Notes
to Financial Statements
1.
ORGANIZATION AND DESCRIPTION OF BUSINESS
Imaging3,
Inc. (the “Company”, “us”, “we”, “Imaging3”) incorporated in the state of California
on October 29, 1993 as Imaging Services, Inc. The Company filed a certificate of amendment of articles of incorporation to change
its name to Imaging3, Inc. on August 20, 2002. In March of 2018, the Company incorporated in Delaware.
The
Company is a development stage medical device company. The Company has developed a portable proprietary imaging technology designed
to produce 3D images in real time. The Company’s devices emit low levels of radiation and require less specialized power
sources than currently available imaging devices. The Company’s lead device, the Dominion Smartscan, for which the Company
plans to submit a 510K application with the FDA in mid-2018, will be portable and works on conventional household current. While
the primary focus is applications for the healthcare industry, there are many potential non-healthcare related uses for the Company’s
technology, including agriculture and security.
2.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
On
September 13, 2012 (the “Petition Date”), the Company filed a voluntary petition with the federal bankruptcy court
in Los Angeles, California, to enter bankruptcy under Chapter 11 of the United States Bankruptcy Code. On or about July 15, 2013,
our Plan of Reorganization was approved by the United States Bankruptcy Court. On July 30, 2013, we emerged from bankruptcy and
continued operations under the terms and conditions of our Bankruptcy Reorganization Plan as it applies to post bankruptcy operations.
For accounting purposes, management deemed the effective date of the Chapter 11 Plan (the “Plan”) to be June 30, 2013.
The Plan adopted by Imaging3, Inc. is a reorganizing plan. Payments under the Plan were made by utilizing existing cash on hand,
borrowings on a secured and unsecured basis, future cash flow, if any, capital raised through the sale of our common stock in
private placements, and by conversion of debt to equity.
Upon
emergence from bankruptcy, Imaging3 adopted fresh-start accounting which resulted in Imaging3 becoming a new entity for financial
reporting purposes. Imaging3 applied fresh start accounting as of July 1, 2013. As a result of the application of fresh start
accounting and the effects of the implementation of the plan of reorganization, the financial statements on or after July 1, 2013
are not comparable with the financial statements prior to that date.
On
March 16, 2018, the Company completed a 1-for-20 reverse stock split. The accompanying financial statements have been retroactively
restated to reflect the 1-for-20 reverse-stock split.
Use
of Estimates
In
preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management
is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash
and Cash Equivalents
The
Company considers all liquid investments with a maturity of three months or less from the date of purchase that are readily convertible
into cash to be cash equivalents. The Company maintains its cash in bank deposit accounts that may exceed federally insured limits.
The Company has not experienced any losses in such accounts. The Company had no cash equivalents at December 31, 2017 or 2016.
Revenue
Recognition
Revenue
is recognized upon shipment, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer,
fees are fixed or determinable and collection of the related receivable is reasonably assured. Revenue is recorded net of estimated
product returns, which is based upon the Company’s return policy, sales agreements, management estimates of potential future
product returns related to current period revenue, current economic trends, changes in customer composition and historical experience.
The Company accrues for warranty costs, sales returns, and other allowances based on its experience. Generally, the Company extends
credit to its customers and does not require collateral. The Company performs ongoing credit evaluations of its customers and
historic credit losses have been within management’s expectations and has a revenue receivables policy for service and warranty
contracts. Warranty revenues are deferred and recognized on a straight-line basis over the term of the contract or as services
are performed.
Deferred
Revenue
Deferred
revenue consists substantially of amounts received from customers in advance of the Company’s performance service period.
Deferred revenue is recognized as revenue on a systematic basis that is proportionate to the period that the underlying services
are rendered, which in certain arrangements is straight-line over the remaining contractual term or estimated customer life of
an agreement.
Accounts
Receivable
The
Company’s customer base is geographically dispersed. The Company maintains reserves for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations,
customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these
reserves. Reserves are recorded primarily on a specific identification basis.
Impairment
of Long-Lived Assets
Long-lived
assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the
assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value
exceeds the fair value.
The
Company tests long-lived assets, including property, plant, equipment and intangible assets subject to periodic amortization,
for recoverability at least annually or more frequently upon the occurrence of an event or when circumstances indicate that the
net carrying amount is greater than its fair value. Assets are grouped and evaluated at the lowest level for their identifiable
cash flows that are largely independent of the cash flows of other groups of assets. The Company considers historical performance
and future estimated results in its evaluation of potential impairment, and then compares the carrying amount of the asset to
the future estimated cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated
expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the
asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows at the rate
the Company utilizes to evaluate potential investments. The Company estimates fair value based on the information available in
making whatever estimates, judgments and projections are considered necessary.
Basic
and Diluted Net Income Per Share
Basic
net income per share is based upon the weighted average number of common shares outstanding. Diluted net income per share is based
on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by
applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the
period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average
market price during the period. During 2016, potentially dilutive securities were excluded from the computation of weighted average
shares outstanding-diluted because their effect was anti-dilutive.
Numerator:
|
|
|
|
Net income attributable to common shareholders, for the year ended December 31, 2017
|
|
$
|
2,852,511
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
Weighted-average number of common shares outstanding during the period
|
|
|
13,825,914
|
|
Dilutive effect of stock options, warrants, and convertible promissory notes
|
|
|
1,841,365
|
|
Common stock and common stock equivalents used for diluted earnings per share
|
|
$
|
15,667,279
|
|
Derivative
Financial Instruments
The
Company generally does not use derivative financial instruments to hedge exposures to cash-flow risks or market-risks that may
affect the fair values of its financial instruments. The Company utilizes various types of financing to fund its business needs,
including convertible notes and warrants and other instruments not indexed to our stock. The Company is required to record its
derivative instruments at their fair value. Changes in the fair value of derivatives are recognized in earnings in accordance
with ASC 815. The Company’s only asset or liability measured at fair value on a recurring basis is its derivative liability
associated with warrants to purchase common stock and convertible notes.
Fair
Value of Financial Instruments
The
fair value accounting standard creates a three-level hierarchy to prioritize the inputs used in the valuation techniques to derive
fair values. The basis for fair value measurements for each level within the hierarchy is described below with Level 1 having
the highest priority and Level 3 having the lowest.
Level
1: Observable prices in active markets for identical assets or liabilities.
Level
2: Observable prices for similar assets or liabilities in active markets; quoted prices for identical or similar instruments in
markets that are not active; and model-derived valuations in which all significant inputs are observable in the market.
Level
3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable. These unobservable assumptions
reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include
use of option pricing models, discounted cash flow models, and similar techniques.
The
Company had the following assets or liabilities measured at fair value on a recurring basis at December 31, 2017 and 2016 respectively.
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Derivative Liabilities 2017
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
701,347
|
|
|
$
|
701,347
|
|
Derivative Liabilities 2016
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
5,532,898
|
|
|
$
|
5,532,898
|
|
Income
Taxes
The
Company accounts for income taxes in accordance with ASC 740-10, “Income Taxes” which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial
statements or tax returns.
Under
this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases
of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established,
when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents
the tax payable for the period and the change during the period in deferred tax assets and liabilities.
Research
and Development
Costs
and expenses that can be clearly identified as research and development are charged to expense as incurred in accordance with
FASB ASC 730-10. Included in research and development costs are operating costs, facilities, supplies, external services, clinical
trial and manufacturing costs, and overhead directly related to the Company’s research and development operations, as well
as costs to acquire technology licenses.
Recent
Accounting Pronouncements
In
May 2014, FASB issued Accounting Standards Update (ASU) No. 2014-09,
Revenue from Contracts with Customers
. The standard
will eliminate the transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with
a principle-based approach for determining revenue recognition. ASU 2014-09 is effective for annual and interim periods beginning
after December 15, 2016. Early adoption is not permitted. The revenue recognition standard is required to be applied retrospectively,
including any combination of practical expedients as allowed in the standard. We are evaluating the impact, if any, of the adoption
of ASU 2014-09 to our financial statements and related disclosures. The Company has not yet selected a transition method nor has
it determined the effect of the standard on its ongoing financial reporting.
In
August 2014, the FASB issued ASU 2014-15,
Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern
. ASU 2014-15 changes to the disclosure of
uncertainties about an entity’s ability to continue as a going concern. These changes require an entity’s management
to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s
ability to continue as a going concern within one year after the date that financial statements are issued. Substantial doubt
is defined as an indication that it is probable that an entity will be unable to meet its obligations as they become due within
one year after the date that financial statements are issued. If management has concluded that substantial doubt exists, then
the following disclosures should be made in the financial statements: (i) principal conditions or events that raised the substantial
doubt, (ii) management’s evaluation of the significance of those conditions or events in relation to the entity’s
ability to meet its obligations, (iii) management’s plans that alleviated the initial substantial doubt or, if substantial
doubt was not alleviated, management’s plans that are intended to at least mitigate the conditions or events that raise
substantial doubt, and (iv) if the latter in (iii) is disclosed, an explicit statement that there is substantial doubt about the
entity’s ability to continue as a going concern. These changes became effective for the Company for the 2017 annual period.
The adoption of these changes did not have a material impact on the financial statements.
In
February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
, which supersedes existing guidance on accounting for leases
in “Leases (Topic 840)” and generally requires all leases to be recognized in the consolidated balance sheet. ASU
2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018; early adoption is permitted.
The provisions of ASU 2016-02 are to be applied using a modified retrospective approach. The Company is currently evaluating the
impact of the adoption of this standard on its consolidated financial statements.
In
March 2016, the FASB issued ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
. This ASU affects entities
that issue share-based payment awards to their employees. The ASU is designed to simplify several aspects of accounting for share-based
payment award transactions which include – the income tax consequences, classification of awards as either equity or liabilities,
classification on the statement of cash flows and forfeiture rate calculations. ASU 2016-09 will become effective for the Company
in the first quarter of fiscal 2018. Early adoption is permitted in any interim or annual period. The Company is currently evaluating
the impact of this guidance on its consolidated financial statements.
In
April 2016, the FASB issued AS 2016-10, Revenue from Contracts with Customers (Topic 606), which amends certain aspects of the
Board’s new revenue standard, ASU 2014-09, Revenue from Contracts with Customers. The standard should be adopted concurrently
with adoption of ASU 2014-09 which is effective for annual and interim periods beginning after December 15, 2017. The Company
has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
In
July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and
Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement
of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily
Redeemable Noncontrolling Interests with a Scope Exception, (ASU 2017-11). Part I of this update addresses the complexity of accounting
for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments
(or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings Current
accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible
instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Part
II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence
of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite
deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain
mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not have an accounting effect. This
ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company is currently
assessing the potential impact of adopting ASU 2017-11 on its financial statements and related disclosures.
3.
INCOME TAXES
The
Company’s book losses and other timing differences result in a net deferred income tax benefit which is offset by a valuation
allowance for a net deferred asset of zero. The Company has concluded, in accordance with the applicable accounting standards,
that it is more likely than not that the Company may not realize the benefit of all of its deferred tax assets. Accordingly, management
has provided a 100% valuation allowance against its deferred tax assets until such time as management believes that its projections
of future profits as well as expected future tax rates make the realization of these deferred tax assets more-likely-than-not.
Significant judgment is required in the evaluation of deferred tax benefits and differences in future results from our estimates
could result in material differences in the realization of these assets. The Company has recorded a full valuation allowance related
to all of its deferred tax assets. The Company has performed an assessment of positive and negative evidence regarding the realization
of the net deferred tax asset in accordance with FASB ASC 740-10, “Accounting for Income Taxes.” This assessment included
the evaluation of scheduled reversals of deferred tax liabilities, the availability of carry forwards and estimates of projected
future taxable income. The availability of the Company’s net operating loss carry forwards is subject to limitation if there
is a 50% or more change in the ownership of the Company’s stock. The provision for income taxes consists of the state minimum
tax imposed on corporations of $800. The Company has adopted guidance issued by the FASB that clarifies the accounting for uncertainty
in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold of more likely
than not and a measurement process for financial statement recognition and measurement of a tax position taken or expected to
be taken in a tax return. In making this assessment, a company must determine whether it is more likely than not that a tax position
will be sustained upon examination, based solely on the technical merits of the position and must assume that the tax position
will be examined by taxing authorities. The Company’s policy is to include interest and penalties related to unrecognized
tax benefits in income tax expense. The Company has not recognized any unrecognized tax benefits and does not have any interest
or penalties related to uncertain tax positions as of December 31, 2016 or December 31, 2017.
As
of December 31, 2017, the Company estimated it had available gross net operating loss (NOL) carry forwards of approximately $12
million, which expire at various dates through 2037.
The
components of the net deferred income taxes at December 31, 2016 and 2017 are summarized below:
|
|
December 31, 2016
|
|
|
December 31, 2017
|
|
Deferred income tax assets
|
|
|
|
|
|
|
|
|
Net operating loss carry forwards
|
|
$
|
5,962,000
|
|
|
$
|
3,373,000
|
|
Less: valuation allowance
|
|
|
(5,962,000
|
)
|
|
|
(3,373,000
|
)
|
Deferred income tax assets, net
|
|
$
|
-
|
|
|
$
|
-
|
|
The
following is a reconciliation of the provision for income taxes at the U.S. federal income tax rate to the income taxes reflected
in the Statement of Operations:
|
|
December 31, 2016
|
|
|
December 31, 2017
|
|
Tax expense (benefit) at federal statutory rate
|
|
|
(34
|
)%
|
|
|
34
|
%
|
State tax expense, net of federal tax
|
|
|
(6
|
)
|
|
|
6
|
|
Change in deferred taxes due to statutory rate change
|
|
|
-
|
|
|
|
51
|
|
Changes in valuation allowance
|
|
|
40
|
|
|
|
(91
|
)
|
Effective income tax rate
|
|
$
|
-
|
|
|
$
|
-
|
|
Income
tax expense for the period ended December 31, 2016 and the year ended December 31, 2017 is summarized below.
|
|
2016
|
|
|
2017
|
|
Current tax expense:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
800
|
|
|
|
800
|
|
Total current tax expense
|
|
$
|
800
|
|
|
$
|
800
|
|
|
|
|
|
|
|
|
|
|
Deferred tax expense:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
State
|
|
|
-
|
|
|
|
-
|
|
Total deferred tax expense, net
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Tax expense
|
|
$
|
800
|
|
|
$
|
800
|
|
On
December 22, 2017, the U.S. government enacted comprehensive tax reform commonly referred to as the Tax Cuts and Jobs Act (“TCJA”).
Under FASB Accounting Standards Codification (“ASC 740”), the effects of changes in tax rates and laws are recognized
in the period which the new legislation is enacted. The TCJA makes broad and complex changes to the U.S. tax code, including,
but not limited to: (1) reducing the U.S. federal corporate tax rate from 34% to 21%; (2) changing rules related to uses and limitations
of net operating loss carryforwards created in tax years beginning after December 31, 2017; (3) bonus depreciation that will allow
for full expensing of qualified property; (4) creating a new limitation on deductible interest expense; (5) eliminating the corporate
alternative minimum tax (“AMT”); (6) limitation on the deductibility of executive compensation under Internal Revenue
Code §162(m); and (7) new tax rules related to foreign operations.
On
December 22, 2017, the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 118, which provides guidance on accounting
for the tax effects of TCJA. The purpose of SAB No. 118 was to address any uncertainty or diversity of view in applying ASC Topic
740, Income Taxes in the reporting period in which the TCJA was enacted. SAB No. 118 addresses situations where the accounting
is incomplete for certain income tax effects of the TJCA upon issuance of a company’s financial statements for the reporting
period that includes the enactment date. SAB No. 118 allows for a provisional amount to be recorded if it is a reasonable estimate
of the impact of the TCJA. Additionally, SAB No. 118 allows for a measurement period to finalize the impacts of the TCJA, not
to extend beyond one year from the date of enactment.
In
connection with the initial analysis of the impact of the TCJA, we recorded a provisional decrease in our deferred tax assets
and liabilities with a corresponding adjustment to its valuation allowance. While we are able to make a reasonable estimate of
the impact of the reduction in the corporate rate, it is subject to further analysis, interpretation and clarification of the
TCJA, which could result in changes to this estimate during 2018.
4.
NOTES PAYABLE
During
2015 and 2016, the Company issued promissory notes in the aggregate amount of $942,850 for cash proceeds of $872,500. These notes
bear interest at 5%-10% per annum and several were due on various dates between 2015 and 2017. These notes are secured by substantially
all assets of the Company. The convertible promissory notes are convertible into shares of the Company’s common stock at
a rate equal to $0.01-$0.05 per share (pre reverse stock split), subject to downward adjustments for future equity issuances.
In connection with these convertible promissory notes, the Company issued warrants to purchase 3,325,000 shares of common stock
at an exercise price of $0.20 per share, subject to downward adjustments for future equity issuances. The warrants have a term
of 7 years from the date of issuance. The Company is in default under the terms of these notes.
The
conversion features and warrants are considered derivative liabilities pursuant to ASC 815 and were measured at their grant-date
fair value and recorded as a liability and note discount on the date of issuance. Subsequent changes to the value of the derivative
liabilities are recorded in earnings. As a result, during the ended year ended December 31, 2016, the Company recorded an initial
note discount of $455,000, with an additional immediate charge to interest expense of $749,809 relating to the excess value of
the derivative liabilities over the promissory notes.
On
January 5, 2017 the Company entered into a financing arrangement with five accredited investors (the “Investors”),
whereby amendments to certain convertible note agreements totaling $662,000 were enacted. The amendments to the convertible note
agreements involved (1) extending the maturity dates of the note agreements; and (2) amending the optional conversion provisions
of the original note agreements to now describe an adjustable conversion price based on the completion of a qualified financing
offering. If the cumulative gross proceeds of such offerings exceed $2.5 million, the conversion price will be adjusted automatically
to match the offering’s conversion price and conversion to common shares will occur automatically. If the cumulative gross
proceeds of such offerings remain below $2.5 million, the conversion price adjusts to match the offering conversion price for
the Investors. Should there be an event of default under these amended notes, the Investors will have, in addition to all the
other rights described in that certain Securities Purchaser Agreement, the right, at each Investor’s option, to convert
the notes into common shares at $0.20 per share. The Company and certain Investors agreed to amend its warrant agreements to reduce
the number of warrants by 75% to 831,250. The exercise price remains at $0.20 per share. In consideration of this reduction of
the number of warrants, the Company issued to the Investors new convertible promissory notes in total principal amount of $124,688
in the same form as the original convertible notes described above as amended. These additional convertible notes accrue interest
beginning on January 9, 2017 and are due May 18, 2018.
The
amendment to the notes and warrants were accounted for as an extinguishment of debt, which resulted in a gain on extinguishment
of debt totaling $3,668,776 for the year ended December 31, 2017.
The
Investors agreed to lend the Company up to $200,000, in increments of $50,000, at the Company’s discretion (the “Additional
Loans”), as long as the Original Notes are not in default. These loans will be evidenced by note agreements in the form
of the original notes as amended, described above, with a maturity date of May 18, 2018 and bear interest at 10% per annum. These
notes have a face value of 118.75% of the funds actually advanced and contain conversion features (conversion price of $0.50 per
share) making them derivative instruments. As of December 31, 2017, $150,034 of cash proceeds have been received from this agreement,
for a total principal outstanding of $178,166. The Additional Loans are secured by a UCC filing on the Company’s assets.
In connection with these note agreements, the derivative liability created by these note agreements and warrants totaled $288,057.
The derivative liability in excess of the cash proceeds received was recorded as a charge to interest expense, which totaled $136,835.
In addition, the Company issued 187,500 warrants in the form of the original Warrants as amended granting the Investor the right
to purchase, at $0.20 per share in connection with these notes. These warrants were valued using the black-scholes valuation model
with the assumptions and inputs discussed in note 6.
The
agreement to amend the notes and warrants and to loan additional monies to the Company, as described above, was dependent on the
two officers of the Company—Chief Executive Officer Dane Medley and Chief Financial Officer Xavier Aguilera—agreeing
to restate their respective employment agreement, which they both have done.
On
January 10, 2017, certain note holders converted notes to common shares. The total principal and accrued interest balance converted
amounted to $196,797 along with $234,578 of derivative liability associated with conversion features that were settled upon conversion.
The conversion resulted in the issuance of 431,375 common shares. The fair market value of the common shares on the date of conversion
totaled $431,375.
On
May 25, 2017 the Company completed the sale of $500,000 of Convertible Promissory Notes (the “Notes”) to two accredited
investors (the “Investors”) that are due May 23, 2018 (the “Maturity Date”). After transaction costs,
the company netted $425,000 from the sale of the Notes. These Notes bear interest at the rate of 12% per annum to the Maturity
Date and may be redeemed by the Company for 125% of face value within 90 days of issuance and at 135% of face value from 91 days
after issuance and before 180 days after issuance. Any amount of principal or interest on these notes which is not paid when due
shall bear interest at the rate of 24% per annum from the due date thereof until the same is paid. If the Notes are not repaid
by the end of this period, any balance due is convertible—at the option of the note holders—into common stock at 60%
of the lowest closing price for the prior 20 trading days. In connection with the sale of the Notes, the Investors received a
commitment fee totaling 900,000 shares valued at $180,000, and the holders of a majority of the principal amount of the Company’s
notes outstanding at May 18, 2017 (the “Prior Notes”) executed, as of that date, an Omnibus Amendment that enabled
the transaction by (i) extending the maturity date of these Prior Notes to May 18, 2018 and (ii) restricting the rights of all
the holders of the Prior Notes, including their right to convert until certain conditions are met. In addition, the holders of
these Prior Notes were relieved of their obligation to provide the final note tranche of $50,000. In connection with these notes,
the Company recorded note discounts totaling $648,750 and an immediate charge to interest of $411,725 related to the excess value
of the conversion feature derivative over the carrying value of the notes.
Amortization
of note discounts amounted to $449,281 during the year ended December 31, 2017 and $349,000 for the year ended December 31, 2016.
5.
STOCKHOLDERS’ EQUITY
Preferred
Stock
Dane
Medley relinquished these voting shares during the first quarter ended March 31, 2017 for consideration of $60,000, which has
not yet been paid and is included in accounts payable at December 31, 2017.
Common
Stock
The
Company is authorized to issue 1,000,000,000 shares of no par value common stock.
During
the year ended December 31, 2016, the Company issued 2,663,185 shares of common stock, 2,084,250 shares related to services valued
at $1,903,050, 225,200 shares were issued for cash proceeds of $166,900, and 353,735 shares related to a conversion of notes payable
at $0.20 per share.
During
the year ended December 31, 2017 the Company issued a total of 7,500 shares of common stock for cash in the amount of $7,000 and
2,541,500 shares were issued for services rendered valued at $648,300. In addition, the Company raised $130,600 of capital related
to shares of common stock, however these shares were not issued as of December 31, 2017 and are presented as a subscription payable
on the accompanying balance sheet.
As
of December 31, 2017, there were approximately 568 record holders of our common stock, not including shares held in “street
name” in brokerage accounts which is unknown. As of December 31, 2017, there were 15,474,454 shares of our common stock
outstanding on record.
Stock
Option Plan
During
2014, the Board of Directors adopted, and the shareholders approved, the 2014 Stock Option Plan under which a total of 27,000,000
shares of common stock had been reserved for issuance. The Stock Option Plan will terminate in September 2024.
Stock
Options
Transactions in FY2017
|
|
Quantity
|
|
|
Weighted-
Average
Exercise Price
Per
Share
|
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
Outstanding, December 31, 2016
|
|
|
650,000
|
|
|
$
|
0.69
|
|
|
|
8.86
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(400,000
|
)
|
|
$
|
0.50
|
|
|
|
|
|
Cancelled/Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2017
|
|
|
250,000
|
|
|
$
|
1.00
|
|
|
|
7.57
|
|
Exercisable, December 31, 2017
|
|
|
250,000
|
|
|
$
|
1.00
|
|
|
|
7.57
|
|
Transactions
in FY2016
Outstanding, December 31, 2015
|
|
|
400,000
|
|
|
$
|
0.50
|
|
|
|
9.00
|
|
Granted
|
|
|
250,000
|
|
|
$
|
1.00
|
|
|
|
9.00
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Cancelled/Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2016
|
|
|
650,000
|
|
|
$
|
0.69
|
|
|
|
8.86
|
|
Exercisable, December 31, 2016
|
|
|
650,000
|
|
|
$
|
0.69
|
|
|
|
8.86
|
|
As
of December 31, 2017, employees of the Company hold options to purchase 250,000 shares of common stock at an exercise price of
$0.50. On September 15, 2017, two officers exercised their 400,000 options at a cost of $200,000, by offsetting and reducing their
deferred salary and other amounts owed to them by the Company.
6.
WARRANTS
Following
is a summary of warrants outstanding at December 31, 2017:
Number of
|
|
|
|
|
|
|
Warrants
|
|
|
Exercise Price
|
|
|
Expiration Date
|
|
541,362
|
|
|
$
|
0.00002
|
|
|
July 2023
|
|
25,000
|
|
|
$
|
0.20
|
|
|
April 2022
|
|
312,500
|
|
|
$
|
0.20
|
|
|
August 2022
|
|
287,500
|
|
|
$
|
0.20
|
|
|
April 2023
|
|
125,000
|
|
|
$
|
0.20
|
|
|
May 2023
|
|
81,250
|
|
|
$
|
0.20
|
|
|
August 2023
|
|
2,800,000
|
|
|
$
|
0.40
|
|
|
May 2022
|
|
187,500
|
|
|
$
|
0.20
|
|
|
January 2024
|
Effective
May 1, 2017, the Board of Directors of the Company authorized the issuance of 2,800,000 warrants to purchase 2,800,000 shares
of the Company’s common stock at an exercise price of $0.40 per share for a period of five years from the date of issuance
to the officers of the Company. These warrants were fully-vested upon grant and as such, an expense was recognized upon grant.
The fair value of the warrants was calculated using a Black-Scholes model and was estimated to be $194,956. The significant assumptions
used in the calculations were as follows:
Term
|
|
|
5.0 years
|
|
Dividend Yield
|
|
|
0
|
%
|
Risk-free rate
|
|
|
1.84
|
%
|
Volatility
|
|
|
60
|
%
|
7.
DERIVATIVE LIABILITIES
The
Company’s only asset or liability measured at fair value on a recurring basis was its derivative liability associated with
warrants to purchase common stock and the conversion features embedded in convertible promissory notes.
In
connection with financing transactions, the Company issued warrants to purchase common stock and convertible promissory notes.
These instruments included provisions that could result in a reduced exercise price based on specified full-ratchet anti-dilution
provisions. The “reset” provisions were triggered in the event the Company subsequently issued common stock, stock
warrants, stock options or convertible debt with a stock price, exercise price or conversion price lower than contractually specified
amounts. Upon triggering the “reset” provisions, the exercise / conversion price of the instrument will be reduced.
Accordingly, pursuant to ASC 815, these instruments were not considered to be solely indexed to the Company’s own stock
and were not afforded equity treatment.
The
following table summarizes activity in the Company’s derivative liability during the years ended December 31, 2017 and 2016:
12-31-2015 Balance
|
|
$
|
1,197,952
|
|
Creation
|
|
|
2,813,219
|
|
Settlement
|
|
|
(112,005
|
)
|
Change in Value
|
|
|
1,633,732
|
|
12-31-2016 Balance
|
|
$
|
5,532,898
|
|
12-31-2016 Balance
|
|
$
|
5,532,898
|
|
Creation
|
|
|
1,188,275
|
|
Reclassification to Equity
|
|
|
(163,674
|
)
|
Change in Value and Extinguishment of Debt
|
|
|
(5,856,152
|
)
|
12-31-2017 Balance
|
|
$
|
701,347
|
|
The
Company classifies the fair value of these derivative liabilities under level 3 of the fair value hierarchy of financial instruments.
The fair value of the derivative liability was calculated using a Black Scholes model. The Company’s stock price and estimates
of volatility are the most sensitive inputs in validation of assets and liabilities at fair value. The liabilities were measured
using the following assumptions:
Term
|
|
|
0.5 years -7.0 years
|
|
Dividend Yield
|
|
|
0
|
%
|
Risk-free rate
|
|
|
1.20% - 1.77
|
%
|
Volatility
|
|
|
60
|
%
|
8.
GOING CONCERN
The
Company’s financial statements are prepared using the generally accepted accounting principles applicable to a going concern,
which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has
historically incurred net losses and as of December 31, 2017 had an accumulated deficit totaling $13.1 million. During the years
ended December 31, 2017 and 2016, the Company utilized an aggregate of $1.35 Million of cash in operating activities and incurred
an aggregate net loss of $3.9 million. The continuing losses have adversely affected the liquidity of the Company.
In
view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown
in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s
ability to raise additional capital, obtain financing and to succeed in its future operations. The financial statements do not
include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification
of liabilities that might be necessary as a result of the Company’s going concern uncertainty.
Management’s
plan regarding this matter is to, amongst other things, seek additional equity financing by selling our equity securities, obtaining
funds through the issuance of debt, and continue seeking approval from the FDA to bring to market our real-time imaging platform.
We cannot assure you that funds from these sources will be available when needed or, if available, will be on terms favorable
to us or to our stockholders. If we raise additional funds or settle liabilities by issuing equity securities, the percentage
ownership of our stockholders will be reduced, stockholders may experience additional dilution or such equity securities may provide
for rights, preferences or privileges senior to those of the holders of our common stock. Our ability to execute our business
plan and continue as a going concern may be adversely affected if we are unable to raise additional capital or operate profitably.
The
Company anticipates that further equity/debt financings will be necessary to continue to fund operations in the future and there
is no guarantee that such financings will be available or, if available, on acceptable terms.
9.
COMMITMENTS AND CONTINGENCIES
Leases
The
Company entered into a facility lease agreement effective June 1, 2015 for three years with an option to extend for a 24 month
period effective on June 1, 2018.
Future
annual minimum lease commitments, excluding property taxes and insurance, on this lease are as follows:
Litigation
In
2009, the Company was notified by the Internal Revenue Service that additional payroll taxes, interest, and penalty charges were
still owed. After researching, it is believed that the Internal Revenue Service double booked the original payments made and released
the lien in error. Settlement was reached and the Company is currently paying $2,578 per month on a total liability of $16,831
as of December 31, 2017, including interest and penalties, with a potential balloon payment in one year subject to re-negotiation
after one year with the IRS.
Administrative
Claim of Greenberg Glusker Fields Claman & Machtinger LLP
On
January 30, 2017 the Company entered into a new Agreement. Under the terms of the Agreement, the Company has agreed to pay Greenberg
$1,117,574 plus any interest that has accrued at the rate of 6.0% per annum, as follows: (i) $100,000 on or before December 31,
2017 (which as of April 17, 2018 has not been paid); (ii) $150,000 on or before December 31, 2018 (iii) 4.0% of the first $2.5
million of gross proceeds of any private or public offering by the company (an “Offering”); (iv) 2.0% of the next
$2.5 million of gross proceeds from such Offerings; (v) 4.0% of any gross proceeds thereafter from such Offerings; and (vi) the
remaining balance on or before December 31, 2019.
In
addition, Greenberg has the option to convert up to $150,000 of the balance into a warrant that would convert on terms that are
equal to (or, in certain cases, better than) the terms offered in subsequent rounds of financing.
Bankruptcy
Closure
On
January 31, 2017, United States Bankruptcy Judge for the Central District of California, Neil Bason, granted the Company’s
unopposed motion for entry of final decree and also granted approval of the two stipulations regarding payment of court-approved
fees. As a result, the Imaging3 Chapter 11 proceeding is now closed. The Company is no longer subject to the jurisdiction of the
Bankruptcy Court, and the case cannot be converted to a Chapter 7 proceeding, except that the Judge’s order in its final
paragraph stated that “Notwithstanding the foregoing [order closing the bankruptcy case pursuant to 11 United States Code
Section 350(a)] the bankruptcy case may be reopened on motion as set forth in the Greenberg, Glusker Fee Agreement and/or the
Mentor Fee Agreement and thus the court retains jurisdiction for those purposes and as otherwise provided by law or as contemplated
by the prior orders and proceedings of this court”. Thus, technically, the case could possibly be reopened by either of
those aforementioned creditors. As of the date of filing of this report, the Company is in default of certain terms of the Greenberg,
Glusker and Mentor agreements, however, the Company maintains open and cordial relations with Greenberg, Glusker and Mentor.
Pending
Litigation
On
September 13, 2017 Alpha Capital Anstalt and Brio Capital Master Fund, LTD, two minority members of a group of investors in the
Company, filed a lawsuit seeking damages and injunctive relief in the United States District Court for the Southern District of
New York, claiming that the Company breached certain Note and Warrant agreements among the parties to the action. The holders
of the majority of the investment involved in the above lawsuit chose not to join in the lawsuit. On November 21, 2017, the Court
denied the Plaintiff’s request for injunctive relief against the Company. As a result the case essentially becomes an action
for money damages against the Company, which the Company believes to be without merit and will vigorously defend.
10. RELATED PARTY TRANSACTIONS
In January of 2017, the Company issued 1,500,000 shares valued at $45,000 to Emilio
Aguilera, the son of the Company’s Chief Financial Officer, for services rendered.
11.
SUBSEQUENT EVENTS
On
March 16, 2018, the Company effected a reverse split of all the outstanding shares of common stock at a ratio of 1 for 20.
Effective
March 5, 2018, Imaging3, Inc. (the “Company”) completed a change of domicile (the “Reincorporation”) to
Delaware from California by means of a merger of Imaging3 Inc., a California corporation (“IGNG-CA”) with and into
the Company’s wholly-owned subsidiary, Imaging3, Inc., a Delaware corporation (“IGNG-DE”). The merger agreement
was entered into on September 22, 2017 and was previously disclosed and attached as an appendix to the Company’s Definitive
Proxy Statement on Form 14A filed with the Securities and Exchange Commission on October 3, 2017 (the “Proxy Statement”).
The certificate of merger was accepted by the State of Delaware on March 5, 2018. The Reincorporation was approved by a majority
of the Company’s stockholders at a special meeting of stockholders on November 16, 2017.
During
the first quarter ending March 31, 2018, the Company issued 16,374,615 shares of common stock, 1,900,000 shares related to services
valued at $413,000. 474,615 shares were issued for cash proceeds of $70,000, and 14,000,000 shares related to Stock-based compensation.