Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

** **

| **x**                                                                                                                                                                                                                     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                      | ** **                                                                                                        |
| **For  the quarterly period ended March 31, 2010**                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                |
| **OR**                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                | ** **                                                                                                        |
| **o**                                                                                                                                                                                                                     | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                | ** **                                                                                                        |
| **For  the transition period from               to               ** |

 

**CommissionFile Number 333-143236**

 

**TECHNISCAN, INC.**

(Exact name of registrant asspecified in its charter)

 

| **DELAWARE**  (State or other jurisdiction of  incorporation or organization) | ** ** | **27-1093363**  (I.R.S. Employer Identification  Number) |
|-------------------------------------------------------------------------------|------------|----------------------------------------------------------|

 

**3216 South Highland Drive, Suite 200,**

**Salt Lake City, UT 84106**

(Address of principalexecutive offices) (Zip Code)

 

**(801) 521-0444**

Registrant’s telephonenumber, including area code

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. x Yes  o No

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act:

 

| o Large accelerated  filer                                           |   | o Accelerated filer          |
|---------------------------------------------------------------------------|--------|-----------------------------------|
|                                                                      |   |                              |
| o Non-accelerated filer  (Do not check if a small reporting company) |   | x Smaller  reporting company |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  x No

 

The number of sharesoutstanding of the registrant’s common stock, par value $0.001 per share as of April 30,2010 was 82,897,454.

 

 

 

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**Table of Contents**

** **
| PART I  — FINANCIAL INFORMATION | 1                                                                                               |
|-------------------------------------------|-------------------------------------------------------------------------------------------------|
| **ITEM 1.**                               | **FINANCIAL  STATEMENTS**                                                                       | 1 |
| **ITEM 2.**                               | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 11 |
| **ITEM 3.**                               | **QUANTITATIVE  AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**                                  | 16 |
| **ITEM 4T.**                              | **CONTROLS AND  PROCEDURES**                                                                    | 16 |
|                                      |                                                                                            |
| PART II  — OTHER INFORMATION    | 18                                                                                              |
| **ITEM  1.**                              | **LEGAL  PROCEEDINGS**                                                                          | 18 |
| **ITEM  1A.**                             | **RISK  FACTORS**                                                                               | 18 |
| **ITEM 5.**                               | **EXHIBITS**                                                                                    | 18 |

 

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Table of Contents

 

# **PART I — FINANCIALINFORMATION**

# ** **

## **ITEM 1.**      FINANCIALSTATEMENTS

## ** **

**TECHNISCAN, INC.**

**(A Development Stage Company)**

**CONDENSED BALANCE SHEETS**

**(unaudited)**

** **
| ** **                                                                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **2010**           | ** ** | **2009**              | ** ** |
|                                                                                          |       |               |       |                  |       |
| **ASSETS**                                                                                    |       |               |       |                  |       |
| Current  assets:                                                                              |       |               |       |                  |       |
| Cash  and cash equivalents                                                                    |       | $                  | 746,017    |                  | $          | 232,706 |   |
| Debt  issuance costs                                                                          |       | 180,627            |       | —                |       |
| Prepaid  expense                                                                              |       | 161,559            |       | 271,209               |       |
| Total  current assets                                                                         |       | 1,088,203          |       | 503,915               |       |
|                                                                                          |       |               |       |                  |       |
| Property  and equipment, net                                                                  |       | 674,413            |       | 617,142               |       |
|                                                                                          |       |               |       |                  |       |
| Deposits                                                                                      |       | 28,153             |       | 28,153                |       |
|                                                                                          |       |               |       |                  |       |
| Total  assets                                                                                 |       | $                  | 1,790,769  |                  | $          | 1,149,210 |   |
|                                                                                          |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  DEFICIT**                                               |       |               |       |                  |       |
| Current  liabilities:                                                                         |       |               |       |                  |       |
| Accounts  payable                                                                             |       | $                  | 736,484    |                  | $          | 472,367 |   |
| Accrued  liabilities                                                                          |       | 365,848            |       | 670,638               |       |
| Convertible  notes payable, net of discount of $1,850,000                                     |       | —             |       | —                |       |
| Embedded  derivative liability                                                                |       | 978,542            |       | —                |       |
| Common  stock warrant liability                                                               |       | 1,270,148          |       | —                |       |
| Customer  deposits                                                                            |       | 260,000            |       | 260,000               |       |
| Total  current liabilities                                                                    |       | 3,611,022          |       | 1,403,005             |       |
|                                                                                          |       |               |       |                  |       |
| Deferred  rent                                                                                |       | 141,517            |       | 139,330               |       |
| Other  liabilities                                                                            |       | 250,000            |       | 250,000               |       |
|                                                                                          |       |               |       |                  |       |
| Total  liabilities                                                                            |       | 4,002,539          |       | 1,792,335             |       |
|                                                                                          |       |               |       |                  |       |
| Commitments                                                                                   |       |               |       |                  |       |
|                                                                                          |       |               |       |                  |       |
| Stockholders’  deficit:                                                                  |       |               |       |                  |       |
| Common  stock, $.001 par value: 150,000,000 shares authorized; 82,897,454 shares  outstanding |       | 82,897             |       | 82,897                |       |
| Additional  paid-in-capital                                                                   |       | 24,656,983         |       | 24,461,846            |       |
| Accumulated  deficit prior to development stage                                               |       | (389,393           | )          | (389,393              | )          |
| Accumulated  deficit during development stage                                                 |       | (26,562,257        | )          | (24,798,475           | )          |
| Total  stockholders’ deficit                                                             |       | (2,211,770         | )          | (643,125              | )          |
|                                                                                          |       |               |       |                  |       |
| Total  liabilities and stockholders’ deficit                                             |       | $                  | 1,790,769  |                  | $          | 1,149,210 |   |

 

Seeaccompanying notes to the condensed financial statements.

 

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**TECHNISCAN, INC.**

**(A Development Stage Company)**

**CONDENSED STATEMENTS OF OPERATIONS**

**(unaudited)**

** **
| ** **                                                                | ** ** | **For the Three Months Ended March 31,** | ** ** | **For the Period From  January 1, 2002  (inception of  development stage)  Through March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2010**                                      | ** ** | **2009**                                                                                                 | ** ** | **2010** | ** ** |
| Revenues:                                                                 |       |                                          |       |                                                                                                     |       |   |   |
| Government  grant                                                         |       | $                                             | 88,510     |                                                                                                     | $          | 355,360 |   | $ | 3,133,974 |   |
| Related-party  research                                                   |       | —                                        |       | —                                                                                                   |       | 240,000 |   |
| Total  revenues                                                           |       | 88,510                                        |       | 355,360                                                                                                  |       | 3,373,974 |   |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Operating  expenses:                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Selling,  general and administrative                                      |       | 872,305                                       |       | 289,700                                                                                                  |       | 13,835,890 |   |
| Research  and development                                                 |       | 451,113                                       |       | 325,696                                                                                                  |       | 13,298,870 |   |
| Direct  grant                                                             |       | 111,165                                       |       | 215,829                                                                                                  |       | 1,986,321 |   |
| Total  operating expenses                                                 |       | 1,434,583                                     |       | 831,225                                                                                                  |       | 29,121,081 |   |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Loss  from operations                                                     |       | (1,346,073                                    | )          | (475,865                                                                                                 | )          | (25,747,107 | ) |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Interest  income                                                          |       | 102                                           |       | 1,021                                                                                                    |       | 55,915 |   |
| Interest  expense                                                         |       | (19,121                                       | )          | (109                                                                                                     | )          | (474,836 | ) |
| Loss  on derivatives                                                      |       | (398,690                                      | )          | —                                                                                                   |       | (398,690 | ) |
| Gain  on sale of property and equipment                                   |       | —                                        |       | —                                                                                                   |       | 2,461 |   |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Net  loss                                                                 |       | $                                             | (1,763,782 | )                                                                                                        | $          | (474,953 | ) | $ | (26,562,257 | ) |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Net  loss per common share - basic and diluted                            |       | $                                             | (0.02      | )                                                                                                        | $          | (0.01 | ) |   |   |
|                                                                      |       |                                          |       |                                                                                                     |       |   |   |
| Weighted  average number of common shares outstanding - basic and diluted |       | 82,897,454                                    |       | 34,841,664                                                                                               |       |   |   |

 

Seeaccompanying notes to the condensed financial statements.

 

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**TECHNISCAN, INC.**

**(A Development Stage Company)**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(unaudited)**

 
| ** **                                                                                                    | ** ** | **For the Three Months Ended** | ** **    | **For the Period  From January  1, 2002  (inception of  development  stage) Through** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------|---------------|--------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **March 31,  2010**       | ** **    | **March 31,  2009**                                                                   | ** ** | **March 31,  2010** | ** ** |
| CASH  FLOWS FROM OPERATING ACTIVITIES                                                                         |       |                           |          |                                                                                       |       |   |   |
| Net  loss                                                                                                     |       | $                              | (1,763,782    | )                                                                                          | $          | (474,953 | ) | $ | (26,562,257 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                                  |       |                           |          |                                                                                       |       |   |   |
| Depreciation  and amortization                                                                                |       | 46,943                         |          | 10,208                                                                                     |       | 548,890 |   |
| Impairment  of intangible assets                                                                              |       | —                         |          | —                                                                                     |       | 14,179 |   |
| Gain  on sale of property and equipment                                                                       |       | —                         |          | —                                                                                     |       | (2,461 | ) |
| Non-cash  interest expense                                                                                    |       | —                         |          | —                                                                                     |       | 383,610 |   |
| Issuance  of common stock for services                                                                        |       | —                         |          | —                                                                                     |       | 375,000 |   |
| Stock-based  compensation                                                                                     |       | 195,137                        |          | 5,698                                                                                      |       | 1,321,238 |   |
| Loss  on derivatives                                                                                          |       | 398,690                        |          | —                                                                                     |       | 398,690 |   |
| Changes  in assets and liabilities:                                                                           |       |                           |          |                                                                                       |       |   |   |
| Accounts  receivable                                                                                          |       | —                         |          | —                                                                                     |       | 267 |   |
| Inventory                                                                                                     |       | —                         |          | —                                                                                     |       | 61,649 |   |
| Prepaid  expense                                                                                              |       | 109,650                        |          | 6,230                                                                                      |       | 1,035,287 |   |
| Accounts  payable                                                                                             |       | 264,117                        |          | 3,524                                                                                      |       | 727,564 |   |
| Accrued  liabilities                                                                                          |       | (304,790                       | )             | (30,483                                                                                    | )          | 26,030 |   |
| Customer  deposits                                                                                            |       | —                         |          | —                                                                                     |       | 260,000 |   |
| Deferred  rent                                                                                                |       | 2,187                          |          | 18,206                                                                                     |       | 141,517 |   |
| Other  liabilities                                                                                            |       | —                         |          | —                                                                                     |       | 250,000 |   |
| Net  cash used in operating activities                                                                        |       | (1,051,848                     | )             | (461,570                                                                                   | )          | (21,020,797 | ) |
|                                                                                                          |       |                           |          |                                                                                       |       |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES                                                                         |       |                           |          |                                                                                       |       |   |   |
| Proceeds  from sale of property and equipment                                                                 |       | —                         |          | —                                                                                     |       | 4,000 |   |
| Purchase  of property and equipment                                                                           |       | (104,214                       | )             | —                                                                                     |       | (1,121,028 | ) |
| Net  cash used in investing activities                                                                        |       | (104,214                       | )             | —                                                                                     |       | (1,117,028 | ) |
|                                                                                                          |       |                           |          |                                                                                       |       |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES                                                                         |       |                           |          |                                                                                       |       |   |   |
| Principal  payments on debt                                                                                   |       | —                         |          | —                                                                                     |       | (79,292 | ) |
| Proceeds  from exercise of stock options and warrants, and from the issuance of stock,  net of issuance costs |       | —                         |          | 441,873                                                                                    |       | 18,748,587 |   |
| Payment  of debt issuance costs                                                                               |       | (180,627                       | )             | —                                                                                     |       | (180,627 | ) |
| Proceeds  from issuance of convertible notes payable                                                          |       | 1,850,000                      |          | —                                                                                     |       | 4,250,000 |   |
| Net  cash provided by financing activities                                                                    |       | 1,669,373                      |          | 441,873                                                                                    |       | 22,738,668 |   |
|                                                                                                          |       |                           |          |                                                                                       |       |   |   |
| Net  increase (decrease) in cash and cash equivalents                                                         |       | 513,311                        |          | (19,697                                                                                    | )          | 600,843 |   |
|                                                                                                          |       |                           |          |                                                                                       |       |   |   |
| Cash  and cash equivalents at beginning of period                                                             |       | 232,706                        |          | 269,192                                                                                    |       | 145,174 |   |
|                                                                                                          |       |                           |          |                                                                                       |       |   |   |
| Cash  and cash equivalents at end of period                                                                   |       | $                              |  746,017 |                                                                                       | $          | 249,495 |   | $ | 746,017 |   |

 

Seeaccompanying notes to the condensed financial statements.

 

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**TECHNISCAN, INC.**

**(A Development Stage Company)**

**CONDENSED STATEMENTS OF CASH FLOWS**

**(Continued)**

**(unaudited)**

 
| ** **                                                                                 | ** ** | **For the Three Months Ended** | ** ** | **For the Period  From January  1, 2002  (inception of  development  stage) Through** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **March 31,  2010**       | ** ** | **March 31,  2009**                                                              | ** ** | **March 31,  2010** | ** ** |
|                                                                                       |       |                           |       |                                                                                  |       |   |   |
| **Supplemental Disclosure of Cash Flow Information:**                                      |       |                           |       |                                                                                  |       |   |   |
| Cash  paid for interest                                                                    |       | $                              | 12,814     |                                                                                  | $          | — |   | $ | 26,581 |   |
| Cash  paid for income tax                                                                  |       | 100                            |       | 100                                                                                   |       | 900 |   |
| **Supplemental Disclosure of Noncash Investing and****Financing  Activities:**             |       |                           |       |                                                                                  |       |   |   |
| Embedded  derivative liability associated with convertible notes payable                   |       | $                              | 978,542    |                                                                                  | $          | — |   | $ | 978,542 |   |
| Common  stock warrant liability associated with convertible notes payable                  |       | 1,270,148                      |       | —                                                                                |       | 1,270,148 |   |
| Common  stock issued to stockholders of Castillo, Inc. in connection with the  Merger |       | —                         |       | —                                                                                |       | 6,000 |   |
| Issuance  of common stock for future services                                              |       | —                         |       | —                                                                                |       | 225,000 |   |
| Conversion  of preferred stock and common stock warrants to common stock                   |       | —                         |       | —                                                                                |       | 38,937 |   |
| Issuance  of Series E convertible preferred stock for future services                 |       | —                         |       | —                                                                                |       | 1,000,000 |   |
| Conversion  of notes payable, including accrued interest, to preferred stock               |       | —                         |       | —                                                                                |       | 2,611,831 |   |

 

Seeaccompanying notes to the condensed financial statements.

 

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**TECHNISCAN, INC.**

**(A Development Stage Company)**

** **

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.****             ****ORGANIZATION AND DESCRIPTION OFBUSINESS**

 

***Organization***

 

TechniScan, Inc. (the “Company”)(formerly known as Castillo, Inc. or “Castillo”) was originally formed asa Nevada corporation on February 2, 2007. The Company changed its state of incorporation from the state of Nevadato the state of Delaware on October 8, 2009.

 

On October 9, 2009,TechniScan, Inc. a Utah corporation (“TechniScan Utah”), was first mergedinto its wholly owned subsidiary, and then immediately merged into TechniScan, Inc.(collectively referred to as the “Merger”). Pursuant to the Merger, the Companysucceeded to the business of TechniScan Utah as its sole line of business andchanged its name to TechniScan, Inc. Because the owners of TechniScan Utahobtained approximately 92% of the common stock of the Company through theMerger, the Merger has been accounted for as a recapitalization of TechniScanUtah with TechniScan Utah as the acquirer (reverse merger). The historicalfinancial statements prior to the Merger are those of TechniScan Utah.

 

***Description of Business***

 

TechniScan Utah was incorporated in 1984 forthe purpose of conducting research on advanced ultrasound imaging and inversescatter technology. The Company is in the development stage, as defined by theFinancial Accounting Standards Board (“FASB”) Accounting Standards Codification(“ASC”) Subtopic 915-10, *Development Stage Entities*,as it has not generated significant revenues. The development stage began January 1,2002, when the Company was capitalized for research, development andcommercialization of innovative medical imaging products for the detection anddiagnosis of breast cancer.

 

The Company’s commercial focus is thedevelopment of an ultrasound-based product known as the Warm Bath Ultrasound (“WBU”)system that is expected to provide radiologists with unique information aboutthe bulk properties of tissue in the breast as well as clear images ofthe tissue structure.

 

**2.****             ****SIGNIFICANT ACCOUNTING POLICIES**

 

***Basis of Presentation***

 

Theaccompanying unaudited condensed financial statements of the Company arepresented on the accrual basis of accounting in accordance with U.S. generallyaccepted accounting principles (“GAAP”) for interim financial information andin accordance with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they may not include all of the information andnotes required by GAAP for complete financial statements. In the opinion ofmanagement, all adjustments (consisting only of normal recurring accruals)considered necessary for a fair presentation have been included. Operating resultsfor the three months ended March 31, 2010 are not necessarily indicativeof results that may be expected for the year ending December 31,2010. The condensed balance sheet as of December 31, 2009 has been derivedfrom the Company’s audited financial statements as of that date, but does notinclude all of the information and notes required by GAAP for completefinancial statements. For further information refer to the financial statementsand notes thereto included in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2009, filed with the Securities and ExchangeCommission (“SEC”) on March 22, 2010.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

***Cash Equivalents***

 

The Company considers all highly liquidinvestments with an initial maturity of three months or less to be cashequivalents.

 

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***Concentration of Credit Risk***

 

Financial instruments that potentiallysubject the Company to a concentration of credit risk consist principally ofcash and cash equivalents.  The Companyplaces its cash with one financial institution. Accounts are secured by the Federal Deposit Insurance Corporation up to$250,000.  At times, balances may exceedfederally insured limits.

 

***Debt Issuance Costs***

 

Debt issuancecosts include costs incurred in connection with the sale of the Company’sconvertible notes payable, as well as the issuance of warrants, which are beingamortized over the six-month term of the notes (see Note 5).  There has been no amortization expenserecorded for the period ended March 31, 2010 as the notes were effectivelyissued on March 30, 2010.

 

***Property and Equipment***

 

Property and equipment are recorded at cost and depreciated using thestraight-line method over the estimated useful lives of the related assets.

 

***Impairment of Long-Lived Assets***

 

Long-lived assets of the Company are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amounts may not be recoverable, in accordance with FASB ASC Subsection360-10-45, *Impairment or Disposal of Long-LivedAssets*.

 

***Derivative Instruments***

 

In connection withthe sale of debt or equity instruments, the Company may sell warrants topurchase its common stock.  In certain circumstances, these warrants maybe classified as derivative liabilities, rather than as equity. Additionally, the debt or equity instruments may contain embedded derivativeinstruments, such as conversion options, which in certain circumstances may berequired to be bifurcated from the associated host instrument and accounted forseparately as a derivative asset or liability.

 

The accounting for derivative instruments is complex.  The Company’sderivative liabilities are re-valued at the end of each reporting period, withchanges in the fair value of the derivative liability recorded as charges orcredits to other income (expense), in the period in which the changes in fairvalue occur.  For embedded derivatives and warrants that are accounted foras derivative instrument liabilities, the Company determines the fair value ofthese instruments using both the Black-Scholes option-pricing model and theBinomial option-pricing model. These models require assumptions related tothe expected term of the instrument and risk-free rates of return, the Company’scurrent common stock price, expected dividend yield and the expected volatility(currently calculated using the Dow Jones Small Cap Medical Equipment Index)corresponding to the expected life of the instrument.

 

***Revenue Recognition***

 

The Companyrecords revenue in accordance with FASB ASC Topic 605, *Revenue Recognition*. The Company’srevenues are sourced from federal research grants and private and governmentresearch contracts. The Company recognizes revenues when products have beendelivered or services have been provided and invoiced to the government orother research partners. The FDA has not yet approved the WBU product forcommercial sale. Therefore, the Company has not yet generated any revenues fromnon-research product sales.

 

***Fair Value Measurements***

 

As defined in FASB ASC 820, *Fair Value Measurements and Disclosures*,fair value is based on the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. In order to increase consistency and comparabilityin fair value measurements, FASB ASC 820 establishes a fair value hierarchythat prioritizes observable and unobservable inputs used to measure fair valueinto three broad levels, which are described below:

 
| Level 1 |   | Quoted prices (unadjusted) in active markets that are accessible at  the measurement date for assets or liabilities.                               |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                               |
| Level 2 |   | Other inputs that are observable directly or indirectly, such as  quoted prices for similar assets and liabilities or market corroborated  inputs. |

 

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| Level 3 |   | Unobservable inputs that are used when little or no market data is  available, which require the Company to develop its own assumptions about how  market participants would value the assets or liabilities. |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Determining which category an asset orliability falls within the hierarchy requires significant judgment.  The Company evaluates its hierarchydisclosure each quarter.  Assets andliabilities measured at fair value on a recurring basis as of March 31,2010 and December 31, 2009 are summarized as follows:

 
| **Assets**          | ** ** | **Level 1** | ** **                                                                             | **Level 2** | ** ** | **Level 3** | ** ** | **March 31, 2010** | ** ** |
|---------------------|------------|-------------|----------------------------------------------------------------------------------------|-------------|------------|-------------|------------|-------------------------|------------|
| Money  market funds |       | $           |        715,060                                           |        | $          | —      |       | $                       | —     |   | $ |       715,060 |   |
|                |       |        |                                                                                   |        |       |        |       |                    |       |
| Total               |       | $           |               715,060 |        | $          | —      |       | $                       | —     |   | $ |            715,060 |   |

 
| **Liabilities**                | ** ** | ** ** | ** ** | ** **                                                                                                                                                                | ** ** | ** **         | ** ** | ** ** | ** **                                                       |
|--------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------|------------------------------------------------------------------|
| Embedded  derivative liability |       | $          | —     |                                                                                                                                                                      | $          | —   |       | $          |         978,542               |   | $ |         978,542 |   |
| Common  stock warrant          |       | —     |       |                           —   |       | 1,270,148          |       | 1,270,148  |                                                             |
|                           |       |       |       |                                                                                                                                                                      |       |               |       |       |                                                             |
| Total                          |       | $          | —     |                                                                                                                                                                      | $          | —   |       | $          |           2,248,690 |   | $ |           2,248,690 |   |

 
| **Assets**          | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **December 31, 2009** | ** ** |
|---------------------|------------|-------------|------------|-------------|------------|-------------|------------|----------------------------|------------|
| Money  market funds |       | $           | 130,028    |        | $          | —      |       | $                          | —     |   | $ | 130,028 |   |
|                |       |        |       |        |       |        |       |                       |       |
| Total               |       | $           | 130,028    |        | $          | —      |       | $                          | —     |   | $ | 130,028 |   |

 

The following table presents the fair valuereconciliation of Level 3 liabilities measured at fair value on a recurringbasis during the three months ended March 31, 2010:

 
| ** **                                                                 | ** ** | **Fair Value Mearsurments Using**   | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                 | ** ** | **Significant Unobservable Inputs** | ** ** |
| ** **                                                                 | ** ** | **(Level 3)**                  | ** ** |
| ** **                                                                 | ** ** | **Embedded  Derivative**            | ** ** | **Warrant Derivative** | ** ** | **Total** | ** ** |
|                                                                       |       |                                |       |   |   |   |   |
| Beginning  balance, December 31, 2009                                 |       | $                                   | —     |   | $ | — |   | $ | — |   |
| Total  (gains) losses included in earnings                                 |       |                                | —     |   |   | — |   |   | — |   |
| Issuances:                                                                 |       |                                |       |   |   |   |   |
| Embedded  derivatives issued in conjunction with convertible notes payable |       | 978,542                             |       | — |   | 978,542 |   |
| Warrants  issued in conjunction with convertible notes payable             |       | —                              |       | 1,270,148 |   | 1,270,148 |   |
| Ending  balance, March 31, 2010                                       |       | $                                   | 978,542    |   | $ | 1,270,148 |   | $ | 2,248,690 |   |

 

***Net Loss Per Common Share***

 

Basic net loss per common share (“Basic EPS”)is computed by dividing the net loss by the weighted average number of commonshares outstanding. Diluted net loss per common share (“Diluted EPS”) iscomputed by dividing net loss by the sum of the weighted average number ofcommon shares outstanding and the dilutive potential common share equivalentsthen outstanding. Potential common share equivalents consist of the weightedaverage number of shares issuable upon the exercise of outstanding stockoptions and warrants to acquire common stock, and shares issuable uponconversion of convertible debt. If these potential common share equivalents aredilutive, the Company computes Diluted EPS using the treasury stock method.

 

Due to the fact that for all periodspresented, the Company has incurred net losses, weighted average common shareequivalents of 14,434,569 and 25,342,688 for the three months ended March 31,2010 and 2009, respectively, are not included in the calculation of Diluted EPSbecause they are anti-dilutive.

 

***Operating Segment***

 

The Company conducts business within oneoperating segment.  The Company’soperations are all related to the research and development of its WBUsystem.  All assets of the business arelocated in the United States.

 

***Recent Accounting Pronouncements***

 

In March 2010, theFASB issued Accounting Standards Update (“ASU”) No. 2010-11, which isincluded in the Codification under ASC 815.  This update clarifiesthe type of embedded credit derivative that is exempt from embedded derivativebifurcation requirements.  Only an embedded credit derivative that isrelated to the subordination of one financial instrument

 

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to another qualifies forthe exemption.  This guidance became effective for the Company’sinterim and annual reporting periods beginning January 1,2010.  The adoption of this guidance did not have a material impacton the Company’s condensed financial statements.

 

In February 2010,the FASB issued ASU No. 2010-09, which is included in the Codificationunder ASC 855, *Subsequent Events* (“ASC 855”).  Thisupdate removes the requirement for an SEC filer to disclose the date throughwhich subsequent events have been evaluated and became effective for interimand annual reporting periods beginning January 1, 2010.  Theadoption of this guidance did not have a material impact on the Company’scondensed financial statements.

 

In January 2010,the FASB issued ASU No. 2010-06, which is included in the Codificationunder ASC 820, *Fair Value Measurements and Disclosures*(“ASC 820”).  This update requires the disclosure of transfersbetween the observable input categories and activity in the unobservable inputcategory for fair value measurements.  The guidance also requiresdisclosures about the inputs and valuation techniques used to measure fairvalue and became effective for interim and annual reporting periods beginning January 1,2010.  The adoption of this guidance did not have a material impacton the Company’s condensed financial statements.

 

**3.****             ****GOING CONCERN**

 

Since entering the development stage, Companyhas not generated revenues in excess of expenses and has been dependent ongovernment grants and equity raised from individual investors to sustain itsoperations. The WBU system has not yet been approved by the U.S. Food and DrugAdministration (“FDA”) for commercial sale. Therefore, the Company has notgenerated any revenues from non-research product sales. The Company hasincurred losses and used cash in operating activities since entering thedevelopment stage. As of March 31, 2010, the Company had an accumulateddeficit of $26,951,650, negative working capital of $2,522,819 and minimalrevenues.  These factors, among others,raise substantial doubt about the Company’s ability to continue as a goingconcern. The accompanying financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

The Company’s plans to address its liquidityissues include the (1) sale of debt and equity securities, (2) collaborationwith third parties to accelerate the introduction of product and services intothe market, and (3) continued focus on obtaining approval from the FDA forthe Company’s product and services to qualify for commercial sale.

 

There can be no assurance that the Company’splanned sales of debt and equity securities, its collaborative efforts, or itseffort to obtain FDA approval will be successful or that the Company will havethe ability to commercialize its imaging system and ultimately attainprofitability.

 

**4.****             ****ACCRUED LIABILITIES**

 

Accrued liabilities as of March 31, 2010and December 31, 2009 consisted of the following:

 
| ** **                             | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Accrued  compensation and benefits     |       | $                       | 158,646    |                       | $          | 195,811 |   |
| Accrued  software liability            |       | 150,000                 |       | 150,000                    |       |
| Accrued  interest                      |       | 11,767                  |       | —                     |       |
| Other  accrued liabilities             |       | 45,435                  |       | 53,465                     |       |
| Liabilities  to dissenter stockholders |       | —                  |       | 271,362                    |       |
|                                   |       | $                       | 365,848    |                       | $          | 670,638 |   |

 

**5.****             ****CONVERTIBLE NOTES PAYABLE ANDDERIVATIVES**

 

On March 30, 2010, the Company enteredinto a Note and Warrant Purchase Agreement with five accredited investorspursuant to which the investors purchased senior secured convertible notes (“Notes”)in the aggregate amount of $1,850,000. Of this amount $500,000 was received from members of the Company’s Boardof Directors.  The Notes are due andpayable on September 30, 2010, together with accrued interest at the rateof 10% per annum, unless the principal amount of a note is converted into sharesof common stock of the Company, in which case the interest is payable on theprincipal at a rate of 12% per annum. The Company is recording interest at 12%.   At its option, the Company may prepay all ofthe outstanding principal and accrued interest on the Notes, subject to aprepayment charge of 10% of the principal amount of the Notes.  The Notes are convertible in whole or in partat any time at the option of the holder of the Note into the number of sharesequal to the principal amount of the Note and all accrued interest divided by$0.67, subject to customary adjustments as set forth in the Notes for stocksplits, stock dividends, etc. In addition, in the event that the Companyreceives cash investments from one or more investors in one or more transactionsfor gross proceeds of not less than $5,000,000 in exchange for the issuance

 

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of shares or any other securities that areconvertible into or exercisable for shares at any time between March 30,2010 and September 30, 2010, the Notes are convertible into shares at thesame price and on the same terms as the investors.

 

In conjunction with the Notes, the Companyissued warrants (“Warrants”) to investors to purchase an aggregate of 2,761,192shares of the Company’s common stock. The exercise price per share is $0.67, subject to customary adjustmentsas set forth in the Warrants for stock splits, stock dividends, etc.  The Warrants expire five years from the dateof grant.

 

The Notes and Warrants contain a provisionwhich adjusts the exercise price of the Notes and Warrants if the Companyissues or sells common stock or securities convertible into common stock at aprice per share, or equivalent price per share lower than $0.67.  The Company assessed the terms of the Notesand Warrants in accordance with ASC Topic 815 — 40, and determined that theunderlying terms of the Notes and Warrants are not indexed to the Company’scommon stock. Therefore, the conversion option and the warrants are accountedfor as an embedded derivative and as a derivative, respectively, and are valuedat fair value at the date of issuance and each subsequent interim period.

 

Pursuant to certain prepayment provisions setforth in the Notes, including the Company’s failure to file a registrationstatement covering the “resale” of all of the shares issuable upon conversionof the Notes and exercise of the Warrants by May 14, 2010, the investorshave the right, at the investors’ option to require the Company to prepay allor a portion of the Notes in cash at a price equal to the greater of (1) 125%of the aggregate principal amount of the Notes plus all accrued and unpaidinterest and (2) the aggregate principal amount of the Notes plus allaccrued and unpaid interest, divided by the conversion price on the date theinvestor demands payment, pursuant to this provision or the date the payment isactually made by the Company to the investor pursuant to this provision,whichever is less, multiplied by the daily volume weighted average price of theCompany’s common stock on the greater of either of the two dates used todetermine the conversion price in connection with a payment pursuant to this provision.  The fair value of the prepayment penaltiesare included in the embedded derivative liability.

 

As of March 30, 2010, the fair value ofthe liabilities were $978,542 and $1,270,148 for the embedded derivatives onthe Notes and the derivatives on the Warrants, respectively.  As a result, the Company recorded a discountof $1,850,000 on the convertible notes payable, embedded derivatives of$978,542, a warrant liability of $1,270,148 and an inception loss of $398,690.The fair values of the derivatives as of March 31, 2010 and March 30,2010 were identical.  The fair values ofthe derivatives were determined using the following assumptions:

 

*Embedded Derivatives*

* *
| ** **                        | ** ** | **March 30,** | ** ** | **March 31,** | ** ** |
|-----------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                        | ** ** | **2010**           | ** ** | **2010**           | ** ** |
| Expected  volatility              |       | 16.82              | %          | 16.82              | %          |
| Expected  life, range in years    |       | 0.5                |       | 0.5                |       |
| Expected  dividend yield on stock |       | 0.00               | %          | 0.00               | %          |
| Risk  free interest rate range    |       | 0.28               | %          | 0.28               | %          |

 

*Common Stock Warrant Liability*

 
| ** **                        | ** ** | **March 30,** | ** ** | **March 31,** | ** ** |
|-----------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                        | ** ** | **2010**           | ** ** | **2010**           | ** ** |
| Expected  volatility              |       | 21.25              | %          | 21.25              | %          |
| Expected  life, range in years    |       | 5                  |       | 5                  |       |
| Expected  dividend yield on stock |       | 0.00               | %          | 0.00               | %          |
| Risk  free interest rate range    |       | 2.63               | %          | 2.63               | %          |

 

**6.****             ****STOCKHOLDERS’ DEFICIT**

 

***Stock Options***

 

Under the Company’s Comprehensive ManagementIncentive Plan (the “Plan”), the number of options authorized is limited to 18percent of the total outstanding common shares. As of March 31, 2010, the number of options authorized was14,921,542.

 

As of March 31, 2010 there was$1,236,532 of total unrecognized compensation cost with a weighted averagevesting period of 1.92 years related to unvested share-based compensationarrangements granted under the Plan.  Thetotal fair value of shares vested during the three months ended March 31,2010 was $171,466.

 

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A summary of the status of the Company’sstock option as of March 31, 2010 and changes during the period then endedare presented in the table below:

 
| ** **                                        | ** ** | **Three Months Ended March 31, 2010** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                        | ** ** | **Number of  Options  Outstanding**        | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Contractual  Term (Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
| Options  outstanding as of December 31, 2009 |       | 14,384,778                                 |       | $ | 0.39 |   |   |   |   |   |
| Granted                                           |       | 20,000                                     |       | 0.84 |   |   |   |   |   |
| Exercised                                         |       | —                                     |       | — |   |   |   |   |   |
| Forfeited                                         |       | (40,000                                    | )          | 0.38 |   |   |   |   |   |
| Options  outstanding as of March 31, 2010    |       | 14,364,778                                 |       | 0.39 |   | 4.78 |   | $ | 5,206,297 |   |
| Options  exercisable as of March 31, 2010    |       | 12,499,778                                 |       | 0.40 |   | 4.61 |   | 4,514,422 |   |
|                                                   |            |                                            |            |  |  |  |  |  |  |  |  |

 

The Company uses the Black-Scholes option-pricingmodel to estimate the calculated value of its share-based payments. Theassumptions used in the Black-Scholes option-pricing model for the three monthsended March 31, 2010 are set forth in the following table. The expectedvolatility is based on the volatility of the Dow Jones Small Cap MedicalEquipment Index. The Company calculated the historical volatility of that indexusing the daily closing total returns for that index for a period of time equalto the expected term of the options immediately prior to the grant date. TheCompany uses historical data to estimate option exercise and employeetermination patterns. The expected term of the options granted represents theperiod of time that options granted are expected to be outstanding. The riskfree rate for periods within the contractual life of the option is based on theU.S. treasury securities constant maturity rate that corresponds to theexpected term in effect at the time of grant.

 
| Expected  volatility              |   | 22.63 | %      |
|-----------------------------------|--------|-------|--------|
| Expected  life, range in years    |   | 6.25  |   |
| Expected  dividend yield on stock |   | 0.00  | %      |
| Risk  free interest rate range    |   | 3.85  | %      |

 

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## **ITEM 2.      MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

## ** **

**STATEMENTON FORWARD-LOOKING INFORMATION**

 

*Thisreport on Form 10-Q contains certain forward-looking statements.  Allstatements other than statements of historical fact are “forward-lookingstatements” for purposes of these provisions, including any projections ofearnings, revenues, or other financial items; any statements of the plans,strategies, and objectives of management for future operations; any statementsconcerning proposed new products, services, or developments; any statementsregarding future economic conditions or performance; statements of belief; andany statement of assumptions underlying any of the foregoing. Suchforward-looking statements are subject to inherent risks and uncertainties, andactual results could differ materially from those anticipated by theforward-looking statements.*

 

*Theseforward-looking statements involve significant risks and uncertainties,including, but not limited to, the following: competition, promotional costs,and risk of declining revenues.  Our actual results could differmaterially from those anticipated in such forward-looking statements as aresult of a number of factors.  These forward-looking statements are madeas of the date of this filing, and we assume no obligation to update suchforward-looking statements.  The following discusses our financial conditionand results of operations based upon our financial statements which have beenprepared in conformity with accounting principles generally accepted in theUnited States of America.  It should be read in conjunction with ourfinancial statements and the notes thereto included elsewhere herein.*

 

The following discussion and analysisprovides information which our management believes to be relevant to anassessment and understanding of our results of operations and financialcondition.  The discussion should be readtogether with our financial statements and the notes to the financialstatements, which are included in this report.

 

Our financial statements prior to the Mergerare the financials of TechniScan Utah. Pursuant to the Merger, TechniScan Utah’sfinancial statements became our financial statements.

 

**Overview**

 

We are a development stage company. Ourdevelopment stage began January 1, 2002 when we were capitalized for theresearch, development, and commercialization of innovative medical imagingproducts for the detection and diagnosis of breast cancer. We consider ouroperations to comprise one business segment.

 

Our current commercial focus is thedevelopment of an ultrasound-based product, the WBU system, that is expected toprovide radiologists with information about the bulk properties of tissue inthe breast as well as useful images of the tissue structure.

 

Our technology has been developed throughresearch supported, in part, by federal research grants and private andgovernment research contracts.

 

From inception through March 31, 2010,we have generated revenues solely from grants and research contracts. The WBUsystem has not yet been approved by the FDA for commercial sale; therefore, wehave not yet generated revenues from non-research product sales. We haveincurred losses since we began operating. As of March 31, 2010 and December 31,2009, we had an accumulated deficit of $26,951,650 and $25,187,868,respectively. To date, we have been dependent on equity raised from individualinvestors to support our operations, and we will continue to be dependent ondebt and equity financing to support our operations until we generatesignificant revenues from the WBU system. There is substantial doubt about ourability to continue as a going concern, and no adjustments have been reflectedin our financial statements that may result from the outcome of thisuncertainty.

 

**RecentDevelopments**

 

On March 30, 2010, we entered into aNote and Warrant Purchase Agreement with five accredited investors pursuant towhich the investors purchased senior secured convertible promissory notes inthe aggregate principal amount of $1,850,000. Of this amount $500,000 wasreceived from members of our Board of Directors.

 

Thenotes are due and payable on September 30, 2010, together with accrued interestat the rate of 10% per annum, unless the principal amount of a note isconverted into shares of our common stock, in which case interest is payable onthe principal at a rate of 12% per annum. We are recording interest at 12%.  At our option, we may prepay all of theoutstanding principal

 

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andaccrued interest on all of the notes, subject to a prepayment charge of 10% ofthe principal amount of the notes.  Thenotes are convertible in whole or in part at any time at the option of theholder of the note into that number of shares equal to the principal amount ofthe note and all accrued interest divided by $0.67, subject to customaryadjustments as set forth in the notes for stock splits, stock dividends, etc.  In addition, in the event that we receivecash investments from one or more investors in one or more transactions forgross proceeds of not less than $5,000,000 in exchange for the issuance ofshares or any other securities that are convertible into or exercisable forshares at any time between March 30, 2010 and September 30, 2010, thenotes are convertible into shares at the same price and on the same terms asthe investors.

 

Inconjunction with the notes, we issued warrants to investors to purchase anaggregate of 2,761,192 shares of our common stock.  The exercise price per share is $0.67,subject to customary adjustments as set forth in the warrants for stock splitsstock dividends, etc.  The warrantsexpire five years from the date of the grant.

 

We also entered into a Registration Rights Agreement with the investorspursuant to which we agreed to file a “resale” registration statement coveringall of the shares issuable upon conversion of the notes and exercise of thewarrants by May 14, 2010. Furthermore, in connection with the Note and Warrant Purchase Agreement,we granted the investors a security interest in all of our personal propertynow owned or hereafter acquired pursuant to a Security Agreement and a Patent,Trademark and Copyright Agreement.

 

**Significant Accounting Policies**

 

*Revenues*

 

Since inception, we have generated revenuesfrom federal research grants and private and government research contracts. Werecognize revenues when services have been provided and invoiced to the federalgovernment or other research partners.

 

Duringthe three months ended March 31, 2010 and 2009, we recognized revenues inconnection with federal grants from the Department of Health and Human Servicesfor cancer treatment research.  In March 2009,a second no-cost extension was applied for and received on our UltrasoundQuantitative Backscatter and Inverse Scattering (“QUB”) grant as well as on ourThermoacoustic and Inverse Scattering Breast Cancer Scanner (“Thermoacoustic”)grant extending the period on both grants to March 28, 2010 and March 31,2010 respectively. The QUB Grant was completed by March 31, 2010.  InMarch 2010, we applied for and received a third no-cost extension on theThermoacoustic Grant extending the period to March 31, 2011.

 

The FDA has not approved the WBU system forcommercial sale; therefore, we have not generated revenues from commercialproduct sales.

 

*Operating Expenses*

 

We classify our operating expenses betweendirect grant expenses, research and development expenses, and selling, generaland administrative expenses.

 

Direct grant expenses consist primarily ofpersonnel and personnel-related costs for employees and contractors engaged onprojects specified within the scope allowed by specific federal grants, as wellas the cost of direct equipment and materials.

 

Research and development expenses consistprimarily of personnel and personnel-related costs for employees andcontractors engaged in the development of the WBU technology, as well asindirect costs supporting these activities, including allocated depreciationand amortization of property and equipment and allocated rent for researchfacilities.

 

Selling, general and administrative expensesconsist primarily of personnel and personnel-related costs for employees andcontractors engaged in business development, regulatory, executive, finance,accounting, human resources, information technology, marketing and legal roles.These costs also include general corporate costs such as rent for the corporateoffices, insurance, depreciation on information technology equipment, andstock-based compensation expenses that are not allocated to research anddevelopment and direct grant expenses.

 

*Income Taxes*

 

We have significant deferred income taxassets resulting primarily from net operating loss carryforwards and researchand development tax credit carryforwards. These deferred income tax assets mayreduce taxable income in future periods, if any. A valuation allowance isrequired when it is more likely than not that all or a portion of the deferredincome tax assets will not be realized. We have recorded a valuation allowanceagainst the deferred income tax assets that are not offset by deferred

 

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income tax liabilities because there issignificant uncertainty as to our ability to generate sufficient profits torealize these deferred income tax assets.

 

**Critical Accounting Policies and Use of Estimates**

 

*Use of Estimates*

 

In preparing the financial statements inaccordance with GAAP, our management makes estimates and assumptions that affectthe reported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

 

*Inventory*

 

Inventory is stated at the lower of cost ormarket value. Cost is determined using the first-in, first-out method.Inventory consists of raw materials and work in process. As appropriate,provisions are made to reduce inventory to its net realizable value. The costof inventory that potentially may not sell prior to expiration or is deemed tohave no commercial value has been written-off when identified. Net inventoryhas been valued at zero as of March 31, 2010 and December 31, 2009.

 

*Patent Costs*

 

Since entering the development stage, legalcosts incurred to register and defend patents have been expensed as incurreddue to the uncertainty surrounding future cash flows and future benefits to berealized from those patents.

 

***Derivative Instruments***

 

In connection withthe sale of debt or equity instruments, we may sell warrants to purchase ourcommon stock.  In certain circumstances, these warrants may be classifiedas derivative liabilities, rather than as equity.  Additionally, the debtor equity instruments may contain embedded derivative instruments, such asconversion options, which in certain circumstances may be required to bebifurcated from the associated host instrument and accounted for separately asa derivative asset or liability.

 

The accounting for derivative instruments is complex.  Ourderivative instrument liabilities are re-valued at the end of each reportingperiod, with changes in the fair value of the derivative liability recorded ascharges or credits to other income (expense), in the period in which thechanges in fair value occur.  For embedded derivatives and warrants thatare accounted for as derivative instrument liabilities, we determine the fairvalues of these instruments using the Black-Scholes option-pricing model andthe Binomial option-pricing model.  Thesemodels require assumptions related to the expected term of the instrument andrisk-free rates of return, our current common stock price, expected dividendyield and the expected volatility (currently calculated using the Dow JonesSmall Cap Medical Equipment Index) corresponding to the expected life of theinstrument.

 

*Revenue Recognition*

 

Our revenues are sourced from federalresearch grants and private and government research contracts. We recognizerevenues when products have been delivered or services have been provided andinvoiced to the government or other research partners. The FDA has not yetapproved the WBU system for commercial sale; therefore, we have not yetgenerated revenues from non-research product sales.

 

*Stock-based Compensation*

 

We account for stock-based compensation inaccordance with FASB ASC 718, *StockCompensation*. Stock-based compensation for stock options isestimated at the grant date based on each option’s calculated value instead ofthe fair value as calculated by the Black-Scholes option-pricing model. Allstock-based payments to employees are grants of stock options that arerecognized in the statement of operations based on the calculated value at thedate of grant instead of the fair value because it has not been practical toestimate the volatility of the share price. The calculated value methodrequires that the volatility assumption used in an option-pricing model bebased on the historical volatility of an appropriate industry sector index. Weanticipate calculating the fair value of stock options instead of thecalculated value when sufficient stock trading history to estimate volatilityis available, which is anticipated to occur during the year ending December 31,2010.

 

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We use the Black-Scholes option-pricing modelto estimate the calculated value of our share-based payments. The expectedvolatility is based on the volatility of the Dow Jones Small Cap MedicalEquipment Index. We calculated the historical volatility of that index usingthe daily closing total returns for that index for a period of time equal to theexpected term of the options immediately prior to the grant date. We usehistorical data to estimate option exercise and employee termination patterns.The expected term of the options granted represents the period of time that theoptions granted are expected to be outstanding. The risk free rate for theperiods within the contractual life of the option is based on the United Statestreasury securities constant maturity rate that corresponds to the expectedterm in effect at the time of grant.

 

**Resultsof Operations**

 

**For theThree Months Ended March 31, 2010 compared to the Three Months Ended March 31,2009**

 

*Revenues*

* *
| ** **        | ** ** | **For the Three Months Ended March 31,** | ** ** | ** ** | ** ** |
|-------------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **        | ** ** | **2010**                                      | ** ** | **2009**   | ** ** | **% Change** | ** ** |
| Government  grant |       | $                                             | 88,510     |       | $          | 355,360 |   | -75 | % |
|                   |            |                                               |            |            |            |  |  |  |  |

 

Government grant revenues decreased $266,850,or 75% for the three months ended March 31, 2010 as compared to the threemonths ended March 31, 2009. This decrease in revenues is the result ofdecreased expenditures incurred on the second phase of our Inverse ScatterBreast Scan (“SBIR”) grant, as well as decreased expenditures on the QUB grantand the Thermoacoustic grant. All of the current grants are nearing the end ofthe awarded amount and the proposed scope of the work. Grant revenues areexpected to decline with the primary emphasis shifting to the subcontract workof completing the clinical studies under our largest Small Business InnovativeResearch Award.

 

*OperatingExpenses*

* *
| ** **                           | ** ** | **For the Three Months Ended March 31,** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **                           | ** ** | **2010**                                      | ** ** | **2009**   | ** ** | **% Change** | ** ** |
| Operating  Expenses                  |       |                                          |       |       |       |   |   |
| Selling,  general and administrative |       | $                                             | 872,305    |       | $          | 289,700 |   | 201 | % |
| Research  and development            |       | 451,113                                       |       | 325,696    |       | 39 | % |
| Direct  grant                        |       | 111,165                                       |       | 215,829    |       | -48 | % |
|                                      |            |                                               |            |            |            |  |  |  |  |

 

Selling,general and administrative expenses increased $582,605, or 201%, for the threemonths ended March 31, 2010, as compared to the three months ended March 31,2009.  This increase was primarily due tothe following:

 

·                  stock-based compensation of$188,963 primarily due to options that were granted to employees and directorsduring the fourth quarter of 2009;

·                  professional fees of$154,660 for legal and accounting services;

·                  marketing expenses of$128,700 primarily due to costs associated with public relations;

·                  travel and related costs of$28,566;

·                  board of director fees of$25,000;

·                  compensation and relatedcosts of $23,093 primarily due to the Company previously reducing employeeswages for the three months ended March 31, 2009; and

·                  other selling, general andadministrative expenses of $33,623.

 

Researchand development expense increased $125,417, or 39%, for the three months ended March 31,2010, as compared to the three months ended March 31, 2009.  This increase was primarily due to thefollowing:

 

·                  Compensation and relatedcosts of $83,684 primarily due to the Company previously reducing wages duringthe three months ended March 31, 2009;

·                  Depreciation expense of$29,387 and

·                  Other research anddevelopment expenses of $12,346.

 

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Directgrant expense decreased $104,664, or 48% for the three months ended March 31,2010, as compared to the three months ended March 31, 2009.  This decrease is primarily the result ofdecreased expenditures on the SBIR grant, as well as expenditures incurred inconnection with the QUB and Thermoacoustic grants.

 

*OtherIncome and Expenses*

* *
| ** **                 | ** ** | **For the Three Months Ended March 31,** | ** ** | ** ** | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2010**                                      | ** ** | **2009**   | ** ** | **% Change** | ** ** |
| Other  income and expenses |       |                                          |       |       |       |   |   |
| Interest  income           |       | $                                             | 102        |       | $          | 1,021 |   | -90 | % |
| Interest  expense          |       | (19,121                                       | )          | (109       | )          | 17,442 | % |
| Loss  on derivatives       |       | (398,690                                      | )          | —     |       | N/A |   |
|                            |            |                                               |            |            |            |  |  |  |  |

 

Interestincome decreased $919, or 90% for the three months ended March 31, 2010,as compared to the three months ended March 31, 2009, primarily as theresult of lower interest-bearing cash and cash equivalent balances during thethree months ended March 31, 2010.

 

Interestexpense increased as a result of interest that was paid to the dissenterstockholders during March 2010 as well as interest expense being incurredon the convertible notes payable.

 

Losson derivatives increased as a result of the valuation of our derivative financialinstruments associated with our convertible notes payable issued during thethree months ended March 31, 2010, as detailed in the notes to thefinancial statements.

 

**Resultsof Operations for the Development Stage**

 

Since the inception of our development stage(January 1, 2002) through March 31, 2010, we have generated$3,133,974 of revenues from government grants and have experienced cumulativenet losses of $26,562,257. Selling, general and administrative expenses were$13,835,890, research and development expenses were $13,298,870, and directgrant expenses were $1,986,321 for the development stage period. All researchand development costs are expensed as they are incurred, which include, but arenot limited to, personnel, prototype materials, lab supplies, consulting andresearch-related overhead.

 

**Liquidityand Capital Resources**

** **
| ** **                                 | ** ** | **For the Three Months Ended March 31,** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **2010**                                      | ** ** | **2009**   | ** ** | **% Change** | ** ** |
|                                       |       |                                          |       |       |       |   |   |
| Net  cash used in operating activities     |       | $                                             | (1,051,848 | )          | $          | (461,570 | ) | 128 | % |
| Net  cash used in investing activities     |       | (104,214                                      | )          | —     |       | N/A |   |
| Net  cash provided by financing activities |       | 1,669,373                                     |       | 441,873    |       | 278 | % |
|                                            |            |                                               |            |            |            |  |  |  |  |

 

*OperatingActivities*

 

Weused cash in operating activities of $1,051,848 for the three months ended March 31,2010, as compared to using $461,570 for the three months ended March 31,2009. We continue to use significant amounts of cash as we move our productdevelopment efforts forward. We have used cash in operating activities of$21,020,797 from the inception of the development stage (January 1, 2002)through March 31, 2010.

 

*InvestingActivities*

 

Weused cash from investing activities of $104,214 for the three months ended March 31,2010, for the purchase of equipment. In comparison, we had no cash frominvesting activities for the three months ended March 31, 2009. We haveused cash in investing activities of $1,117,028 from the inception of thedevelopment stage (January 1, 2002) through March 31, 2010.

 

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*FinancingActivities*

 

We generated cash from financing activitiesof $1,669,373 for the three months ended March 31, 2010, as compared to$441,873 for the three months ended March 31, 2009, primarily from theissuance of convertible notes, net of discounts. We have generated cash fromfinancing activities of $22,738,668 from the inception of the development stage(January 1, 2002) through March 31, 2010. We expect to continue toseek additional funding to meet our working capital requirements throughcollaborative arrangements and securities, research grants, and/or bankborrowings. There can be no assurance, however, that additional funds will beavailable from any of the foregoing or other sources on favorable terms, if atall.

 

Our future capital requirements will dependon many factors, including cash flows from operating activities, technologydevelopments, and our ability to develop and successfully market the WBU systemand other new products. We expect that we will need to raise additionalcapital, through other equity offerings or debt financings to satisfy ouranticipated operations, expenses and capital requirements for the next twelvemonths or longer. Because of our accumulated deficit, rate of cash used inoperating activities, negative working capital, minimal revenues, and otherfactors, substantial doubt exists about our ability to continue as a goingconcern.

 

***Recent Accounting Pronouncements***

 

In March 2010, theFASB issued Accounting Standards Update (“ASU”) No. 2010-11, which isincluded in the Codification under ASC 815.  This update clarifiesthe type of embedded credit derivative that is exempt from embedded derivativebifurcation requirements.  Only an embedded credit derivative that isrelated to the subordination of one financial instrument to another qualifiesfor the exemption.  This guidance became effective for our interimand annual reporting periods beginning January 1, 2010.  Theadoption of this guidance did not have a material impact on our condensedfinancial statements.

 

In February 2010,the FASB issued ASU No. 2010-09, which is included in the Codificationunder ASC 855, *Subsequent Events* (“ASC 855”).  Thisupdate removes the requirement for an SEC filer to disclose the date throughwhich subsequent events have been evaluated and became effective for ourinterim and annual reporting periods beginning January 1,2010.  The adoption of this guidance did not have a material impacton our condensed financial statements.

 

In January 2010,the FASB issued ASU No. 2010-06, which is included in the Codificationunder ASC 820, *Fair Value Measurements and Disclosures*(“ASC 820”).  This update requires the disclosure of transfersbetween the observable input categories and activity in the unobservable inputcategory for fair value measurements.  The guidance also requiresdisclosures about the inputs and valuation techniques used to measure fairvalue and became effective for our interim and annual reporting periodsbeginning January 1, 2010.  The adoption of this guidance didnot have a material impact on our condensed financial statements.

 

## **ITEM 3.**           QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

## ** **

Notrequired.

 

## **ITEM 4T. CONTROLS AND PROCEDURES**

## ** **

**i)****                                       ****Evaluation of Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures to ensure thatinformation required to be disclosed in the reports we file pursuant to theSecurities Exchange Act of 1934, as amended, are recorded, processed,summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure based on the definition of “disclosure controlsand procedures” in Rule 13a-15(e) of the Exchange Act. In designingand evaluating the disclosure controls and procedures, management recognizedthat any controls and procedures, no matter how well designed and operated, canonly provide a reasonable assurance of achieving the desired controlobjectives, and in reaching a reasonable level of assurance, managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

We carried out an evaluation, under the supervision and with theparticipation of management, including the Chief Executive Officer and theChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures as of the end of the period covered bythis report. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this report.

 

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**ii)****                                   ****Changes in Internal Controls Over Financial Reporting**

 

There were no changes in our internal control over financial reporting(as such term is defined in Exchange Act Rule 13a-15(f)) that occurredduring our most recent quarter that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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# **PART II — OTHERINFORMATION**

# ** **

## **ITEM 1.**           LEGAL PROCEEDINGS

## ** **

We are currently notinvolved in any litigation that we believe could have a material adverse effecton our financial condition or results of operations. There is no action, suit,proceeding, inquiry or investigation before or by any court, public board,government agency, self-regulatory organization or body pending or, to theknowledge of the executive officers of our company, threatened against oraffecting our company, or our common stock, in which an adverse decision couldhave a material adverse effect.

 

## **ITEM 1A. RISK FACTORS**

## ** **

We believe thereare no changes that constitute material changes from the risk factorspreviously disclosed in our Annual Report on Form 10-K for the year ended December 31,2009, filed with the SEC on March 22, 2010.

 

## **ITEM 5. EXHIBITS**

** **
| **Exhibit** | ** ** | **Identification of Exhibit**                                                                                 |
|-------------|------------|---------------------------------------------------------------------------------------------------------------|
| 3.1         |       | Certificate  of Incorporation, filed with the Secretary of State of the State of Delaware                     |   | Incorporated  by reference to our Form 8-K filed with the SEC on October 16, 2009 |
| 3.2         |       | Bylaws                                                                                                        |   | Incorporated  by reference to our Form 8-K filed with the SEC on October 16, 2009 |
| 4.1         |       | The  Convertible Note                                                                                         |   | Incorporated  by reference to our Form 8-K filed with the SEC on April 5, 2010 |
| 4.2         |       | Warrant                                                                                                       |   | Incorporated  by reference to our Form 8-K filed with the SEC on April 5, 2010 |
| 10.1        |       | Note  and Warrant Purchase Agreement                                                                          |   | Incorporated  by reference to our Form 8-K filed with the SEC on April 5, 2010 |
| 10.2        |       | Registration  Rights Agreement                                                                                |   | Incorporated  by reference to our Form 8-K filed with the SEC on April 5, 2010 |
| 10.3        |       | Security  Agreement                                                                                           |   | Incorporated  by reference to our Form 10-K filed with the SEC on April 5, 2010 |
| 10.4        |       | Patent  Security Agreement                                                                                    |   | Incorporated  by reference to our Form 8-K filed with the SEC on April 5, 2010 |
| 10.5        |       | Indemnification  Agreement                                                                                    |   | Incorporated  by reference to our Form 8-K filed with the SEC on March 25, 2010 |
| 31.1        |       | Certification  of Principal Executive Office pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002  |   | Filed  herewith |
| 31.2        |       | Certification  of Principal Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 |   | Filed  herewith |
| 32.1        |       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350                             |   | Filed  herewith |
| 32.2        |       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350                             |   | Filed  herewith |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Act of 1934, as amended, the registrant has duly caused thisquarterly report to be signed on its behalf by the undersigned, in Salt LakeCity, State of Utah, on May 4, 2010.

 
|   | **TECHNISCAN, INC.** |
|--------|---------------------------|
|   | (Registrant)              |
|   |                      |
|   |                      |
|   | By:                       | /s/ DAVID C. ROBINSON |
|   |                      | David C. Robinson |
|   |                      | Chief Executive Officer |
|   |                      | (principal executive officer) |
|   |                      |   |
|   |                      |   |
|   | By:                       | /s/ STEVEN  K. PASSEY |
|   |                      | Steven K. Passey |
|   |                      | Chief Financial Officer |
|   |                      | (principal financial and accounting officer) |

 

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