- Quarterly Report (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-Q

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to

Commission File Number 333-143236

TECHNISCAN, INC.
(Exact name of registrant as specified in its charter)

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

3216 South Highland Drive, Suite 200,
Salt Lake City, UT 84106
(Address of principal executive offices) (Zip Code)

[phone]
Registrant's telephone number, including area code

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        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.  ý  Yes     o  No 

        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  o     No  o

        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 the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act:

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

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

        The number of shares outstanding of the registrant's common stock, par value $0.001 per share as of November 18, 2010 was 20,999,444.

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					Page No.
PART I—FINANCIAL INFORMATION
	ITEM 1.		FINANCIAL STATEMENTS (UNAUDITED)
			CONDENSED BALANCE SHEETS AS OF SEPTEMBER 30, 2010 AND DECEMBER 31, 2009			1
			CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009 AND FOR THE PERIOD FROM JANUARY 1, 2002 (INCEPTION OF DEVELOPMENT STAGE) THROUGH SEPTEMBER 30, 2010			2
			CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009 AND FOR THE PERIOD FROM JANUARY 1, 2002 (INCEPTION OF DEVELOPMENT STAGE) THROUGH SEPTEMBER 30, 2010			3
			NOTES TO CONDENSED FINANCIAL STATEMENTS			4
	ITEM 2.		MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			16
	ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK			25
	ITEM 4.		CONTROLS AND PROCEDURES			25
PART II—OTHER INFORMATION
	ITEM 6.		EXHIBITS			27
	SIGNATURES					29

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PART I—FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

        

TECHNISCAN, INC.
(A Development Stage Company)

CONDENSED BALANCE SHEETS

(unaudited)

					September 30, 2010			December 31, 2009
ASSETS
Current assets:
	Cash and cash equivalents				$	47,868		$	232,706
	Prepaid expenses					495,760			271,209
		Total current assets				543,628			503,915
Property and equipment, net						635,050			617,142
Deposits						28,153			28,153
			Total assets		$	1,206,831		$	1,149,210
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
	Accounts payable				$	1,235,742		$	472,367
	Accrued liabilities					722,117			670,638
	Note payable to related party					135,000			—
	Convertible notes payable					2,750,000			—
	Embedded derivative liability					101,764			—
	Common stock warrant liability					507,932			—
	Related-party customer deposits					360,000			260,000
		Total current liabilities				5,812,555			1,403,005
Deferred rent						144,449			139,330
Accrued software license fees						—			250,000
			Total liabilities			5,957,004			1,792,335
Commitments
Stockholders' deficit:
	Common stock, $.001 par value: 150,000,000 shares authorized; 20,724,444 shares outstanding					20,724			20,724
	Additional paid-in-capital					25,191,133			24,524,019
	Accumulated deficit prior to development stage					(389,393	)		(389,393	)
	Accumulated deficit during development stage					(29,572,637	)		(24,798,475	)
		Total stockholders' deficit				(4,750,173	)		(643,125	)
			Total liabilities and stockholders' deficit		$	1,206,831		$	1,149,210

See accompanying notes to condensed financial statements.

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TECHNISCAN, INC.
(A Development Stage Company)

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

																	For the Period From January 1, 2002 (inception of development stage) Through September 30, 2010
					For the Three Months Ended September 30,						For the Nine Months Ended September 30,
					2010			2009			2010			2009
Revenues:
	Government grant				$	6,764		$	118,939		$	101,105		$	750,738		$	3,146,569
	Related-party research					—			120,000			—			120,000			240,000
		Total revenues				6,764			238,939			101,105			870,738			3,386,569
Operating expenses:
	Selling, general and administrative					701,667			417,461			2,379,434			961,379			15,343,019
	Research and development					361,789			405,508			1,395,466			990,210			14,243,223
	Direct grant					12,086			160,598			126,746			537,986			2,001,902
		Total operating expenses				1,075,542			983,567			3,901,646			2,489,575			31,588,144
			Loss from operations			(1,068,778	)		(744,628	)		(3,800,541	)		(1,618,837	)		(28,201,575	)
Interest income						55			58			615			1,137			56,428
Interest expense						(1,696,002	)		(8	)		(2,989,848	)		(118	)		(3,445,563	)
Gain on derivatives, net						2,168,687			—			2,015,612			—			2,015,612
Gain on sale of property and equipment						—			—			—			—			2,461
Net loss					$	(596,038	)	$	(744,578	)	$	(4,774,162	)	$	(1,617,818	)	$	(29,572,637	)
Net loss per common share—basic and diluted					$	(0.03	)	$	(0.08	)	$	(0.23	)	$	(0.18	)
Weighted average number of common shares outstanding—basic and diluted						20,724,444			8,769,206			20,724,444			8,747,742

See accompanying notes to condensed financial statements.

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TECHNISCAN, INC.
(A Development Stage Company)

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

													For the Period From January 1, 2002 (inception of development stage) Through September 30, 2010
							For the Nine Months Ended
							September 30, 2010			September 30, 2009
CASH FLOWS FROM OPERATING ACTIVITIES
	Net loss						$	(4,774,162	)	$	(1,617,818	)	$	(29,572,637	)
	Adjustments to reconcile net loss to net cash used in operating activities:
			Depreciation and amortization					139,503			29,688			641,450
			Impairment of intangible assets					—			—			14,179
			Gain on sale of property and equipment					—			—			(2,461	)
			Non-cash interest expense					—			—			383,610
			Issuance of common stock for services					—			—			375,000
			Stock-based compensation					667,114			23,429			1,793,215
			Debt discount amortization on convertible notes payable					2,625,308			—			2,625,308
			Gain on derivatives					(2,015,612	)		—			(2,015,612	)
			Changes in assets and liabilities:
				Accounts receivable				—			—			267
				Inventory				—			—			61,649
				Prepaid expenses				(224,551	)		137,051			701,086
				Accounts payable				763,375			49,168			1,226,822
				Accrued liabilities				51,479			9,761			382,299
				Related-party customer deposits				100,000			80,000			360,000
				Deferred rent				5,119			38,597			144,449
				Other liabilities				(250,000	)		—			—
					Net cash used in operating activities			(2,912,427	)		(1,250,124	)		(22,881,376	)
CASH FLOWS FROM INVESTING ACTIVITIES
	Proceeds from sale of property and equipment							—			—			4,000
	Purchase of property and equipment							(157,411	)		—			(1,174,225	)
					Net cash used in investing activities			(157,411	)		—			(1,170,225	)
CASH FLOWS FROM FINANCING ACTIVITIES
	Principal payments on debt							—			—			(79,292	)
	Proceeds from exercise of stock options and warrants, and from the issuance of stock, net of issuance costs							—			1,407,291			18,748,587
	Payment of debt issuance costs							—			—			—
	Proceeds from issuance of notes payable to related party							135,000			—			135,000
	Proceeds from issuance of convertible notes payable							2,750,000			—			5,150,000
					Net cash provided by financing activities			2,885,000			1,407,291			23,954,295
Net increase (decrease) in cash and cash equivalents								(184,838	)		157,167			(97,306	)
Cash and cash equivalents at beginning of period								232,706			269,192			145,174
Cash and cash equivalents at end of period							$	47,868		$	426,359		$	47,868
Supplemental Disclosure of Cash Flow Information:
		Cash paid for interest					$	12,814		$	110		$	26,581
		Cash paid for income taxes						200			100			1,000
Supplemental Disclosure of Noncash Investing and Financing Activities:
		Embedded derivative liability associated with convertible notes payable					$	1,206,702		$	—		$	1,206,702
		Common stock warrant liability associated with convertible notes payable						2,587,367			—			2,587,367
		Common stock issued to stockholders of Castillo, Inc. in connection with the Merger						—			—			6,000
		Issuance of common stock for future services						—			—			225,000
		Conversion of preferred stock and common stock warrants to common stock						—			—			38,937
		Issuance of Series E convertible preferred stock for future services						—			—			1,000,000
		Conversion of notes payable, including accrued interest, to preferred stock						—			—			2,611,831

See accompanying notes to condensed financial statements.

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

Organization

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

        On October 9, 2009, TechniScan Acquisition, Inc., a Utah corporation and wholly owned subsidiary of the Company, was merged with and into TechniScan, Inc., a Utah corporation ("TechniScan Utah"). TechniScan Utah was then immediately merged into the Company (collectively referred to as the "Merger"). Pursuant to the Merger, the Company succeeded to the business of TechniScan Utah as its sole line of business and changed its name to TechniScan, Inc. The Merger has been accounted for as a recapitalization of TechniScan Utah and the historical financial statements prior to the Merger are those of TechniScan Utah.

Description of Business

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

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

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

        The accompanying unaudited condensed financial statements of the Company are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they may not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of results that may be expected for the year ending December 31, 2010. The condensed balance sheet as of December 31, 2009 has been derived from the Company's audited financial statements as of that date, but does not include all of the information and notes required by GAAP for complete financial statements. For further information refer to the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission ("SEC") on March 22, 2010.

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

Use of Estimates

        The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash Equivalents

        The Company considers all highly liquid investments with an initial maturity of three months or less to be cash equivalents.

Concentration of Credit Risk

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

Property and Equipment

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

Impairment of Long-Lived Assets

        Long-lived assets of the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable.

Derivative Instruments

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

        The accounting for derivative instruments is complex. The Company's derivative liabilities are re-valued at the end of each reporting period, with changes in the fair value of the derivative liability recorded as charges or credits to other income (expense), in the period in which the changes in fair value occur. For embedded derivatives and warrants that are accounted for as derivative instrument liabilities, the Company determines the fair value of these instruments using both the Black-Scholes option-pricing model and the Binomial option-pricing model (see Note 7). These models require assumptions related to the expected term of the instrument, risk-free rates of return, the Company's

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

current common stock price, expected dividend yield and the expected volatility corresponding to the expected life of the instrument.

Revenue Recognition

        The Company's revenues are sourced from federal research grants and private and government research contracts. Revenue is recognized when the following criteria are met: (1) a contractual agreement exists; (2) products have been delivered or services have been rendered; (3) the fee is fixed or determinable, and (4) collectability is reasonably assured. Government grant revenue is recognized during the period qualifying expenses are incurred for research and development of the WBU system as set forth under the terms of the grant award agreements. The Company has complied with the federal statutes and regulations, including the delivery of all required periodic reports, and believes that no refunds will be required under the terms of the grant award agreements.

Direct Grant Expenses

        Direct grant expenses consist of costs incurred directly related to performance on the government grants. These expenses consist primarily of payroll, travel and direct material expenses. These expenses are charged to direct grant expense as incurred. Due to the fact that: (1) the Company is incurring the expenses regardless of whether or not a government grant is obtained; (2) the Company is the primary obligor; (3) the Company has reasonable latitude in establishing the grant amount; (4) the Company performs the services; (5) the Company has discretion in supplier selection; and (6) the Company determines the specifications of the research; the direct grant expenses are presented gross of government grant revenues.

Fair Value Measurements

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

Level 1		Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.
Level 2		Other inputs that are observable directly or indirectly, such as quoted prices for similar assets and liabilities or market corroborated inputs.
Level 3		Unobservable inputs that are used when little or no market data is available, which require the Company to develop its own assumptions about how market participants would value the assets or liabilities.

        Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosure each quarter. Assets and liabilities measured

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

at fair value on a recurring basis as of September 30, 2010 and December 31, 2009 are summarized as follows:

		Fair Value as of September 30, 2010
		Level 1			Level 2			Level 3			Total
Assets
Money market funds		$	972		$	—		$	—		$	972
Total		$	972		$	—		$	—		$	972
Liabilities
Embedded derivative liability		$	—		$	—		$	101,764		$	101,764
Common stock warrant			—			—			507,932			507,932
Total		$	—		$	—		$	609,696		$	609,696

 

		Fair Value as of December 31, 2009
		Level 1			Level 2			Level 3			Total
Assets
Money market funds		$	130,028		$	—		$	—		$	130,028
Total		$	130,028		$	—		$	—		$	130,028

        The following table presents the fair value reconciliation of Level 3 liabilities measured at fair value on a recurring basis during the nine months ended September 30, 2010:

			Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
			Embedded Derivative			Warrant Derivative			Total
Beginning balance, December 31, 2009			$	—		$	—		$	—
Issuances:
	Embedded derivatives issued in conjunction with convertible notes payable			1,206,702			—			1,206,702
	Warrants issued in conjunction with convertible notes payable			—			2,587,367			2,587,367
Total gains included in earnings				(1,104,938	)		(2,079,435	)		(3,184,373	)
Ending balance, September 30, 2010			$	101,764		$	507,932		$	609,696

Net Loss Per Common Share

        Basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. Diluted net income per common share is computed by dividing

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

net income, if any, by the sum of the weighted average number of common shares outstanding and the dilutive potential common share equivalents then outstanding. Potential common share equivalents consist of the weighted average number of shares issuable upon the exercise of outstanding stock options and warrants to acquire common stock, and shares issuable upon conversion of convertible debt. If the Company generates net income and these potential common share equivalents are dilutive, the Company computes diluted net income per share using the treasury stock method.

        Due to the fact that for all periods presented, the Company has incurred net losses, weighted average common share equivalents of 4,498,476 and 8,020,734 for the three months ended September 30, 2010 and 2009, respectively, and 4,168,038 and 6,289,453 for the nine months ended September 30, 2010 and 2009, respectively, are not included in the calculation of diluted net loss per common share because they are anti-dilutive.

Operating Segment

        The Company conducts business within one operating segment. The Company's operations are all related to the research and development of its WBU system. All assets of the business are located in the United States.

Recent Accounting Pronouncements

        On September 15, 2010, the SEC issued Release No. 33-9142, "Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers." This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.

        In March 2010, the FASB issued Accounting Standards Update ("ASU") No. 2010-11, which is included in the Codification under ASC 815. This update clarifies the type of embedded credit derivative that is exempt from embedded derivative bifurcation requirements. Only an embedded credit derivative that is related to the subordination of one financial instrument to another qualifies for the exemption. This guidance became effective for the Company's interim and annual reporting periods beginning January 1, 2010. The adoption of this guidance did not have a material impact on the Company's condensed financial statements.

        In February 2010, the FASB issued ASU No. 2010-09, which is included in the Codification under ASC 855, Subsequent Events . This update removes the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated and became effective for interim and annual reporting periods beginning January 1, 2010. The adoption of this guidance did not have a material impact on the Company's condensed financial statements.

        In January 2010, the FASB issued ASU No. 2010-06, which is included in the Codification under ASC 820, Fair Value Measurements and Disclosures . This update requires the disclosure of transfers

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SIGNIFICANT ACCOUNTING POLICIES (Continued)

between the observable input categories and activity in the unobservable input category for fair value measurements. The guidance also requires disclosures about the inputs and valuation techniques used to measure fair value and became effective for interim and annual reporting periods beginning January 1, 2010. The adoption of this guidance did not have a material impact on the Company's condensed financial statements.

Reclassifications

        Certain reclassifications have been made to the 2009 information to conform to the 2010 presentation.

3. GOING CONCERN

        Since entering the development stage, the Company has not generated revenues in excess of expenses and has been dependent on government grants and equity raised from individual investors to sustain its operations. The WBU system has not yet been approved by the U.S. Food and Drug Administration ("FDA") for commercial sale. Therefore, the Company has not generated any revenues from non-research product sales. The Company has incurred losses and used cash in operating activities since entering the development stage. As of September 30, 2010, the Company had an accumulated deficit of $29,962,030, negative working capital of $5,268,927, and minimal revenues. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

        The Company's plans to address its liquidity issues include the (1) sale of debt and equity securities, (2) collaboration with third parties to accelerate the introduction of product and services into the market, and (3) continued focus on obtaining approval from the FDA for the Company's products and services to qualify for commercial sale.

        There can be no assurance that the Company's planned sales of debt and equity securities, its collaborative efforts, or its effort to obtain FDA approval will be successful or that the Company will have the ability to commercialize its imaging system and ultimately attain profitability.

4. PREPAID EXPENSES

        Prepaid expenses as of September 30, 2010 and December 31, 2009 consisted of the following:

		September 30, 2010			December 31, 2009
Deferred offering costs		$	492,837		$	42,568
Prepaid professional services			—			150,000
Prepaid payroll expense			—			59,709
Other			2,923			18,932
		$	495,760		$	271,209

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. ACCRUED LIABILITIES

        Accrued liabilities as of September 30, 2010 and December 31, 2009 consisted of the following:

		September 30, 2010			December 31, 2009
Accrued software license fees		$	375,000		$	150,000
Accrued compensation and benefits			125,541			195,811
Accrued interest			158,764			—
Other accrued liabilities			62,812			53,465
Liabilities to dissenter stockholders			—			271,362
		$	722,117		$	670,638

6. RELATED-PARTY TRANSACTIONS

        In connection with a European Market Development Agreement that the Company entered into during October 2008 with Esaote S.p.A. ("Esaote"), an Italian ultrasound equipment manufacturer, which is also a 10% stockholder of the Company, the Company has delivered two prototype systems and Esaote has paid the Company an aggregate of $600,000. The Company has recorded $240,000 of other research revenues for the period from January 1, 2002 (inception of development stage) through September 30, 2010, in conjunction with the shipment of prototype systems per the terms of a product development agreement. The remaining balance is recorded in related-party customer deposits.

        From August 9, 2010 through September 8, 2010, the Company received $135,000 by issuing short-term notes to two related parties. The notes bear interest at 8% per annum. The principal amount of the notes and accrued interest are due in full upon the earlier of: (1) the Company receiving cash proceeds from equipment sales, loans, investments or otherwise in excess of an aggregate of $135,000; (2) the closing of an equity offering where the Company receives gross proceeds of not less than $2,000,000; or (3) December 31, 2010.

7. CONVERTIBLE NOTES PAYABLE AND DERIVATIVES

March 2010 Offering

        On March 30, 2010, the Company entered into a Note and Warrant Purchase Agreement with five accredited investors pursuant to which the investors purchased senior secured convertible notes ("Notes") in the aggregate amount of $1,850,000. Of this amount $500,000 was received from members of the Company's Board of Directors. During the period from May 13, 2010 through May 27, 2010, the Company issued Notes in the aggregate amount of $700,000 to nine accredited investors. Of this amount $100,000 was received from a member of the Company's Board of Directors.

        On September 30, 2010, the due date of the Notes was extended to October 8, 2010 (see Note 9), together with accrued interest at the rate of 10% per annum, unless the principal amount of a note is converted into shares of common stock of the Company, in which case the interest is payable on the principal at a rate of 12% per annum. The Company is recording interest at 12%. At its option, the Company may prepay all of the outstanding principal and accrued interest on the Notes, subject to a prepayment charge of 10% of the principal amount of the Notes. The Notes are convertible in whole

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. CONVERTIBLE NOTES PAYABLE AND DERIVATIVES (Continued)

or in part at any time at the option of the holder of the Note into the number of shares equal to the principal amount of the Note and all accrued interest divided by $2.68, subject to customary adjustments as set forth in the Notes for stock splits, stock dividends, etc. In addition, in the event that the Company receives cash investments from one or more investors in one or more transactions for gross proceeds of not less than $5,000,000 in exchange for the issuance of shares or any other securities that are convertible into or exercisable for shares at any time between March 30, 2010 and October 8, 2010, the Notes are convertible into shares at the same price and on the same terms as the investors.

        In conjunction with the Notes, the Company issued warrants ("Warrants") to investors to purchase an aggregate of 951,499 shares of the Company's common stock. The exercise price per share is $2.68, subject to customary adjustments as set forth in the Warrants for stock splits, stock dividends, etc. The Warrants expire March 30, 2015.

        The Notes and Warrants contain a provision which adjusts the exercise price of the Notes and Warrants if the Company issues or sells common stock or securities convertible into common stock at a price per share, or equivalent price per share lower than $2.68. The Company assessed the terms of the Notes and Warrants in accordance with ASC Topic 815-40, and determined that the underlying terms of the Notes and Warrants are not indexed to the Company's common stock. Therefore, the conversion option and the warrants are accounted for as an embedded derivative and as a derivative, respectively, and are valued at fair value at the date of issuance and each subsequent interim period.

        Pursuant to certain prepayment provisions set forth in the Notes, the investors have the right, at the investors' option to require the Company to prepay all or a portion of the Notes in cash at a price equal to the greater of (1) 125% of the aggregate principal amount of the Notes plus all accrued and unpaid interest and (2) the aggregate principal amount of the Notes plus all accrued and unpaid interest, divided by the conversion price on the date the investor demands payment, pursuant to this provision or the date the payment is actually made by the Company to the investor pursuant to this provision, whichever is less, multiplied by the daily volume weighted average price of the Company's common stock on the greater of either of the two dates used to determine the conversion price in connection with a payment pursuant to this provision. The prepayment provisions are embedded derivates and the fair value of the prepayment penalties are included in the embedded derivative liability.

July 2010 Offering

        During the period from July 29, 2010 through August 24, 2010, two members of the Company's Board of Directors purchased senior secured convertible promissory notes in the amount of $200,000. In conjunction with the notes, the Company issued warrants to purchase an aggregate of 74,627 shares of its common stock. Except as adjusted for the later issuance date, the note and warrant have the same material terms as the Notes and Warrants, respectively, that the Company issued pursuant to a Note and Warrant Purchase Agreement and other investment documents in connection with the March 2010 Offering.

        On March 30, 2010 (date of issuance) and on March 31, 2010, the fair value of the embedded derivatives and warrant liability was $1,016,897 and $2,001,864, respectively. Because the embedded

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. CONVERTIBLE NOTES PAYABLE AND DERIVATIVES (Continued)

derivatives and warrant liability collectively exceeded the proceeds from the Notes of $1,850,000, the Company recorded an inception loss on derivatives of $1,168,761 and a discount of $1,850,000 on the Notes.

        During May 2010 (date of additional issuance), the fair value of the embedded derivatives and warrant liability for the additional issuance was $180,566 and $501,174, respectively. As a result, the Company recorded a discount of $681,740 on the Notes issued during May 2010.

        During July 2010 and August 2010 (date of additional issuance), the fair value of the embedded derivatives and warrant liability for the additional issuance was $9,239 and $84,329, respectively. As a result, the Company recorded a discount of $93,568 on the Notes issued during July 2010 and August 2010.

        The revaluation of the derivatives as of September 30, 2010 resulted in the fair value of the liabilities of $101,764 and $507,932 for the embedded derivative liability on the Notes and the common stock warrant liability, respectively. The decrease in the fair value resulted in a gain on derivatives of $2,168,687 for the three months ended September 30, 2010. The Company uses the Black-Scholes option-pricing model to estimate the value of its embedded derivatives, and the Company uses the Black-Scholes and Binomial option-pricing models to estimate the value of its common stock warrant liability. The assumptions used in the Black-Scholes and Binomial option-pricing models for the three and nine months ended September 30, 2010 and 2009 are set forth in the following table. The expected volatility is based on the volatility of public companies that are similar to the Company's industry, size, financial leverage and stage of life cycle. The Company calculated the historical volatility of these companies using the daily closing total returns for a period of time equal to the expected term of the embedded derivatives and common stock warrant liability as of the valuation date. The expected term represents the period of time that the embedded derivatives and common stock warrant liability are expected to be outstanding. The risk free rate is based on the U.S. treasury securities constant maturity rate that corresponds to the expected term.

Embedded Derivatives

		September 30, 2010			July 29 - August 24, 2010			June 30, 2010			May 13 - 27, 2010			March 31, 2010
Expected volatility			64.1	%		64.1	%		88.1	%		84.3	%		46.1	%
Expected life, range in years			0.34			0.10			0.25			0.35			0.50
Expected dividend yield on stock			0.0	%		0.0	%		0.0	%		0.0	%		0.0	%
Risk free interest rate			0.23	%		0.21	%		0.24	%		0.24	%		0.28	%

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TECHNISCAN, INC.
(A Development Stage Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. CONVERTIBLE NOTES PAYABLE AND DERIVATIVES (Continued)