares and paid-in capital was increased by approximately $22,421. Deferred compensation expense of $24,509 was recorded during the service period and $2,009 was applied to paid-in-capital for the remeasurement of deferred compensation during the same period.  During May 2010, the Company issued to three consultants 93,712 shares of common stock as compensation for services rendered.  Common stock was increased by $94 for the par value of the shares and paid-in capital was increased by approximately $32,416. Stock compensation expense of $32,510 was also recorded.  On April 19, 2010, the Company issued an aggregate of 40,000 shares of common stock as compensation for services rendered. The fair value of the stock was $11,200, resulting in an increase in common stock by $40 for the par value of the shares, $11,160 to paid-in capital, and $11,200 to stock-based compensation expense.  On April 1, 2010, the Company issued to a consultant 23,698 shares of common stock as compensation for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $24 for the par value of the shares and paid-in capital was increased by approximately $3,294. Stock compensation expense of approximately $3,318 was also recorded.  In March 2010, the Company issued to two consultants 82,528 shares of common stock as compensation for services rendered. The shares were issued under the 2009 Stock Compensation Plan. Common stock was increased by $82 for the par value of the shares and paid-in capital was increased by approximately $8,996.  Stock compensation expense of $6,578 was also recorded.  In February 2010, the Company issued to two consultants 303,892 shares of common stock as compensation for services rendered.  Common stock was increased by $304 for the par value of the shares and paid-in capital was increased by approximately $45,280. Stock compensation expense of $44,113 was recorded during 2010.  In January 2010, the Company issued an aggregate of 1,725,000 shares of common stock to certain employees. The issuance was compensation to the employees for the continued hardship of not regularly receiving their salaries, wages, or other compensation, and the continuing nonpayment of such amounts by the Company. The issuance of the common stock was not in lieu of the payment of such      compensation, which remains accrued and unpaid. The fair value of the stock was $266,250, resulting in an increase in common stock by $1,725 for the par value of the shares, $264,525 to paid-in capital, and $266,250 to stock-based compensation expense.  During 2009, the Company issued an aggregate of 1,125,000 shares of common stock to certain employees. The issuance was compensation to the employees for the hardship of not regularly receiving their salaries, wages, or other compensation during the period of June 2008 through July 2009, and the continued or continuing nonpayment of such amounts by the Company. The issuance of the common stock was not in lieu of the payment of such compensation, which remains accrued and unpaid. The fair value of the stock was $236,250, resulting in an increase in common stock by $1,125 for the par value of the shares, $235,125 to paid-in capital, and $236,250 to stock-based compensation expense.  On November 1, 2009, the Company granted to its public relations firm 109,329 shares of common stock issued as compensation for services rendered. Common stock was increased by $109 for the par value of the shares and $44,391 to paid-in capital. The fair value of the deferred compensation is being expensed over the three-month consulting period ending January 31, 2010, of which $15,000 was expensed in 2009.  On July 17, 2009, the Company issued to a consultant 200,000 shares of common stock as compensation for services rendered. Common stock was increased by $200 for the par value of the shares and $39,800 to paid-in capital. The fair value of the deferred compensation is being expensed over the six-month consulting period ending January 31, 2010, of which $36,667 was expensed in 2009.  Additional Stockholders Equity Activity  During 2010, the Company remeasured the redemption value of outstanding common shares subject to repurchase, which were previously issued in the December 19, 2003 Difference Engine asset purchase. The Company recorded a net adjustment for the current year of $59,368 by increasing temporary equity and decreasing permanent equity.  During 2010, the Company recorded the reclassification of common shares previously subject to repurchase, which were issued in the December 19, 2003 Difference Engine asset purchase. The Company recorded a net adjustment for the current year of $2,733 by decreasing temporary equity and increasing permanent equity.  During 2010, the Company remeasured the fair value of equity instruments (outstanding common shares, options and warrants) issued pursuant to consulting agreements, which had been previously issued. During the fiscal year 2010, the Company accordingly recorded a net adjustment for the remeasurement of the equity instruments of approximately $4,100 by increasing additional paid-in capital account and decreasing the additional paid-in capital contra account deferred stock compensation.  During 2009, the Company remeasured the fair value of equity instruments (outstanding common shares, options and warrants) issued pursuant to consulting agreements, which had been previously issued. During the fiscal year 2009, the Company accordingly recorded a net adjustment for the remeasurement of the equity instruments of approximately $13,454 by decreasing additional paid-in capital account and increasing the additional paid-in capital contra account deferred stock compensation.  During 2009, the Company remeasured the redemption value of outstanding common shares subject to repurchase, which were previously issued in the December 19, 2003 Difference Engine asset purchase. The Company recorded a net adjustment for the current year of $12,090 by decreasing temporary equity and increasing permanent equity.          NOTE 7.    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 the Company 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, the Company 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 the Companys 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.  During the fiscal 2010, the temporary equity account was increased and the permanent equity account decreased by $59,368 for the change in the estimated redemption value of the outstanding shares currently held by the shareholders of Difference Engines Corporation, and reducedby $2,733 for the reclassification of common shares previously subject to repurchase. During the fiscal 2009, the temporary equity account was decreased and the permanent equity account increased by $12,090 for the change in the estimated redemption value of the outstanding shares currently held by the shareholders of Difference Engines Corporation.  Since the acquisition of the intellectual property and through December 31, 2010, 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 is a reduction of $1,309,496, and due to the sale of the Companys stock previously held by the shareholders of Difference Engines Corporation is a reduction of $635,786. Therefore, the balance of the temporary equity account for the purchase of the intellectual property owned by Difference Engines as of the consolidated balance sheet date is $98,946.          NOTE 8.    GOODWILL AND INTANGIBLE ASSETS The Company follows ASC 350, which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with ASC 350. ASC 350 also requires that intangible assets with finite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with ASC 360, "Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. 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. 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, unless information during the year becomes available that requires an earlier evaluation of impairment testing.  Based on a net realizable value analysis for the period ended June 30, 2007, goodwill and the acquired software (FlowPointTM) from the acquisition of Wise Systems Ltd. was determined to be fully impaired. Therefore, the balance of goodwill at December 31, 2010 and 2009 was $0, respectively.  The Company acquired intangible assets consist of acquired software technology and patents. Under ASC 350 goodwill and other intangible assets acquired including software technology is considered to have a finite life. Management has estimated the useful life to be 5 years and amortized such costs on a straight-line basis over this period.  Patent acquisition costs pertaining to PinPointTM and Signature MappingTM (products not acquired through acquisition) have been capitalized, and are being amortized on a straight-line basis over the expected 20-year legal life of the patents. The Company evaluates the periods of amortization continually to determine whether later events or circumstances require revised estimates of useful lives. In addition, ASC 985-20, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, requires the Company to consider whether or not the software technology is impaired on a quarterly basis, using a net realizable value analysis based on projected discounted cash flows. The Company prepared this analysis as of December 31, 2010 and concluded that the intangible assets are not impaired.    Year Ended December 31, 2010Beginning Period CostAdditionsReductionsNet Book ValueIntangibles with finite lives:Software technology$ -$ -$ -$ -Patent acquisition costs352,57834,77622,181365,173$ 352,578$ 34,776$ 22,181$ 365,173   The Companys intangible software technology was fully amortized as of December 31, 2009. Therefore, there was no amortization costs associated with software technology during fiscal 2010.  We anticipate incurring additional patent acquisition costs during the year ending December 31, 2011 (Fiscal 2011). Based on the net book value of patents acquisition costs at December 31, 2010, the Company estimates amortization expense for intangible assets to be $24,072 for each of the Fiscal years 2011 through 2015, and $244,813 thereafter.  On July 27, 2004, the Company completed the acquisition of Wise Systems Ltd.  This transaction has been accounted for as a business combination.  The purchase price for these assets and liabilities assumed has been allocated to acquired intangible assets (FlowPointTM software) and goodwill. As explained more fully below, in conjunction with its net realizable value analysis required by ASC 985-20 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed” during June 2007, the Company      determined that its entire investment in the Wise Systems FlowPointTM software was impaired.  This was based on the Company’s determination that the carrying amount of these assets, as reflected on the Company’s consolidated balance sheet, exceeded its projected net realizable value; accordingly, the Company wrote-off the remaining unamortized acquired intangible assets (FlowPointTM software) and goodwill totaling $1,125,122.          NOTE 9.    INCOME TAXES There is no benefit or provision for income taxes reflected in the accompanying financial statements.  Reconciliation between the provision for income taxes computed by applying the statutory Federal income tax rate and the provision for income taxes is as follows:                  YEAR ENDED DECEMBER 3120102009Federal benefit at statutory rate$ (1,241,079)-34.0%$ (2,901,395)-34.0%Increase (decrease) due to:State benefits, net of federal benefits(146,009)-4.0%(341,341)-4.0%Stock based compensation242,0676.6%461,3635.4%Effect of foreign operations(495,947)-13.6%13,5730.2%Other, net8610.0%8140.0%Valuation allowance1,640,10744.9%2,766,98632.4%Provision for income taxes$ -0.0%$ -0.0%   Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  Significant components of the Companys net deferred tax assets as of December 31, 2010 and 2009 were as follows:         YEAR ENDED DECEMBER 3120102009Deferred tax assets:Accrued salaries$ 476,990$ 585,280Accrued leave13,52737,762Depreciation and amortization(57,371)(57,317)Net operating loss carryforwards, not yet utilized15,460,35314,404,119Total deferred tax assets15,893,49914,969,844Valuation allowance for deferred tax assets(15,893,499)(14,969,844)Net deferred tax assets$ -$ -   For income tax purposes, the Company has a cumulative net operating loss carryforwards at December 31, 2010 of approximately $43,859,200 that, subject to applicable limitations, may be applied against future taxable income.  If not utilized, the net US operating loss carryforward will begin to expire in 2023.         NOTE 10.  COMMITMENTS AND CONTINGENCIES Contractual Obligations The following table summarizes scheduled maturities of our contractual obligations extending beyond one year for which cash flows are fixed and determinable as of December 31, 2010.         CategoryPayments Due in FiscalTotal20112012201320142015ThereafterShort-term convertible debentures (1)$ 1,688,205$ 1,688,205$ -$ -$ -$ -$ -Interest payments (2)-------Operating lease commitments (3)22,33822,388-----Unconditional purchase obligations (4)-------Total contractual obligations$ 1,710,543$ 1,710,593$ -$ -$ -$ -$ -(1) Represents the outstanding Series A Convertible Debentures that originally matured November 8, 2008, and were amended October 15, 2010. Under terms of the amendment, the Company and the debenture holders agreed to an extension of the maturity date to June 30, 2011.  Commencing March 3, 2011, the Company may force a conversion of the debentures if certain trading price and volume conditions are met.(2) The outstanding Series A convertible debentures, under the October 15, 2010 amendment, will not bear interest through the new maturity date of June 30, 2011.(3) Represents projected rent cost for the existing office lease, which expires on April 30, 2011.  Total rental expense included in the accompanying consolidated statements of earnings was $158,318 in fiscal 2010, and $307,361 in fiscal 2009.(4) The company currently does not have any outstanding unconditional purchase obligations.  They would though include inventory commitments, future royalty, consulting agreements, other than month-to-month arrangements or those that expire in less then one year, or commitments pursuant to executive compensation arrangements.   In addition to the above obligations, we are conditionally obligated to redeem shares related to the acquisition of intellectual property (IP) from Difference Engines.  As of December 31, 2010, and as more fully disclosed in Note 7, Acquisitions, a conditional redemption value of $98,946 was estimated and recorded.   Default under Series A Debentures and Series D Common Stock Purchase Warrants  Our outstanding Series A 10% Senior Convertible Debentures became due on November 7, 2008 and the Company was considered in default, although, the holders had not sought to enforce their rights under the default provisions of the debentures.  On October 15, 2010, the Company entered into an agreement with the two remaining Series A Debenture holders to amend and effect a restructuring of the debentures. Under the agreement, the Company and two debenture holders agreed: (i) to an extension of the maturity date of the debentures to June 30, 2011, (ii) that the $1,688,205 of outstanding principal amount of will not bear interest through the new maturity date, (iii) that, in exchange for the amounts of accrued but unpaid regular interest of approximately $638,163, and waived all additional interest and late fees, liquidated damages and certain other amounts due under the debentures (Interest and Default Amounts) the Company issued an aggregate of 2,552,653 shares of common stock, (iv) that all claims with regard to the payment of the Interest and Default Amounts and all prior events of default under the Debentures and breaches of any covenant, agreement, term or condition (Defaults) in the debenture transaction documents would be waived and the Company was released from any claims with respect to the Additional Interest and Late Fees of approximately $773,314, and Default Amounts of approximately $2,541,739, and prior Defaults Events, (v) to terminate the registration rights agreements between the Company and each debenture holder, and (vi) that the Company may force a conversion of the debentures under certain conditions. The Company and the debenture holders also agreed to certain other amendments to the debentures and transaction documents covering the issuance of the debentures.  During 2010, the debenture holders converted an aggregate of $427,500 in principal amount into an aggregate of 1,710,000 shares of our common stock.         NOTE 11.  EMPLOYMENT AGREEMENTS WITH EXECUTIVE OFFICERS The employment agreements for each named executive officer are multiple years in duration. Each of the named executive officers employment agreement provides for an annual base salary and a discretionary annual incentive cash bonus and/or equity awards.  In subsequent years, the amount of annual incentive cash and/or equity award bonus is subject to determination by our Board of Directors without limitation on the amount of the award. Each of the agreements provides for a severance payment over a prescribed term in the event the named executive is terminated without cause, including for Mr. Donovan and Mr. Hare, if their duties are materially changed in connection with a change in control. Each agreement also provides that no severance payment is due in the event of termination for cause, which includes termination for willful misconduct, conviction of a felony, dishonesty or fraud. Each agreement further contains an agreement by the named executive officer not to compete with us for a defined term equal in length to the applicable severance payment in the respective employment agreement, which the Company feels is reasonable and consistent with industry guidelines.    Michael W. Trudnak.  Mr. Trudnak serves as Chairman of the Board, Secretary, and Chief Executive Officer and a Class III director.  The Company entered into an employment agreement with Mr. Trudnak, which commenced on January 1, 2003.  The Company amended his agreement effective December 10, 2004. The amended agreement is for a three year term commencing June 26, 2003, and is renewable for one year terms.  The employment agreement provides for annual compensation to Mr. Trudnak of $275,000 and a monthly automobile allowance of $500.  Mr. Trudnaks original employment agreement provided for the grant of an aggregate of 400,000 shares of our      restricted stock. However, effective June 21 2004, Mr. Trudnak agreed to accept in lieu of the issuance of such shares, ten year nonqualified options to purchase an aggregate of 400,000 shares of common stock at an exercise price of $.36 per share. The employment agreement also provides for incentive compensation and/or bonuses as determined by the Company, participation in the Companys stock option plan, and participation in any company employee benefit policies or plans.  The employment agreement may be terminated upon the death or disability of the employee or for cause, in which event the Companys obligation to pay compensation shall terminate immediately.  In the event the agreement is terminated by us other than by reason of the death or disability of the employee or for cause, the employee is entitled to payment of his base salary for one year following termination.  The employee may terminate the agreement on 30 days prior notice to the Company. The employee has entered into an employee proprietary information, invention assignment and non-competition agreement, pursuant to which the employee agrees not to disclose confidential information regarding the Company, agrees that inventions conceived during his employment become the property of the Company, agrees not to compete with the business of the Company for a period of one year following termination of employment, and agrees not to  solicit employees or customers of the Company following termination of employment.  William J. Donovan.  Mr. Donovan serves as President and Chief Operating Officer of the Company, and previously served as Chief Financial Officer.  The Company entered into a new employment agreement with Mr. Donovan on November 18, 2005, which superseded his previous employment agreement with the Company, dated effective August 18, 2003. The new employment agreement is for a term of three years unless earlier terminated, and is automatically renewable for one year terms. The employment agreement provides for an annual salary of $265,000. The agreement provides for annual performance bonuses based on goals established by the Company and agreed to by Mr. Donovan, a monthly automobile allowance of $500, participation in our stock option and other award plans (which options or awards shall immediately vest upon a change in control), and participation in any benefit policies or plans adopted by us on the same basis as other employees at Mr. Donovans level.  The employment agreement may be terminated by Mr. Donovan on 30 days prior written notice. The employment agreement may be terminated by us by reason of death, disability or for cause.  In the event the agreement is terminated for death or disability of the employee, our obligation to pay compensation to the employee shall terminate immediately; provided that if the Company does not maintain disability insurance for the employee, he is entitled to be paid his base salary for one year following his disability.  In the event the he is terminated other than by reason of his death, disability, for cause, or change in control, Mr. Donovan is entitled to payment of his base salary for one year following termination. Further if Mr. Donovan terminates his employment for the following material reasons (each a material reason): written demand by us to change the principal workplace of the employee to a location outside of a 50-mile radius from the current principal address of the Company; a material reduction in the number or seniority of personnel reporting to employee or a material reduction in the frequency or in nature of matters with respect to which such personnel are to report to employee, other than as part of a company-wide reduction in staff; an adverse change in employees title; a material decrease in employees responsibilities; or a material demotion, Mr. Donovan is entitled to be paid the greater of the base salary remaining under the employment agreement or twelve months base salary.  In the event of a change in control of the Company and, within 12 months of such change of control, employees employment is terminated or one of the events in the immediately preceding sentence occurs, Mr. Donovan is entitled to be paid his base salary for 18 months following such termination or event.  A change in control would include the occurrence of one of the following events:  · the approval of the stockholders for a complete liquidation or dissolution of the Company;  · the acquisition of 20% or more of the outstanding common stock of the Company or of voting power by any person, except for purchases directly from the Company, any acquisition by the Company, any acquisition by a the Company employee benefit plan, or a permitted business combination;  · if two-thirds of the incumbent board members as of the date of the agreement cease to be board members, unless the nomination of any such additional board member was approved by three-quarters of the incumbent board members;  · upon the consummation of a reorganization, merger, consolidation, or sale or other disposition of all or substantially all of the assets of the Company, except if (i) all of the beneficial owners of the Companys outstanding common stock or voting securities who were beneficial owners before such transaction own more than 50% of the outstanding common stock or voting power entitled to vote in the election of directors resulting from such transaction in substantially the same proportions, (ii) no person owns more than 20% of the outstanding common stock of the Company or the combined voting power of voting securities except to the extent it existed before such transaction, and (iii) at least a majority of the members of the board before such transaction were members of the board at the time the employment agreement was executed or the action providing for the transaction.       Also, Mr. Donovan has entered into a proprietary information, invention assignment and non-competition agreement (non-competition agreement), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to solicit our employees or customers following termination of his employment. The employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.  Gregory E. Hare.  Mr. Hare serves as our Chief Financial Officer and Treasurer. The Company entered into an employment agreement with Mr. Hare commencing on January 30, 2006. The employment agreement is essentially the same as the agreement the Company entered into with Mr. Donovan, except that the agreement is for a term of two years unless earlier terminated and shall automatically renew for successive one year terms unless terminated prior thereto. The employment agreement provides for a base salary of $200,000 per annum and no automobile allowances. The agreement provides for annual performance bonuses based on goals established by the Company and agreed to by Mr. Hare, participation in the Companys stock option and other award plans, and participation in any company benefit policies or plans adopted by us on the same basis as other employees at Mr. Hares level. The Company agreed to grant to Mr. Hare, subject to approval of our Compensation Committee, stock options to purchase 200,000 shares of our common stock pursuant to our 2003 Stock Incentive Plan, one-half of which options will vest on the one year anniversary of the commencement of his employment and the remaining options vesting on the two year anniversary of the commencement of his employment.  Also, Mr. Hare has entered into a proprietary information, invention assignment and non-competition agreement (non-competition agreement), pursuant to which he has agreed not to disclose confidential information regarding us, agrees that inventions conceived during his employment become our property, agrees not to compete with our business for a period of one year following termination or expiration of his employment, and agrees not to  solicit our employees or customers following termination of his employment. The employment agreement provides for arbitration in the event of any dispute arising out of the agreement or his employment, other than disputes arising under the non-competition agreement.  Richard F. Borrelli. Mr. Borrellis employment as Vice President and Officer for the Company is at-will, and thus has not entered into employment agreements.  Therefore, there is no employment, severance or change of control arrangements.          NOTE 12.  RELATED PARTY TRANSACTIONS Note Payable to Stockholder and Executive Officer On April 21, 2006, the Company entered into a Loan Agreement with Mr. Michael W. Trudnak, the Chairman and Chief Executive Officer pursuant to which Mr. Trudnak loaned the Company $200,000. The Company issued a non-negotiable promissory note, dated effective April 21, 2006, to Mr. Trudnak in the principal amount of $200,000. The note is unsecured, non-negotiable and non-interest bearing. The note is repayable on the earlier of (i) six months after the date of issuance, (ii) the date the Company receives aggregate proceeds from the sale of its securities after the date of the issuance of the Note in an amount exceeding $2,000,000, or (iii) the occurrence of an event of default. The following constitute an event of default under the note: (a) the failure to pay when due any principal or interest or other liability under the loan agreement or under the note; (b) the material violation by us of any representation, warranty, covenant or agreement contained in the loan agreement, the note or any other loan document or any other document or agreement to which the Company is a party to or by which the Company or any of our properties, assets or outstanding securities are bound; (c) any event or circumstance shall occur that, in the reasonable opinion of the lender, has had or could reasonably be expected to have a material adverse effect; (d) an assignment for the benefit of our creditors; (e) the application for the appointment of a receiver or liquidator for us or our property; (f) the issuance of an attachment or the entry of a judgment against us in excess of $100,000; (g) a default with respect to any other obligation due to the lender; or (h) any voluntary or involuntary petition in bankruptcy or any petition for relief under the federal bankruptcy code or any other state or federal law for the relief of debtors by or with respect to us, provided however with respect to an involuntary petition in bankruptcy, such petition has not been dismissed within 30 days of the date of such petition.  In the event of the occurrence of an event of default, the loan agreement and note shall be in default immediately and without notice, and the unpaid principal amount of the loan shall, at the option of the lender, become immediately due and payable in full.  The Company agreed to pay the reasonable costs of collection and enforcement, including reasonable attorneys fees and interest from the date of default at the rate of 18% per annum. The note is not assignable by Mr. Trudnak without our prior consent. The Company may prepay the note in whole or in part upon ten days notice. On October 21, 2006, Mr. Trudnak extended the due date of the loan to December 31, 2006. Subsequently, on October 3 and October 18, 2006, Mr. Trudnak loaned the Company $102,000 and $100,000, respectively, on substantially the same terms as the April 21, 2006 loan, except that each loan is due six months after the date thereof. Accordingly, following such additional loans, the Company owed an aggregate of approximately $402,000 to Mr. Trudnak. On November 10, 2006, Mr. Trudnak extended the due dates of such loans to May 31, 2007, except that $100,000 of the April 21, 2006, loan becomes due upon the Company raising $2,500,000 in financing after November 6, 2006, and the remaining amount of $202,000 of such loans become due upon the Company raising an aggregate of $5,000,000 in financing after November 6, 2006, and prior to May 31, 2007. Following the first closing of our Debenture and Series D Warrant financing on November 8, 2006, the Company repaid $100,000 on November 20,      2006, in principal amount of the April 1, 2006, and paid an additional $100,000 to Mr. Trudnak on April 17, 2007 upon the second closing of our Debenture and Series D Warrant financing. On May 31, 2007, Mr. Trudnak extended the due dates of the remaining loans to May 31, 2008. Although, the anticipated payment of $202,000 had not been made, and Mr. Trudnak made an additional $24,000 loan to the company on June 25, 2008, for total outstanding notes of $226,000.  Subsequently, the maturity date of the outstanding loans was extended to May 31, 2009, and subsequently to May 31, 2010.  On June 1, 2010, the outstanding loans were extended to June 30, 2011.  During 2010, the Company repaid an aggregate of $108,900 of the notes, resulting in an outstanding balance at December 31, 2010, of $117,100. The terms of the above transaction were reviewed and approved by the Companys audit committee and by our Board of Directors.  Consulting Agreement with BND Software, Principal Owner Sean Kennedy, a Director of the Company  On July 15, 2008, The Company entered into a consulting agreement with BND Software, Inc. (BND), a corporation that is owned and controlled by Mr. Sean W. Kennedy, a director of the Company. BND agreed to provide certain consulting services to the Applied Visual including managing the research, development and information systems activities of the Company. The agreement is for a term of one year commencing on May 27, 2008, and expires on May 31, 2009. The agreement provided for an extension of a twelve (12) month period upon mutual agreement by both parties. The agreement may be terminated upon 60 days prior written notice by one party to the other party. The agreement also provided for an annual compensation of $216,000. The Company did not renew the agreement with BND, although Mr. Kennedy continues to provide management services for the research, development and information systems activities.  We paid or agreed to pay BND an aggregate of $208,000 during 2010, and $216,000 during 2009, of which $325,796 is accrued and unpaid as of December 31, 2010.         NOTE 13.  OPERATING LEASES The Company previously leased 15,253 square feet for its headquarters building in Herndon, Virginia, pursuant to a 5 year commercial lease that expired on April 30, 2010.  The annual base rental rate during the last year of the lease was approximately $24,557.  The Company elected not to exercise the renewal option provision of the lease, and negotiated with the landlord to lease 3,269 square feet of office space in the same business park.  The new lease, for a monthly lease payment of $5,585, was entered into on April 13, 2010 and expires on April 30, 2011. The lease term included a security deposit of $22,244, of which one-half of the security deposit was returned after the first six months of the lease, resulting in a net security deposit at December 31, 2010 of $11,122. Although the lease does not contain a renewal provision, the Company is negotiating to extend the lease with provisions to expand as needed during the next 12 months.  Total rental expense for the leased offices included in the accompanying consolidated statements of operations was $156,823 in 2010 and $307,361 in 2009.      NOTE 14.  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 March 15, 2011, the United States Patent & Trademark Office (USPTO) issued to the Company Patent No. US 7,907,762, titled Method of Creating a Divergence Transform for Identifying a Feature of Interest in Hyperspectral Data which is related to our underlying intelligent imaging informatics (3iTM) technology for our core products.  This fifth patent issued to the Company addresses the identification of features of interest in hyperspectral imaging.  Hyperspectral imaging collects data from across the entire electromagnetic spectrum including visible light, as well as the range from ultraviolet to infrared.  Hyperspectral remote sensing is used in a wide array of real-life applications.  Although originally developed for mining and geology, it has now spread into fields as widespread as ecology and surveillance. Our ability to analyze and differentiate objects across the entire spectrum of light expands our technical capabilities to new levels of opportunity beyond homeland security and healthcare, into areas as diverse as satellite image analysis, military applications for aerial surveillance, and sub-surface analysis of mineral deposits.  From January 19 - February 24, 2011, an employee exercised 101,000 stock options that resulted in the issuance of 101,000 shares of common stock for cash proceeds to the Company of $30,300, and converted $11,340 of accrued and unpaid wages for 42,000 shares of common stock.  On February 23, 2011, the Company executed a Securities Purchase Agreement, (the SPA), with an institutional accredited investor for an investment up to $1,000,000, subject to certain stock price and volume conditions.  Subsequently, on February 24, 2011, we sold to the institutional investor at the first closing of the private placement of securities, an aggregate of 600,000 shares of common stock, and 600,000 common stock purchase warrants to purchase an aggregate of 600,000 shares of common stock, for gross proceeds of $150,000 ($136,000 net of certain expenses and sales commissions in the amount of $14,000). The warrants are exercisable at a price of $0.25 per      share for a period of five years after the date of issuance, contain a cashless exercise provision and other customary provisions. Also, we issued to a broker an aggregate of 72,000 placement agents warrants as compensation in connection with the offering.  The placement agents warrants are under the same terms and conditions as those issued to the institutional investor.  In addition, under the SPA, the investor has agreed to provide additional financing to us by purchasing shares of our common stock at seven subsequent closings and in the following amounts; i) at a second closing to be held one month following the first closing, an amount of shares equal to forty percent (40%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a third closing to be held one month following the second closing, an amount of shares equal to thirty percent (30%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, ii) at a fourth closing to be held one month following the third closing, an amount of shares equal to twenty percent (20%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding such closing, and iv) at each of four additional subsequent closings to be held one month following the immediately preceding closing, an amount of shares equal to ten percent (10%) of the total number of shares traded during normal hours during the twenty (20) trading days immediately preceding the subsequent closing. The investor agreed to purchase our shares at each subsequent closing for a price per share equal to the lower of an amount equal to: (a) 60% of the volume weighted average of actual trading prices of the shares for the ten (10) consecutive trading days immediately prior to a date of the applicable closing and (b) 64% of the volume weighted average of actual trading prices of the shares for the trading day immediately prior to the applicable closing date.  If, under this calculation, the price of a share at a subsequent closing does not exceed a floor price of $0.25, the investor will not be obligated to purchase our shares at that closing.  The failure to hold a closing will not impact the holding of the subsequent closings. Also, the investor will not be obligated to purchase shares at a closing if such purchase would cause them to beneficially own in excess of 9.99% of our shares.  We have granted to the investor piggy back registration right with regard to the shares issued in the financing, including the shares underlying the Warrants. The SPA contains representations and warranties of the Company and investor, certain indemnification provisions and customary conditions to each closing.  We may terminate the SPA on ten days prior written notice to the investor, and the investor may terminate the SPA at any time prior to a subsequent financing upon written notice to us if we consummate a reverse stock split or a subsequent financing to which the investor is not a party.  We have agreed to pay the investors counsel with regard to the first closing in the amount of $25,000, $5,000 of which was paid at the first closing and $5,000 will be paid at each of the first four subsequent closings.  We have also agreed to pay additional fees for their counsel for each subsequent closing in the amount of $2,500.  A broker has acted as placement agent for the offering.  Under the terms of a Non-Circumvention and Compensation Agreement, dated January 12, 2011, between the Company and the broker, in connection with the offering, we agreed to pay or issue the broker at a closing a placement fee equal to 6% of the proceeds received by us at the closing and placement agents warrants equal to 6% of the shares sold at the closing (including the shares underlying the Warrants).  From February 1 - 23, 2011, the Company sold an aggregate of 800,000 shares of Common Stock and an aggregate of 800,000 Class Q Common Stock Purchase Warrants to three accredited investors for gross proceeds to the Company of approximately $200,000 ($197,000, net of commissions and expenses in the amount of $3,000).  In connection with the sale of securities, a placement agent fee of $3,000 was paid. The Warrants issued are exercisable at a price of $0.25 per share; contain a conditional call provision if the market price of each share exceeds $3.00, and customary anti-dilution provisions. The warrants expire in thirty-six (36) months from the date of issuance.  During January through March 2011, the Company issued 65,509 stock awards under the 2009 Stock Compensation Plan to two consultants as compensation in lieu of cash payments for services rendered. The aggregate fair value of the compensation of $19,722 is being expensed over the related consulting period.  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.  On January 4, 2011, the Company issued to a consultant 175,000 shares of common stock. The fair value of the compensation of approximately $66,500 is being expensed over the period the services were rendered.