Grapefruit USA, Inc - Annual Report: 2016 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2016

Commission file number 000-50099

IMAGING3, INC.

(Exact name of registrant as specified in its charter)

3022 North Hollywood Way, Burbank, California 91505

(Address of principal executive offices) (Zip Code)

(818) 260-0930

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes [  ] No [X]

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $0 as of December 31, 2016 (computed by reference to the fact that no last sale price of a share of the registrant’s Common Stock on that date was reported by any securities exchange or public securities trading market.)

There were 259,621,593 shares outstanding of the registrant’s Common Stock as of March 31, 2017.

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

General

Imaging3, Inc. has developed a proprietary medical technology designed to produce 3D medical diagnostic images in real time. In the future, healthcare workers using Imaging3 devices will potentially be able to instantly view 3D, high-resolution images of virtually any part of the human body. The company has also entered into a Dealership Agreement with Envisiontec to promote and distribute 3-D Printers. The company feels these units can and will eventually tie into their current 3-D technology.

Business Operations

Imaging3 technology has the potential to contribute to the improvement of healthcare. Our technology is designed to cause 3D images to be instantly constructed using high-resolution fluoroscopy. These images can be used as real time references for any current or new medical procedures in which multiple frames of reference are required to perform medical procedures on or in the human body. Management believes that Imaging3 technology has extraordinary market potential in an almost unlimited number of medical applications, including:

Multi-function Device

A diagnostic medical imaging device built with Imaging3 technology can perform several functions and can potentially replace or supplement a number of existing devices, resulting in considerable cost savings for hospitals and healthcare centers. These functions include:

Our management believes that this multi-function capability will be especially attractive in foreign markets, where the cost of a computed tomography (“CT”) scanner is beyond the means of most hospitals and healthcare centers.

Existing Base of Business to Launch a Proprietary Product

Imaging3 is an established company with revenues and an industry reputation. While we began as a service provider, we quickly expanded to include equipment and parts sales, both new and renewed. Management believes that Imaging3 was one of the largest remanufacturer of C-arms in the world, prior to its bankruptcy in September 2012. We offered new, demonstration, remanufactured, refurbished, and pre-owned systems in all price ranges from every major manufacturer including OEC, General Electric, Philips, Siemens, FluoroScan, XiScan and Ziehm. We currently supply full-size, compact and mini C-arms.

Business and Revenue Models

Our business strategy is straight-forward: (1) maintain our base of C-arm remanufacturing and service business, and, assuming we achieve the FDA approval we are seeking: (2) develop medical diagnostic imaging devices based on our breakthrough Imaging3 technology for the $5 billion medical imaging market, (3) sell our new medical diagnostic imaging devices directly to healthcare providers, as well as through channel partners and distributors, and (4) license our breakthrough Imaging3 technology to other medical diagnostic imaging device manufacturers.

Our management believes that most of our future revenues will come from the sale of medical imaging devices, based on our Imaging3 technology. Other revenues are expected to be derived from the licensing of our proprietary technology to other medical diagnostic imaging device manufacturers. The smallest portion of our future revenue is projected to come from the sale and service of C-arms and tables.

Proprietary Technology

Patent

On June 23, 2004, U.S. Patent No. 6,754,297 was granted in the name of Dean Janes, entitled Apparatus and Method for Three-Dimensional Real-Time Imaging System. The rights to this patent have been assigned to Imaging3, Inc. As of December 31, 2015 Imaging3 Inc. had one UCC filing against assets that were obtained by Gemini Capital in conjunction with secured notes.

Abstract of the Patent Disclosure

A computing device in a three-dimensional imaging system utilizes a plurality of distance readings and reference readings from at least one subject sensor to determine a subject location and a subject volume and establish a base three-dimensional map of a subject. A plurality of two-dimensional image exposures along with a plurality of associated reference locations are created by rotating an image source and an image receptor around an inner circumference of an imaging gantry. The plurality of two-dimensional image exposures is digitized to create a plurality of digital two-dimensional image exposures. The computing device receives the plurality of digital two-dimensional image exposures and the plurality of associated reference locations. The overlaying, interpolating and pasting of the plurality of digital two-dimensional image exposures on the base three-dimensional map creates a base three-dimensional image exposure, which is displayed on a display device.

General Description

Real-time 3D medical diagnostic imaging will be accomplished by scanning the patient, either partially or completely in a 360-degree circumference under fluoroscopy (or other type of image exposure), utilizing a single or multiple x-ray source and image receptor. The information acquired under fluoroscopy (or other type of image exposure) will be digitized at a frame rate of between 30 to 60 frames per second. This information will be sent to a computer system to be incorporated into a three-dimensional image to be displayed on a computer monitor. The image created can then be manipulated and/or rotated to view the scanned image of the patient’s anatomy in any direction or orientation desired by the user. The user could then choose a specific area of the image to update. Once an area is selected, the computer displaying the image would then “gang” or align the x-ray source(s) and image receptor(s) to begin updating scans of new images to be overlaid upon the existing three-dimensional model. This process would then be updated and/or repeated as many times as necessary for the specific procedure to be completed. At any time, a new reference area or scan could be selected or initiated.

The “O” Device

Part of our invention is based on an “O” device to create a circular gantry similar to that used with CT to scan a patient a full 360 degrees with fluoroscopic radiation. This approach is expected to allow imaging of the patient from any frame of reference or angulation (current medical imaging devices are limited to 150 degrees to 360 degrees with mechanical orientation or manipulation). 3D imaging requires an “O” device to scan the patient in increments of 360 degrees to allow construction of a three-dimensional image. By scanning the patient in 360 degrees and acquiring images at 30 to 60 frames per second, management believes a three-dimensional image can be constructed.

Imaging3 Technology Differs from Other Approaches

The “O” device approach is similar to that used in a CT scan. The difference is CT is used to image a “slice” of the anatomy and not intended for real-time fluoroscopic imaging. The slice is obtained by using a fulcrum reference point and rotating the X-ray source and image receptor in reference to that point. This basic geometry creates a 2D image in any depth desired, in any region of the body. The “O” device would use a similar fulcrum point to reference depth, but the scan would not create a slice but instead a real-time image captured at 30 to 60 frames per second in 360 degrees. Further, management believes that the “O” device would be used for conventional fluoroscopic imaging with the advantage of positioning the X-ray source and receptor at any angulation desired.

Currently, 3D imaging is used only for reconstructive post processing reference images. Magnetic resonance imaging (“MRI”), CT and ultrasound currently have this capability. The 3D images are created by multiple scans of 2D images that require a long period of time to process into a three-dimensional image. The image created is then used only for reference, not real-time manipulation in the body. We anticipate that our 3D images will be constructed almost instantly and will be available to be used as real-time references whenever multiple frames of reference are required to perform medical procedures on or in the human body.

The Market

We compete in the medical diagnostic imaging market and this market has never been healthier than it is today. This vitality is due primarily to continual technological improvements that lead to faster and better resolution imaging, greater patient safety, and the provision of these capabilities to a growing and aging population. The result has been a vigorous competition to create the most cost-effective diagnostic imaging systems.

Diagnostic imaging is an evolving part of modern medicine and is now entering a new era of digital imaging. The field has evolved from the early X-rays by Roentgen over 100 years ago to imaging of organs by CT and MRI that are 20 years old. Medical imaging is used for diagnosis in the leading causes of death, heart attacks, strokes, and cancer. What was once called the radiology department is now called the diagnostic imaging department because of the wealth of new technologies available beyond x-rays. A trauma victim’s internal injuries are imaged with a CT scanner. Breast cancer, a leading cause of death in women, is detected with mammography and ultrasound.

According to a Freedonia Group study, the medical imaging equipment market in the U.S. will register gains faster than the projected growth in national health expenditures. Growth is stimulated by an increasing incidence of patient procedures involving diagnostic imaging, partly the result of an aging population and partly reflecting advances in noninvasive imaging technology.

Our management believes that opportunities exist not only for new companies in imaging products but also for software companies for image processing and Picture Archiving and Communication Systems networks. Technological developments continue, which consistently result in new products.

Diagnostic imaging is an important part of medical diagnosis. It ranges from a dentist’s X-ray to find tooth decay to angiograms done to aid a cardiologist in performing an angioplasty. The aging baby boomer population will need the new imaging capabilities for cancer and heart disease detection. The revolution in medical imaging is being fueled not only by new medical imaging technology, but also by advances in computer hardware and software. New systems such as spiral CT or multi-slice CT would not be possible without today’s faster processors. Better software algorithms for image analysis and compression make the process more accurate and efficient. The growth of diagnostic imaging could be an important source of revenue for computer manufacturers and software companies specializing in diagnostic imaging.

Industry Overview

Diagnostic imaging services are noninvasive procedures that generate representations of the internal anatomy and convert them to film or digital media. Diagnostic imaging systems facilitate the early diagnosis of diseases and disorders, often minimizing the cost and amount of care required and reducing the need for costly and invasive diagnostic procedures.

Computed Tomography

In CT imaging, a computer analyzes the information received from an x-ray beam to produce multiple cross-sectional images of a particular organ or area of the body. CT imaging is used to detect tumors and other conditions affecting bones and internal organs.

Other Services

Other diagnostic imaging technologies include x-ray, single photon emission computed tomography, and ultrasound.

Digital Imaging Technologies

New techniques for the digital capture, display, storage, and transmission of x-ray images are poised to revolutionize the diagnostic imaging market. Although digital technologies and techniques have been in use in other diagnostic imaging areas (such as CT scans, MRI scans, and ultrasound), technical problems have kept x-ray technologies in the era of film. However, new methods of digitally capturing x-ray images are under development and promise to revolutionize x-ray imaging.

The need to cut costs and improve services in healthcare delivery is driving the move to digital systems. The requirement for hospitals to implement electronic access to medical images and other types of information is now widely accepted and regarded as inevitable. The trend toward storing, distributing and viewing medical images in digital form is being fueled by both changes in the economic structure of the healthcare system and by rapidly evolving technologies. In particular, the new economics of health

care will mandate a shift from film-based radiology to the electronic delivery of digital images, while new technology promises the additional benefit of vastly improved diagnostic power.

Users of Diagnostic Imaging

MRI and other imaging services are typically provided in one of the following settings:

Hospitals and Clinics

Imaging systems are located in and owned and operated by a hospital or clinic. These systems are primarily used for the patients of the hospital or clinic, and the hospital or clinic bills third-party payers, such as health insurers, Medicare or Medicaid.

Independent Imaging Centers

Imaging systems are located in permanent facilities not generally owned by hospitals or clinics. These centers depend upon physician referrals for their patients and generally do not maintain dedicated, contractual relationships with hospitals or clinics. In fact, these centers may compete with hospitals or clinics that have their own systems to provide Imaging3 to these patients. Like hospitals and clinics, these centers bill third-party payers for their services.

Outsourced

Imaging systems, largely located in mobile trailers but also provided in fixed facilities, provide services to a hospital or clinic on a shared-service or full-time basis. Generally, the hospital or clinic contracts with the imaging service provider to perform scans of its patients, and the imaging service provider is paid directly by that hospital or clinic instead of by a third-party payor.

Industry Challenges

In a recent report, U.S. Medical Imaging Industry Outlook, Frost & Sullivan identified several challenges facing the diagnostic imaging industry. Low reimbursement rates have become a major challenge, not only for end users, but for manufacturers as well. Imaging reimbursements for many procedures may be inadequate given the expense of the equipment and the expertise required to create and interpret results.

Lack of adequate compensation is a concern for all industry participants, as many healthcare centers are delaying or canceling purchases of high-priced items. Until the financial rewards for imaging are increased substantially, and definitively, low reimbursement will be the foremost hurdle for manufacturers.

Competition

Competitive Landscape

The healthcare industry in general and the market for imaging products in particular is highly competitive. We compete with a number of companies, many of which have substantially greater financial, marketing, and other resources than we have. Our competitors include large companies such as General Electric, Philips, Siemens, Toshiba and Hitachi, which compete in most medical diagnostic imaging modalities, including x-ray imaging.

A study by Theta Reports, Diagnostic Imaging Equipment and Systems World Market, identifies the following 17 key players in the medical diagnostic imaging market:

Direct Competitors

At this time, we are not aware of any existing devices in the marketplace that provide 3D, real-time diagnostic medical imaging, with the exception of ultrasound.

Ultrasound is a real-time tomographic imaging modality. Not only does it produce real-time tomograms of the position of reflecting surfaces (internal organs and structures), but it can also be used to produce real-time images of tissue and blood motion. However, ultrasound is a low-resolution imaging modality that does not produce an image as precise and clear as fluoroscopy. Our devices will rely instead on the use of fluoroscopy, a high-resolution imaging modality, to produce “live” x-ray images of living patients in 3D.

Marketing and Sales Plan

Marketing Strategy

Our marketing strategy is to create a favorable environment to sell our medical diagnostic imaging devices. We intend to enhance, promote and support the fact that Imaging3 technology is the most complete and comprehensive medical diagnostic imaging solution available in the marketplace.

Product and Service Differentiation

According to our management, the differentiating attributes of Imaging3 technology will include:

The Imaging3 medical device will be reasonably priced because it will cost considerably less than comparable MRI and CT Scan machines. It will be easy to install because it is lighter and will be more mobile than the MRI and CT Scan machines. It will have more features than MRI and CT Scan machines because it will provide 3D instant real time images and real time CT emulation, which the other machines currently do not provide. Management believes that the Imaging3 medical device will be more reliable than competing MRI and CT Scan machines because it needs less radiation to provide its 3D images, and its assembled components are simpler, more efficient, and standard (i.e. “off-the-shelf”), rather than customized.

Value Proposition

Our value proposition is simple: diagnostic imaging devices with Imaging3 technology allow healthcare providers to easily produce 3D, real-time, high resolution images at a reasonable cost.

Positioning

Management believes that Imaging3 can be positioned as offering the superior solution for producing medical diagnostic images. Management believes that our unique advantage is that we can offer a diagnostic imaging solution that will allow healthcare providers to view real-time references for virtually any procedure. We plan to reposition our competitors by demonstrating that their offerings are inadequate compared to our device because they:

Sales Strategy

After undertaking a marketing campaign, we intend to aggressively sell our medical diagnostic imaging devices in the United States. International sales efforts will follow after achieving market penetration in the domestic marketplace.

Sales Margin Structure

Our management believes that the majority of our sales will be derived from direct sales to customers, with the balance of sales derived from dealers and manufacturer’s representatives. As a result, the sales margin structure must be attractive to these independent organizations.

Target Market Segment

Our management has identified general medical and surgical hospitals in the United States as our primary target market segment for Imaging3 technology. According to D&B/ iMarket, there are 12,041 general medical and surgical hospitals in the United States.

Distribution Channels

We plan to sell our Imaging3 medical diagnostic imaging devices through several channels of distribution, including:

Direct Sales to End Users

Our policy is to sell directly to end-users whenever possible. Our management expects that direct sales will occur most often with larger customers.

Dealers and Manufacturers’ Representatives

We plan to supplement our own field sales force by entering into agreements with dealers and manufacturers’ representatives. Because dealers and manufacturers’ representatives carry several product/service lines that are compatible with our products and services, Imaging3 plans to select dealers and manufacturers’ representatives carrying complementary and compatible products and services, as well as dealers and manufacturers’ representatives that sell dissimilar products and services yet are appropriate for their customers’ customer.

We have working relationships with a number of independent organizations that help distribute our current product line. We expect to work with these independent organizations to help distribute diagnostic medical imaging devices built with Imaging3 technology. These organizations have well-established relationships with mid-size to large size customers. Many also provide specific vertical market applications.

Executive Sales

Because many of Imaging3’s large customers will tend to be top healthcare managers, it is important that our president and senior managers present our products to our large customers.

Field Sales Force

Management anticipates that the majority of our selling efforts to large accounts will be handled internally through our field sales force. We have chosen to use a direct sales force because our large accounts require considerable customer education and post-sales support directly from us. Management believes that our price points, pricing structure and profits are such that our cost of sales warrants a “person-to-person” selling strategy.

Employees

We currently employ 2 full-time individuals, all of whom are working at our leased offices at 3022 North Hollywood Way, Burbank, California 91505. Both 2 full-time employees are executive officers and directors of the Company.

To support our need for technical staffing, we have established relationships with technical staffing organizations that continuously offer highly qualified personnel to meet our needs, both locally and from out of the area.

Intellectual Property Matters

Our policy is to have all of our employees execute agreements that impose nondisclosure obligations on the employee and in which the employee has assigned to us (to the extent permitted by California law) all copyrights and other inventions created by the employee during employment with us. The rights underlying the application for the patent of the Imaging3 technology have been assigned to us. We have in place a trade secret protection policy that our management believes to be adequate to protect our intellectual property and trade secrets.

Government Regulatory Approval Process

All of our products are classified as Class II (Medium Risk) devices by the FDA and clinical studies with our products will be considered to be Non-Significant Risk Studies, except that our 510(k) application with the FDA for our proprietary medical imaging device has not yet been approved as a Class II device. Imaging3’s business is governed by the FDA and all products typically require 510(k) market clearance before they can be put in commercial distribution. We are also regulated by the FDA’s Quality Systems Regulation, which is similar to the ISO9000 and the European EN46000 quality control regulations. All of our products currently in production or manufactured by other vendors are approved for marketing in the United States under the FDA’s 510(k) regulations.

A 510(k) is a pre-marketing submission made to the FDA to demonstrate that the device to be marketed is as safe and effective, that is, substantially equivalent, to a legally marketed device that is not subject to pre-market approval. Applicants must compare their 510(k) device to one or more similar devices currently on the U.S. market and make and support their substantial equivalency claims. A legally marketed device is a device that was legally marketed prior to May 28, 1976 (pre-amendments device), or a device which has been reclassified from Class III to Class II or I, a device which has been found to be substantially equivalent to such a device through the 510(k) process, or one established through Evaluation of Automatic Class III Definition. The legally marketed device(s) to which equivalence is drawn is known as the “predicate” device(s).

Applicants must submit descriptive data and when necessary, performance data to establish that their device is substantially equivalent to a predicate device. The data in a 510(k) is to show comparability, that is, substantially equivalent of a new device to a predicate device.

The FDA does not offer an opinion or determination of what submission is required. The FDA does provide a database of devices, classifications and Regulation numbers. In our research of this database we determined several Class II devices meet our criteria for submission. These devices are listed in the table below.

This is a broad range of devices with which to compare our device functionality. The FDA requires the manufacturer to submit an application, whether it is a 510(k) or pre-market approval submission. Upon receipt of the submission, the FDA will respond within 30 to 45 days with their determination of acceptance of the submission, questions and/or comments to the submission or requests for more information.

All of our current used rebuilt products are Class II devices, FDA approved through OEM for marketing. Once approved, the FDA will not require the manufacturer to resubmit an application or change the classification. They may, however, request further information about the product(s), manufacturer and GMP requirements. The devices currently sold by us are not manufactured by us. OEC Medical Systems is the original device manufacturer and responsible for the FDA submission of their original device(s). Imaging3 remanufactures OEC Medical Systems devices, thus we are not required to submit any FDA submission for these devices. In some instances, we have performed modifications to these devices to improve the devices functionality, and in these instances Imaging3 has submitted 510(k) applications. These modifications are to existing devices with existing classifications listed in the FDA database and cannot be reclassified. The FDA database listing for current products is listed below:

As to our new product and its potential for classification, the FDA requires us, as the manufacturer, to submit an application in whichever classification we choose in the submission form we choose, meaning 510(k) or pre-market approval application. The FDA reviews the submission and determines whether the application is appropriately filed and in the correct submission format. The criteria they use for determination on a 510(k) is substantially equivalent, which is a comparative analysis of the manufacturer’s device in the submission with existing devices already approved by the FDA. This is the purpose of the FDA’s Device Classification Database, giving manufacturer’s products with approved submissions and categories of devices to compare new device submissions. A new type of device may not be found in the product classification database. If the device is a high risk device (supports or sustains human life, is of substantial importance in preventing impairment of human health, or presents a potential, unreasonable risk of illness or injury) and has been found to be not substantially equivalent to a Class I, II, or III (Class III requiring 510(k)), then a pre-market approval application will be required.

Our new product, the “Real-time 3D Imaging Device” is expected to be submitted as Product Code “IZG,” Device Class II, “System, X-ray, Photo fluorography,” Regulation Number 892.1730, since this is the closest device description.

The pre-market approval applicant is usually the person who owns the rights, or otherwise has authorized access, to the data and other information to be submitted in support of FDA approval. This person may be an individual, partnership, corporation, association, scientific or academic establishment, government agency or organizational unit, or other legal entity. The applicant is often the inventor/developer and ultimately the manufacturer.

FDA regulations provide 180 days to review the pre-market approval application and make a determination. In reality, the review time is normally longer. Before approving or denying a pre-market approval application, the appropriate FDA advisory committee may review the pre-market approval application at a public meeting and provide the FDA with the committee’s recommendation on whether or not the FDA should approve the submission. After the FDA notifies the applicant that the pre-market approval application has been approved or denied, a notice is published on the Internet (1) announcing the data on which the decision is based, and (2) providing interested persons an opportunity to petition the FDA within 30 days for reconsideration of the decision.

A pre-market approval application is a scientific, regulatory documentation to the FDA to demonstrate the safety and effectiveness of the Class II device. There are administrative elements of a pre-market approval application, but good science and scientific writing is a key to the approval of a pre-market approval application. If a pre-market approval application lacks elements listed in the administrative checklist, the FDA will refuse to accept a pre-market approval application and will not proceed with the in-depth review of scientific and clinical data. If a pre-market approval application lacks valid clinical information and scientific analysis based on sound scientific reasoning, it will delay the FDA’s review and approval. Pre-market approval applications that are incomplete, inaccurate, inconsistent, omit critical information, and are poorly organized have resulted in delays in consideration.

Three categories of the pre-market approval application are very important:

Technical Sections. The technical sections containing data and information should allow the FDA to determine whether to approve or disapprove the application. These sections are usually divided into non-clinical laboratory studies and clinical investigations.

Non-clinical Laboratory Studies’ Section. The non-clinical laboratory studies’ section includes information on microbiology, toxicology, immunology, biocompatibility, stress, wear, shelf life, and other laboratory or animal tests. Non-clinical studies for safety evaluation must be conducted in compliance with 21CFR Part 58 (Good Laboratory Practice for Nonclinical Laboratory Studies).

Clinical Investigations Section. The clinical investigations section includes study protocols, safety and effectiveness data, adverse reactions and complications, device failures and replacements, patient information, patient complaints, tabulations of data from all individual subjects, results of statistical analyses, and any other information from the clinical investigations. Any investigation conducted under an Investigational Device Exemption must be identified as such.

We are listed with the FDA as a new device manufacturer, our Registration Number is 20300565, and our Owner Operator Number is 9023393. Though we do not currently manufacture new devices, the FDA requires our registration as a remanufacturer. Imaging3 is subject to the FDA’s Radiological Health Program, under the Center for Devices Radiological Health division of the FDA.

We must be in compliance with Good Manufactures Practices (“GMP”), Quality Control, and Medical Device Reporting (“MDR”). The FDA may from time to time, usually every two to three years, audit us for compliance. In these audits the FDA reviews documents, interviews management and reviews all procedures.

The current GMP requirements set forth in the Quality System (“QS”) regulation are promulgated under Section 520 of the Federal Food, Drug and Cosmetic (“FFD&C”) Act. They require that domestic or foreign manufacturers have a quality system for the design, manufacture, packaging, labeling, storage, installation, and servicing of finished medical devices intended for commercial distribution in the United States. The regulation requires that various specifications and controls be established for devices; that devices be designed under a quality system to meet these specifications; that devices be manufactured under a quality system; that finished devices meet these specifications; that devices be correctly installed, checked and serviced; that quality data be analyzed to identify and correct quality problems; and that complaints be processed. Thus, the QS regulation helps assure that medical devices are safe and effective for their intended use. The FDA monitors device problem data and inspects the operations and records of device developers and manufacturers to determine compliance with the GMP requirements in the QS regulation.

The MDR regulation provides a mechanism for the FDA and manufacturers to identify and monitor significant adverse events involving medical devices. The goals of the regulation are to detect and correct problems in a timely manner. Although the requirements of the regulation can be enforced through legal sanctions authorized by the FFD&C Act, the FDA relies on the goodwill and cooperation of all affected groups to accomplish the objectives of the regulation.

The statutory authority for the MDR regulation is Section 519(a) of the FFD&C Act as amended by the Safe Medical Devices Act of 1990. The Safe Medical Devices Act of 1990 requires user facilities to report:

When a problem arises with a product regulated by the FDA, the agency can take a number of actions to protect the public health. Initially, the agency works with the manufacturer to correct the problem voluntarily. If that fails, legal remedies include asking the manufacturer to recall a product, having federal marshals seize products if a voluntary recall is not done, and detaining imports at the port of entry until problems are corrected. If warranted, the FDA can ask the courts to issue injunctions or prosecute those that deliberately violate the law. When warranted, criminal penalties including prison sentences are sought.

Once on the market, there are post-market surveillance controls with which a manufacturer must comply. These requirements include the Quality Systems (also known as Good Manufacturing Practices), and Medical Device Reporting regulations. The QS regulation is a quality assurance requirement that covers the design, packaging, labeling and manufacturing of a medical device. The MDR regulation is an adverse event reporting program.

We are also required to report under the MDR requirements, which are for injuries and deaths, of which we have had none since our registration.

For all devices manufactured or remanufactured by us, the FDA may request updated information regarding any device with a previously approved 510(k) or pre-market approval submission. If any substantial changes are made to existing approved devices, the FDA may require a 510(k) supplement submission, which, in most cases, does not require the manufacturer to delay production or marketing of the modified device. As with all applications, this determination lies entirely with the FDA.

Our last audit with the FDA was in 2010 and we expect a new audit to take place shortly after our new device is resubmitted to the FDA in a 510(k) application.

In an audit performed by the FDA, our records for service and repair, quality control, device labeling and serial number tracking are reviewed. If the FDA finds issues of non-compliance they issue a letter requesting correction, giving us 30 days to correct the non-compliance. Extensions can be requested to reply, but most issues, if any, can be handled in a 30-day period.

Since our registration with the FDA in 1995, we have had two audits. We did not receive any notice or correspondence of non-compliance due to those audits. We received only one suggestion regarding our record keeping process, which addressed preventive maintenance forms being included in all customer files for which we provide service.

We have had no instances of non-compliance with either the FDA or the State of California. The consequences of non-compliance range from a letter stating non-compliance and a period to cure, suspension of manufacturing and distribution, to fines and suspension of operations.

We intend to seek to obtain FDA approval of our proprietary medical imaging device in 2017, although we cannot assure that this approval will be granted when expected. All of our marketing efforts for the new device must start from the date the FDA approves the device to be marketed. Since we are already registered with the FDA as a new device manufacturer and have been through an audit performed by the FDA, the FDA is already familiar with us and our processes. The FDA may wish to obtain updated information about us and may require more time to process our planned 510(k) resubmission than estimated.

To enter the European market, our products as well as our quality assurance systems will have to be approved and certified by an authorized certifying body such as Technischer Uberwachungsverein; English translation: Technical Inspection Association (“TUV”), Underwriters Laboratories (“UL”) or British Standards Institute (“BSI”). In the future, we may plan to go through this process as a part of our overall enhancement of the quality systems.

TUV, UL and BSI are all standards testing companies assisting manufactures to comply with published standards, regulatory standards and laws necessary for marketing devices throughout the world and the United States. These three companies provide the UL and CE (the European equivalent of the UL mark in the United States) marks, demonstrating compliance with the standards and laws.

TUV is a Nationally Recognized Testing Laboratory and Safety Checklist Contractors certified, providing a full suite of services, including CE Marking assistance, electromagnetic compatibility, electrical & mechanical testing, and many additional global conformity assessment services that help companies gain product compliance to enter individual country markets.

UL is an independent, not-for-profit product-safety testing and certification organization. They have tested products for public safety for more than a century. Since their founding in 1894, they have held the undisputed reputation as a leader in product- safety testing and certification within the United States. Management believes that by building on their household name in the United States, UL is becoming one of the most recognized, reputable conformity assessment providers in the world. Today, their services extend to helping companies achieve global acceptance, whether for an electrical device, a programmable system, or an organization’s quality process.

BSI exists to help industry develop new and better products and to make sure that products meet current and future laws and regulations. It tests products from medical devices to fire extinguishers to lamps for football stadiums against published standards.

Far East, Middle East, Eastern European, and Latin American markets have different regulatory requirements. We intend to comply with applicable requirements if and when we decide to enter those markets.

Other Government Regulations

The delivery of health care services has become one of the most highly regulated of professional and business endeavors in the United States. Both the federal government and individual state governments are responsible for overseeing the activities of individuals and businesses engaged in the delivery of health care services. Federal law and regulations are based primarily upon the Medicare and Medicaid programs. Each of these programs is financed, at least in part, with federal funds. State jurisdiction is based upon the state’s interest in regulating the quality of health care in the state, regardless of the source of payment. We believe that we are materially complying with applicable laws, however, we have not received or applied for a legal opinion from counsel or from any federal or state judicial or regulatory authority. Additionally, many aspects of our business have not been the subject of state or federal regulatory interpretation. The laws applicable to us are subject to evolving interpretations. If our operations are reviewed by a government authority, we may receive a determination that could be adverse to us. Furthermore, laws that are applicable to us may be amended in a manner that could adversely affect us.

Only a small portion of our revenues come through a government system. Virtually all of our revenues are obtained from sales and service to vendees who pay us directly. We have not been subject to Medicare, Medicaid, or any other federally funded health care program.

ITEM 1A. Risk Factors

Not applicable.

ITEM 2. PROPERTIES

We currently maintain and lease our administrative offices and production facility at 3022 North Hollywood Way, Burbank, California 91505. This facility contains 1,800 square feet of space, and we currently pay rent at a rate of $2.00 per square foot gross.

ITEM 3. LEGAL PROCEEDINGS

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; (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. The Company noted that as a result, the Imaging3

Chapter 11 proceeding is now closed—the ompany is no longer subject to the jurisdiction of the Bankruptcy Court, and the case cannot be converted to a Chapter 7 proceeding.

To clarify, the Judge’s order in its final paragraph stated that “Notwithstanding the foregoing [order closing the bankruptcy case pursuant to 11United 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”. Thusly, technically, the case could possibly be reopened by either of those aforementioned creditors.

Vuksich Litigation

During April 2016 John M. Vuksich appealed to Supreme Court on the most recent rulings dismissing his charges. On October 3, 2016 the Supreme Court entered the following order: The petition for a writ of certiorari is denied.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Common Stock

After meeting all of the filing requirements of the SEC, the Company commenced trading on the OTCQB effective June 22, 2016 under the new trading symbol “IGNG”. The OTCQB is part of the quality controlled segment of the over-the-counter market, available only to SEC reporting companies which are current in their regulatory filing requirements and maintain a minimum bid price. The range of high and low bid quotations for each fiscal quarter within the last two fiscal years was as follows:

The above quotations reflect inter-dealer prices, without retail markup, mark-down, or commission and may not necessarily represent actual transactions.

As of March 17, 2017, there were approximately 8,375 record holders of our common stock, not including shares held in “street name” in brokerage accounts which is unknown. As of December 31, 2016, there were approximately 241,520,093 shares of our common stock outstanding on record.

Dividends

We have not declared or paid any cash dividends on our common stock and do not anticipate paying dividends for the foreseeable future.

Stock Option Plan

During 2014, the Board of Directors adopted, and the shareholders approved, the 2014 Stock Option Plan under which a total of 36,228,014 shares of common stock had been reserved for issuance. The 2014 Stock Option Plan will terminate in September 2024.

Stock Options

As of December 31, 2016, employees of the Company hold options to purchase 13,000,000 shares of common stock at an exercise price of $0.025.

The weighted average remaining contractual life of options outstanding issued under the Plan was 8.86 years at December 31, 2016.

Warrants

Following is a summary of warrants outstanding at December 31, 2016:

Preferred Stock

As of January 18, 2016, Imaging3 issued 2000 preferred voting shares to Dane Medley, CEO/Chairman. Each share constitutes 350,000 voting shares.

ITEM 6. SELECTED FINANCIAL DATA

Not applicable because we are a smaller reporting company.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL AND CONDITION RESULTS OF OPERATIONS

Cautionary Statements

This Form 10-K contains financial projections and other “forward-looking statements,” as that term is used in federal securities laws, about Imaging3, Inc.’s financial condition, results of operations and business. These statements include, among others, statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Form 10-K. You can find many of these statements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions used in this Form 10-K. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important facts that could prevent us from achieving our stated goals include, but are not limited to, the following:

We cannot assure that we will be profitable. We may not be able to develop, manage or market our products and services successfully. We may not be able to attract or retain qualified executives and technology personnel. We may not be able to obtain customers for our products or services. Our products and services may become obsolete. Government regulation may hinder our business. Additional dilution in outstanding stock ownership will be incurred due to the issuance or exercise of more shares, warrants and other convertible securities.

Because the statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by the forward-looking statements. We caution you not to place undue reliance on the statements, which speak only as of the date of this Form 10-K. The cautionary statements contained or referred to in this section should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may make. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

The following discussion should be read in conjunction with our financial statements and notes to those statements. In addition to historical information, the following discussion and other parts of this annual report contain forward-looking information that involves risks and uncertainties.

Current Overview

Our current focus is (a) on complying with our Chapter 11 Reorganization Plan by continuing to improve our 3D medical imaging technology, and to prepare to re-file our application with the FDA for approval of our 3D medical imaging device.

On October 28, 2010, we received a letter from the United States Food and Drug Administration (“FDA”) responding to our application for clearance by the FDA of our 3D medical imaging technology and device. In our application to the FDA under Section 510(k) of the applicable federal legislation, we stated that our medical device is substantially equivalent to devices marketed in interstate commerce prior to May 28, 1976 and therefore should be approved for commercial sale and use as a Class II device, without the necessity for clinical trials. The FDA responded by rejecting our position that our medical device is substantially equivalent to such prior devices. We disagree with the FDA’s position and plan to re-file our application with additional information supporting our application for clearance.

In the absence of FDA approval for our medical device, we currently do not and cannot rely upon it as a future source of sales and revenue. We are subject to the uncertainty of not knowing whether or when our proprietary medical device will be approved and can be sold. Under those circumstances, management believes that we will continue our current trend of incurring operating losses, possibly requiring us to raise additional capital or financing from outside sources. We cannot assure that we will be able to raise sufficient capital or financing to maintain our business while we are incurring operating losses, and we cannot assure that we will become profitable if our proprietary medical device is approved by the FDA.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We monitor our estimates on an on-going basis for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

We have identified the policies below as critical to our business operations and the understanding of our results of operations.

Stock-based Compensation

We measure and recognize compensation expense for all share-based payment awards made to employees and directors based on the grant date fair values of the awards. For stock option awards to employees with service and/or performance based vesting conditions, the fair value is estimated using the Black-Scholes option pricing model. The value of an award that is ultimately expected to vest is recognized as expense over the requisite service periods in our statements of operations. Our stock-based awards are comprised principally of shares issued for services and stock options.

We account for stock options issued to non-employees in accordance with the guidance for equity-based payments to non-employees. Stock option awards to non-employees are accounted for at fair value using the Black-Scholes option pricing model. Management believes that the fair value of stock options is more reliably measured than the fair value of the services received. The fair value of the unvested portion of the options granted to non-employees is re-measured each period. The resulting increase in value, if any, is recognized as expense during the period the related services are rendered.

The Black-Scholes option pricing model requires management to make assumptions and to apply judgment in determining the fair value of our awards. The most significant assumptions and judgments include estimating the fair value of our underlying stock, the expected volatility and the expected term of the award. In addition, the recognition of stock-based compensation expense is impacted by estimated forfeiture rates.

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. Equipment sales usually have a one year warranty of parts and service. After a one year period, the Company contacts the buyer to initiate the sale of a new warranty contract for one year. 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.

Other Accounting Factors

The effects of inflation have not had a material impact on our operation, nor are they expected to in the immediate future.

Although we are unaware of any major seasonal aspect that would have a material effect on the financial condition or results of operation, the first quarter of each fiscal year is always a financial concern due to slow collections after the holidays.

The following sets forth selected items from our statements of operations for the years ended December 31, 2016 and 2015.

Results of Operations for the Year Ended December 31, 2016 as compared to the Year Ended December 31, 2015.

We had revenues for the year ended December 31, 2016 of $33,083 as compared to $220,809 for the year ended December 31, 2015, which represented a 85% decrease. The decrease in sales was attributed directly to a decrease in warranty sales and equipment sales for this period. Due to our lack of working capital caused by the reorganization process, the company did not have the ability to maintain requisite technical and sales personnel to continue operating as a cash–generating sales and service business. Therefore, management decided to concentrate its post – reorganization business on obtaining FDA 510k approval of its Smart-Scan technology. As a result, the Company concentrated on generating cash through financing activities. Cash raised through financing activities was expended on day to day business operations in connection with preparation for our 510K submittal, managing the post-bankruptcy emergence administration of our obligations under the approved bankruptcy plan, legal and audit fees, and actual payments to creditors required by the court-approved reorganization plan.

Our cost of revenue was $10,247 for the year ended December 31, 2016 as compared to $169,120 for the year ended December 31, 2015. This decrease was related to a decrease in sales volume. Our gross profit margin for the year ended December 31, 2016 was $22,836 as compared to $51,689 for the year ended December 31, 2015. Our total operating expenses increased in 2016 to $2,697,527 from $1,503,088 for the year ended December 31, 2015, an increase of 79% due primarily to increased Research & Development and stock based compensation expenses. Other expenses increased due to increased interest associated with convertible notes issued during 2016 and the change in value of derivative liabilities. Our net loss for the fiscal year ending December 31, 2016 was $6,761,470 as compared to a net loss of $2,632,432 for the fiscal year ending December 31, 2015.

Under current accounting guidance, deferred income taxes are reported using the liability method. Deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. We have recorded insignificant liabilities of $800 per year for income taxes for the state minimum tax of $800 imposed on corporations.

We expect the trend of operating losses by us to continue into the future at the current or greater rate as we spend money on product development and marketing. We cannot assure that we can achieve profitability. We do not expect litigation against us to expand and believe litigation is on a decreasing trend, although we can give no assurances in relation to future litigation.

Liquidity and Capital Resources

Our total current assets decreased to $22,638 as of December 31, 2016, from $61,013 as of December 31, 2015. The cash account as of December 31, 2016 was $22,638 compared to $9,508 as of December 31, 2015.

Our total current liabilities increased to $8,170,835 as of December 31, 2016 from $3,911,966 as of December 31, 2015. This increase is due in large part to an increase in derivative liability for this reporting period.

The cash account as of December 31, 2016 was $22,638 compared to $9,508 as of December 31, 2015. Due to our lack of working capital caused by the reorganization process, the Company did not have the ability to maintain requisite technical and sales personnel to continue operating as a cash-generating sales and service business. Therefore, management decided to concentrate its post-reorganization business on obtaining FDA 510K approval of its Smart Scan TM technology and on generating cash through financing activities, to fund the approval process. Cash raised through financing activities was expended primarily on: (i) day-to-day business operations in connection with preparation for our 510K submittal, (ii) administration of the bankruptcy process, (iii) legal and audit fees, and (iv ) payments to creditors required by the court-approved reorganization plan

During the year ended December 31, 2016, we used $603,770 of net cash for operating activities, as compared to $609,831 used during the year ended December 31, 2015. Net cash provided by financing activities during the year ended December 31, 2016 was $616,900, as compared to $606,975 during the year ended December 31, 2015.

We expect our working capital requirements in the next twelve months to be met primarily by the proceeds of private placements of common stock, convertible instruments and other securities to our existing shareholders and other investors. We expect to need additional working capital from outside sources to cover our anticipated operating deficits and to finance the re-filing of our application to the FDA for our proprietary 3D medical imaging device. There is no assurance that the Company will be able to raise sufficient additional capital or financing to continue in business or to effectively execute its business plan.

Going Concern Qualification

We have incurred significant losses from operations, and such losses are expected to continue. In their report on our financial statements as of and for the period ended December 31, 2016, our auditors have expressed substantial doubt about our ability to continue as a going concern. In addition, we have limited working capital. The foregoing raises substantial doubt about our ability to continue as a going concern. Management’s plans include seeking additional capital and/or debt financing. We cannot guarantee that additional capital and/or debt financing will be available when and to the extent required, or that if available it will be on terms acceptable to us. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The “Going Concern Qualification” may make it substantially more difficult for us to raise capital.

Off-Balance Sheet Arrangements

None.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

IMAGING3, INC.

FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2016 and 2015

CONTENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Imaging3, Inc.

We have audited the accompanying balance sheets of Imaging3, Inc. (the “Company”) as of December 31, 2016 and 2015, and the related statements of operations, stockholders’ deficit, and cash flows for each of the years in the two-year period ended December 31, 2016. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Imaging3, Inc. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 10 to the financial statements, the Company has incurred significant operating losses and negative cash flows from operations during the years ended December 31, 2016 and 2015. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 10. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Rose, Snyder & Jacobs LLP

Encino, California

April 14, 2017

IMAGING3, INC.

BALANCE SHEETS

The accompanying notes form an integral part of these financial statements.

IMAGING3, INC.

STATEMENTS OF OPERATIONS

The accompanying notes form an integral part of these financial statements.

IMAGING3, INC.

STATEMENTS OF CASH FLOWS

The accompanying notes form an integral part of these financial statements.

IMAGING3, INC.

STATEMENT OF STOCKHOLDERS’ DEFICIT

FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

The accompanying notes form an integral part of these financial statements.

IMAGING3, INC.

Notes to Financial Statements

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

Imaging3, Inc. (the “Company”, “us”, “we”, “Imaging3”) is a California corporation incorporated on October 29, 1993 as Imaging Services, Inc. The Company filed a certificate of amendment of articles of incorporation to change its name to Imaging3, Inc. on August 20, 2002.

The Company’s primary business has been refurbishment and sale of medical equipment, parts and services to hospitals, surgery centers, research labs, physician offices and veterinarians. Equipment sales have included new and used c-arms, c-arms tables, and surgical tables. Part sales are comprised of replacement parts for c-arms.

The Company has developed a proprietary medical technology designed to produce 3d medical diagnostic images in real time. We believe Imaging3 technology has the potential to contribute to the improvement of healthcare. Our technology is designed to cause 3D images to be instantly constructed using high-resolution fluoroscopy. These images can be used as real time references for any current or new medical procedures in which multiple frames of reference are required on or in the human body. This technology is still in the development stage, and the Company intends to seek approval from the Food and Drug Administration (“FDA”), which, if approved, will allow us to offer products utilizing the technology to healthcare providers.

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 Company’s operations between July 1, 2013 and July 30, 2013 were not significant. 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.

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, 2016 or 2015.

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. Equipment sales usually have a one year warranty of parts and service. After a one year period, the Company contacts the buyer to initiate the sale of a new warranty contract for one year. 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.

Property & Equipment

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to expenses as incurred and additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for all assets with estimated lives of three to eight years.

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 Loss Per Share

Basic net loss per share is based upon the weighted average number of common shares outstanding. Diluted net loss per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. During the years ended December 31, 2016 and 2015, potentially dilutive securities were excluded from the computation of weighted average shares outstanding-diluted because their effect was anti-dilutive.

The Company’s policy for Equity – Based compensation is predicated on Employment Agreements for both Dane Medley CEO and

Xavier Aguilera, CFO.

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, 2016 and 2015 respectively.

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 become effective for the Company for the 2017 annual period. Management is evaluating the impact of the adoption of these changes will have on the consolidated financial statements. Subsequent to adoption, this guidance will need to be applied by management at the end of each annual period and interim period therein to determine what, if any, impact there will be on the consolidated financial statements in a given reporting period.

In April 2015, the FASB issued ASU No 2015-3, Simplifying the Presentation of Debt Issuance Costs. This update changes the presentation of debt issuance costs in the balance sheet. ASU 2015-03 requires debt issuance costs related to a recognized debt obligation to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability rather than being presented as an asset. Amortization of debt issuance costs will continue to be reported as interest expense. In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”. This ASU clarified guidance in ASC 2015-03 stating that the SEC staff would not object to a company presenting debt issuance costs related to a line-of-credit arrangement on the balance sheet as a deferred asset, regardless of whether there were any outstanding borrowings at period-end. This update is effective for annual and interim periods beginning after December 15, 2015, which required us to adopt these provisions in the first quarter of 2016. This guidance did not have a material impact to our financial position or results of operations.

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.

3. ACCOUNTS RECEIVABLE

All accounts receivable are trade related. These receivables are current and management believes are collectible except for which a reserve has been provided. The balance of accounts receivable as of December 31, 2015 and 2016 were $51,505 and $-, respectively. The reserve amount for uncollectible accounts was $-0- and $ -0- as of December 31, 2015 and 2016, respectively.

4. ACCRUED EXPENSES

During 2003, the Company paid payroll net of taxes and accrued said taxes without payment due to cash flow limitations resulting from a 2002 warehouse fire that incinerated our inventory. The Company subsequently received a tax lien in 2005 related to 2003 payroll taxes from the Internal Revenue Service and continued to accrue interest and penalty charges. The original amount was $104,052. In 2008, payments were made and the Internal Revenue Service issued a tax lien release for this amount and the liability carried on the Company’s books was relieved. 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 $48,627 as of December 31, 2016, including interest and penalties.

5. 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, 2015 or December 31, 2016.

As of December 31, 2016, the Company estimated it had available gross net operating loss (NOL) carry forwards of approximately $18.665 million, which expire at various dates through 2037.

The components of the net deferred income taxes at December 31, 2015 and 2016 are summarized below:

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:

Income tax expense for the period ended December 31, 2015 and the year ended December 31, 2016 is summarized below.

6. NOTES PAYABLE

During 2015, the Company issued promissory notes in the aggregate amount of $455,000. These notes bear interest at 10% per annum and are past due as of December 31, 2016. The notes are secured by substantially all assets of the Company. The convertible promissory note is convertible into shares of the Company’s common stock at a rate equal to $0.01 per share, subject to downward adjustments for future equity issuances. In connection with these convertible promissory notes, the Company issued 27,000,000 warrants to purchase common stock at an exercise price of $0.01 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.

During 2016, the Company issued promissory notes in the aggregate amount of $487,850 for cash proceeds of $465,000. These notes bear interest at 5%-10% per annum and are due on various dates through June 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, subject to downward adjustments for future equity issuances. In connection with these convertible promissory notes, the Company issued warrants to purchase 36,500,000 shares of common stock at an exercise price of $0.01 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, 2015, 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. During the year ended December 31, 2016, the Company recorded an additional note discount of $388,000, with an immediate charge to interest expense of $2,440,000 relating to the excess value of the derivative liabilities over the promissory notes. Amortization of the note discount amounted to $349,000 during the year ended December 31, 2016 and $378,000 for the year ended December 31, 2015.

7. STOCKHOLDERS’ EQUITY

Preferred Stock

Upon confirmation of the Company’s Chapter 11 Reorganization Plan, the Company is authorized to issue 1,000,000 shares of preferred stock, no par value. The rights, privileges, and preferences of the preferred stock are to be determined by the Company’s board of directors and may be issued in series. As of December 31, 2015 there were no shares of preferred stock outstanding. On January 18, 2016, Imaging3 issued 2000 preferred voting shares to Dane Medley, CEO/Chairman. Each share constitutes 350,000 voting shares.

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, 2015, the Company issued a total of 21,254,000 shares of common stock, 12,379,000 of such shares were issued for cash proceeds of $196,975. The remaining 8,875,000 shares were issued for services rendered, valued at $134,500.

During the year ended December 31, 2016, the Company issued 53,263,700 shares of common stock, 41,685,000 shares related to services valued at $1,903,050, 4,504,000 shares were issued for cash proceeds of $166,900, and 7,074,700 shares related to a conversion of notes payable at $0.01 per share.

Stock Option Plan

During 2014, the Board of Directors adopted, and the shareholders approved, the 2014 Stock Option Plan under which a total of 36,276,614 shares of common stock had been reserved for issuance. The Stock Option Plan will terminate in September 2024.

Stock Options

Transactions in FY2015

The fair value of the options granted during the year ended December 31, 2016 is estimated at approximately $139,535 which was expensed upon grant as the options vested immediately. The fair value of these options was estimated at the date of grant using the Black Scholes option pricing model with the following assumptions for the fiscal year ended December 31, 2016: no dividends, expected volatility of 60%, risk free interest rate of 1.91%, and expected life of 9 years.

The weighted average remaining contractual life of options outstanding issued under the Plan was 8.86 years at December 31, 2016. 

8. WARRANTS

Pursuant to the Chapter 11 Reorganization Plan, the Company issued 7,861,472 and 10,287,224 warrants to purchase common stock to Gemini Master Fund, Ltd and Alpha Capital, respectively. These warrants are exercisable at an exercise price of $0.000001 per share and expire July 30, 2023.

During the years ended December 31, 2016 and 2015, the Company issued warrants to purchase common stock in connection with convertible promissory notes. The warrants are exercisable at $0.01 per share, subject to downward adjustments for future equity issuances, and have a term of 7 years.

Following is a summary of warrants outstanding at December 31, 2016

9. 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, 2016 and 2015:

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:

10. GOING CONCERN

The Company’s financial statements are prepared using the generally accepted accounting principles applicable to a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has historically incurred net losses and as of December 31, 2016 had an accumulated deficit totaling $16.0 M. During the years ended December 31, 2016 and 2015, the Company utilized an aggregate of $1.226 Million of cash in operating activities and incurred an aggregate net loss of $9,393,902. 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.

11. COMMITMENTS AND CONTINGENCIES

Leases

During 2014 through May 2015, the Company leased its facilities on a month-to-month lease, which was cancellable by the parties with 30-days written notice. 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 $48,627 as of December 31, 2016, including interest and penalties, with a potential balloon payment in one year subject to re-negotiation after one year with the IRS.

12. SUBSEQUENT EVENTS

Notes Payable

On January 5, 2017, the Company closed a financing arrangement with five key shareholders, whereby fourteen separate 10% original-issue-discount secured convertible notes held by these shareholders (twelve of which were in default) with an aggregate balance due of about $770,000 have been amended such that (i) the maturity date of all notes is now August 31, 2017 and (ii) the notes are now convertible into subsequent rounds of financing rather than being convertible at $0.01 per share. Should there be an event of default under these amended notes, the conversion price will revert back to $0.01 per share.

As part of the financing arrangement, fifteen separate warrants held by these same shareholders were also amended such that the number of shares exercisable pursuant to each warrant has been reduced by 75%. The exercise price of these warrants remains at $0.01. In consideration for this reduction, Imaging3 has issued to the five holders new convertible promissory notes in the total principal amount of $124,688 in the same form as the notes described above, as amended. The resulting reduction in the number of warrant-shares outstanding is 49,875,000.

Furthermore, these shareholders agreed, as part of the arrangement, to lend Imaging3 up to an additional $200,000, in increments of $50,000, at the Company’s discretion, as long as the original notes are not in default. These loans will: (i) be evidenced by notes in the form of the notes described above, as amended; (ii) be due on August 31, 2017; (iii) bear interest at 10% per annum; and (iv) have a face value of 118.75% of the funds actually advanced. In addition, Imaging3 shall issue warrants granting the noteholder the right to purchase, at $0.01 per share, that number of common shares of the company equal to 25 times the number of dollars loaned.

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; (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. The Company noted that 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.

To clarify, the Judge’s order in its final paragraph stated that “Notwithstanding the foregoing [order closing the bankruptcy case pursuant to 11United 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”. Thusly, technically, the case could possibly be reopened by either of those aforementioned creditors.

Stock

As of April 2017, the Company cancelled 11 million shares of common stock issued in 2016. Furthermore, the company intends to cancel an additional 18 million shares pending negotiations relating to officer employment agreements.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

ITEM 9A. CONTROL AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. To address the material weaknesses, we performed additional analysis and other post-closing procedures in an effort to ensure our consolidated financial statements included in this annual report have been prepared in accordance with generally accepted accounting principles. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated (2013Framework). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We have identified the following material weaknesses:

1. As of December 31, 2016, we did not maintain effective controls over financial statement disclosure. Specifically, controls were not designed and in place to ensure that all disclosures required were originally addressed in our financial statements. Accordingly, management has determined that this control deficiency constitutes a material weakness.

2. As of December 31, 2016 we did not maintain adequate segregation of duties. Accordingly, management has determined that this control deficiently constitutes a material weakness.

Because of these material weaknesses, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2016, based on the criteria established in “Internal Control-Integrated Framework” issued by the COSO.

Independent Registered Accountant’s Internal Control Attestation

This annual report does not include an attestation report of our public accounting firm regarding our internal control over financial reporting.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting through the date of this report or during the quarter ended December 31, 2016, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

The following table lists our executive officers and directors as of December 31, 2016:

Dane Medley has been the Chairman and Chief Executive Officer of the Company since October 2012. Prior to joining us, Mr. Medley was the Senior Vice President of Service and Operations at Xerox Corporation (2008-2012), the Regional Operations Specialist at Sharp Electronics Corporation (2002-2007), a Service Manager at Lewan & Associates, Inc. (1986 to 2001), and served in the United States Air Force from 1981 to 1985 as an Antenna and Radio Maintenance Specialist. His leadership responsibilities and experience at Xerox Corp. included the following:

At Sharp Electronics Corporation, his experience and accomplishments included the following: