As filed with the Securities and
Exchange Commission on May 21, 2007 Registration No. _____________
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM SB-2
REGISTRATION STATEMENT
UNDER THE
SECURITIES ACT OF 1933
-----------------
CNS RESPONSE, INC.
(Name of Small Business Issuer in its Charter)
DELAWARE 8734 87-0419387
(State or Jurisdiction of (Primary Standard (I.R.S Employer
Incorporation or Organization) Industrial Classification Identification No.)
Code Number)
2755 BRISTOL ST., SUITE 285
COSTA MESA, CA 92626
(714) 545-3288
(Address and Telephone Number of Principal Executive Offices)
2755 BRISTOL ST., SUITE 285
COSTA MESA, CA 92626
(Address of Principal Place of Business or intended Place of Business)
LEONARD BRANDT, CHIEF EXECUTIVE OFFICER
CNS RESPONSE, INC.
2755 BRISTOL ST., SUITE 285
COSTA MESA, CA 92626
(714) 545-3288
Copy to:
SCOTT ALDERTON, ESQ.
STUBBS ALDERTON & MARKILES, LLP
15260 VENTURA BOULEVARD, 20TH FLOOR
SHERMAN OAKS, CALIFORNIA 91403
(818) 444-4500
(Name, Address and Telephone Number of Agent for Service)
Approximate date of proposed sale to the public: From time to time after the
effective date of this Registration Statement.
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. [_]
CALCULATION OF REGISTRATION FEE
============================================= ================ ============== ================== ============
PROPOSED MAXIMUM PROPOSED AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE MAXIMUM AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED REGISTERED (1) PER UNIT (2) OFFERING PRICE (2) FEE
- --------------------------------------------- ---------------- -------------- ------------------ ------------
Common Stock, par value $.001 per share...... 7,355,199 $ 1.65 $ 12,136,078.35 $ 372.58
- --------------------------------------------- ---------------- -------------- ------------------ ------------
Common Stock, par value $.001 per share
issuable upon exercise of warrants .......... 2,627,939 $ 1.65 $ 4,336,099.35 $ 133.12
- --------------------------------------------- ---------------- -------------- ------------------ ------------
TOTAL ................................... 9,983,138 -- $ 16,472,177.70 $ 505.70
- --------------------------------------------- ---------------- -------------- ------------------ ------------
(1) In the event of a stock split, stock dividend, or other similar
transaction involving the Registrant's common stock, in order to
prevent dilution, the number of shares registered shall automatically
be increased to cover the additional shares in accordance with Rule
416(a) under the Securities Act.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933, using the
average of the high and low price as reported on the Over-the-Counter
Bulletin Board on May 17, 2007.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE TIME UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================
Subject to Completion, Dated May 21, 2007
CNS RESPONSE, INC.
9,983,138 SHARES COMMON STOCK
This prospectus relates to the offer and sale from time to time of up
to 9,983,138 shares of our common stock that are held by the stockholders named
in the "Selling Stockholders" section of this prospectus. The prices at which
the selling stockholders may sell the shares in this offering will be determined
by the prevailing market price for the shares or in negotiated transactions. We
will not receive any of the proceeds from the sale of the shares. We will bear
all expenses of registration incurred in connection with this offering. The
selling stockholders whose shares are being registered will bear all selling and
other expenses.
Our common stock is quoted on the Over-The-Counter Bulletin Board under
the symbol "CNSO.OB." On May 17, 2007, the last reported sales price of the
common stock on the Over-The-Counter Bulletin Board was $1.65 per share.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 4.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is ______________
TABLE OF CONTENTS
PAGE
Prospectus Summary ........................................................ 1
Risk Factors .............................................................. 4
Cautionary Note Regarding Forward - looking Statements .................... 21
Corporate Background and Merger Transaction ............................... 22
Use of Proceeds ........................................................... 28
Market for Common Equity and Related Stockholder Matters .................. 28
Management's Discussion and Analysis of Financial Condition
and Results of Operations .............................................. 29
Business .................................................................. 41
Management ................................................................ 62
Executive Compensation .................................................... 66
Principal and Selling Stockholders ........................................ 68
Related Party Transactions ................................................ 77
Description of Capital Stock .............................................. 81
Plan of Distribution ...................................................... 84
Legal Matters ............................................................. 86
Experts ................................................................... 86
Where You Can Find More Information ....................................... 86
Index to Financial Statements ............................................. F-1
You should rely only on the information contained in this prospectus or
any supplement. We have not authorized anyone to provide information that is
different from that contained in this prospectus. The information contained in
this prospectus is accurate only as of the date of this prospectus, regardless
of the time of delivery of this prospectus or of any sale of our common stock.
Except as otherwise indicated, information in this prospectus reflects
a one-for-fifty reverse stock split of our common stock which took effect on
January 10, 2007.
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION CONTAINED IN GREATER
DETAIL ELSEWHERE IN THIS PROSPECTUS. THIS SUMMARY DOES NOT CONTAIN ALL THE
INFORMATION YOU SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD
READ THE ENTIRE PROSPECTUS CAREFULLY BEFORE MAKING AN INVESTMENT DECISION,
INCLUDING "RISK FACTORS" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND THE
RELATED NOTES. REFERENCES IN THIS PROSPECTUS TO "CNS RESPONSE, INC," THE
"COMPANY," "WE," "OUR" AND "US" REFER TO CNS RESPONSE, INC. AND OUR CONSOLIDATED
SUBSIDIARY.
OUR BUSINESS
We are a life sciences company focused on the commercialization of a
patented system that guides psychiatrists and other physicians in the
identification and determination of appropriate and effective medications for
patients with certain behavioral (mental or addictive) disorders. Our technology
provides medical professionals with medication sensitivity data for a subject
patient based upon the identification and correlation of treatment outcome
information from other patients with similar neurophysiologic characteristics
which are contained in a proprietary outcomes database. This methodology, called
"Referenced-EEG" or "rEEG" represents an innovative approach to identifying
effective medications for patients suffering from debilitating behavioral
disorders.
In addition, rEEG provides us with significant opportunities in the
area of pharmaceutical development. Using the rEEG methodology in combination
with our proprietary outcomes database, we believe we have the potential to
identify new uses for existing drugs and drug combinations. We intend to enter
into relationships with established drug and biotechnology companies to further
explore these opportunities.
OUR HISTORY AND CONTACT INFORMATION
Our company was originally incorporated on July 10, 1984, under the
name Mammon Oil & Gas, Inc. in the state of Utah. In February 1986, our
shareholders approved proposals to change our business direction to the business
of health care including research, development and marketing, and a name change
to Volt Research, Inc. From August 1986 to August 1988, we engaged in operating
clinics dedicated to Retin-A skin therapy. In August 1988, our management
decided to phase out our clinic operations and concentrate on selling our
expertise and skin care products directly to physicians. On January 1, 2004, we
discontinued our business activities and operations and, since that date until
our acquisition of NBD Marketing, Inc., ProspectWorks, Inc., SalesWare, Inc. and
xSellsys, Inc. (collectively "Acquired Companies") in June 2004, we had no
revenues or earnings from operations.
In a series of transactions consummated in June 2004, we acquired all
of the outstanding capital stock of NBD Marketing, Inc., a California
corporation, or NBD, and SalesWare Inc., a Nevada corporation, or SalesWare, and
formed an acquisition subsidiary, xSellsys, Inc., a California corporation to
acquire substantially all of the assets and liabilities of CRM SalesWare, Inc.,
a California corporation. As a result of the consummation of the above
transactions, SalesWare, NBD, and xSellsys became our wholly-owned subsidiaries
and ProspectWorks, Inc., a Nevada corporation and a subsidiary of NBD,
ProspectWorks, became an indirect, wholly-owned subsidiary of the Company. In
connection with the acquisition of SalesWare, Inc., on August 2, 2004, we
changed our corporate name to "SalesTactix, Inc."
On October 6, 2004, the Acquired Companies, William Noonan, Vincent
Michael Keyes III, and Thomas Ketchum filed a complaint in Orange County
Superior Court, Case No. 04CC00669 against us, Scott Absher, George LeFevre and
Mark Absher. On November 15, 2004, we entered into a settlement agreement with
the plaintiffs whereby (i) the acquisition agreements by and among the parties
were rescinded including an asset purchase agreement and certain stock purchase
agreements; (ii) certain assets
1
owned by SalesTaxtix, Inc. and xSellsys were transferred to certain plaintiffs;
(iii) certain trademarks and tradenames were transferred to CRM SalesWare; and
(iv) our outstanding shares owned by the plaintiffs were canceled. The
Settlement Agreement essentially unwound the acquisition and restored the
parties to their prior positions, as if the acquisitions had never occurred. The
claim was dismissed in the fourth quarter of 2004 pursuant to the terms of the
settlement agreement. In connection with the settlement agreement, we changed
our name to Strativation, Inc. in September 2005.
As a result of our lack of revenue generation and the rescission of the
acquisition, we reassessed our business plan and determined to seek out other
business opportunities capable of increasing stockholder value.
On July 18, 2006, we entered into a stock purchase agreement with
seventeen accredited investors pursuant to which we issued 3,800,000 shares of
our common stock (76,000 shares of our common stock after taking into account
our 1-for-50 reverse stock split which became effective on January 10, 2007) in
consideration for an aggregate of $237,669.00 in cash. In addition, these
investors acquired shares in private transactions with certain of our
stockholders, and acquired a majority stake in our issued and outstanding
shares. In connection with these transactions, effective July 18, 2006, Mr.
Scott Absher and Mr. George LeFevre resigned as officers and members of the
board of directors, and Mr. Silas Philips was appointed our Chief Executive
Officer, Chief Financial Officer, Secretary, and sole director.
On March 7, 2007, we acquired CNS Response, Inc., a California
corporation ("CNSR California") through a merger of CNSR California with a
wholly-owned subsidiary that we formed for the purpose of facilitating this
transaction. Upon the closing of this merger transaction, CNSR California became
our wholly-owned subsidiary, and we changed our name to CNS Response, Inc. The
merger was accounted for as a "reverse acquisition," and for accounting
purposes, CNSR California was demed to be the "accounting acquirer" in the
"reverse acquisition."
In addition, in connection with the closing of the merger with CNSR
California, we received gross proceeds of approximately $7.8 million in a
private placement with institutional investors and other high net worth
individuals. Pursuant to subscription agreements entered into with these
investors, we sold 6,504,765 investment units, at $1.20 per investment unit.
Each investment unit consists of one share of our common stock, and a five year
non-callable warrant to purchase three-tenths of one share of our common stock
at an exercise price of $1.80 per share. After broker commissions and expenses
and legal and other expenses, we received net proceeds of approximately $6.9
million in the private placement financing.
In connection with the private placement, we agreed to file a
registration statement covering the resale of the common stock and the common
stock underlying the warrants sold in the private placement financing. This
prospectus is part of a registration statement on Form SB-2 that we filed
pursuant to the terms of our agreement with the investors in the private
placement financing. The registration statement on Form SB-2 and this prospectus
also covers the resale of common stock held by other security holders named in
the "Selling Stockholders" section of this prospectus.
The address of our principal executive office is 2755 Bristol St.,
Suite 285, Costa Mesa CA 92626, and our telephone number is (714) 545-3288.
2
THE OFFERING
Common stock offered............... Up to 9,983,138 shares by the selling
stockholders
Common stock outstanding
before this offering............. 25,303,302 shares
Common stock to be outstanding
after this offering.............. Up to 27,931,241 shares
Use of proceeds.................... We will not receive any of the proceeds from
the sale of shares of our common stock by
the selling stockholders. See "Use of
Proceeds."
Over-the-Counter Bulletin Board
symbol........................... CNSO.OB
Risk Factors....................... See "Risk Factors" beginning on page 4 for a
discussion of factors that you should
consider carefully before deciding to
purchase our common stock.
In the table above, the number of shares to be outstanding after this
offering is based on 25,303,302 shares outstanding as of May 17, 2007, and
assumes the issuance to the selling stockholders of the following additional
shares which are being offered for sale under the prospectus:
o 2,627,939 shares issuable upon the exercise of outstanding
warrants at a weighted average exercise price of $1.73 per
share.
In the table above, the number of shares to be outstanding after this
offering does not reflect the issuance of the following shares, which are not
being offered for sale under this prospectus:
o 8,407,517 shares of common stock reserved for issuance upon
exercise of warrants and options, as of May 17, 2007.
3
RISK FACTORS
INVESTING IN CNS RESPONSE, INC. INVOLVES A HIGH DEGREE OF RISK. YOU
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION
CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING OUR COMMON STOCK. THE RISKS AND
UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING US. ADDITIONAL RISKS
AND UNCERTAINTIES THAT WE ARE UNAWARE OF, OR THAT WE CURRENTLY DEEM IMMATERIAL,
ALSO MAY BECOME IMPORTANT FACTORS THAT AFFECT US. IF ANY OF THE FOLLOWING RISKS
OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE
MATERIALLY AND ADVERSELY AFFECTED. IN THAT CASE, THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE, AND YOU MAY LOSE SOME OR ALL OF YOUR INVESTMENT.
RISKS RELATING TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY, MAKING IT DIFFICULT TO EVALUATE OUR FUTURE
PERFORMANCE.
CNS Response, Inc., a California Corporation and the operating
subsidiary of CNS Response, Inc., a Delaware corporation (collectively, "we",
"us", "our", "the company"), was incorporated in 2000. As a result of our
limited operating history, investors have limited substantive financial
information on prior operations to evaluate the company as an investment. Our
potential must be viewed in light of the problems, expenses, difficulties,
delays and complications often encountered in the operation of a new business.
We will be subject to the risks inherent in the ownership and operation of a
company with a limited operating history such as fluctuations in expenses,
competition, the general strength of regional and national economies, and
governmental regulation. Any failure to successfully address these risks and
uncertainties would seriously harm our business and prospects.
WE CURRENTLY DEPEND ON SALES OF OUR rEEG ANALYTICAL REPORTS FOR ALL OF OUR
REVENUE, AND IF OUR REPORTS DO NOT GAIN WIDESPREAD MARKET ACCEPTANCE, THEN OUR
REVENUES MAY NOT EXCEED OUR EXPENSES.
We have developed a methodology that aids psychiatrists and other
physicians in selecting appropriate and effective medications for patients with
certain behavioral or addictive disorders based on physiological traits of the
patient's brain and information contained in a proprietary database that has
been developed over the last twenty years. We began selling reports, referred to
as rEEG Analytical Reports, based on our methodology in 2000. To date, we have
not received widespread market acceptance of the usefulness of our rEEG
Analytical Reports in helping psychiatrists and physicians inform their
treatment strategies for patients suffering from behavioral and/or addictive
disorders. Because we currently depend on the sale of rEEG Analytical Reports
for all or our revenue, and we have no other significant products or services,
if we fail to achieve widespread market acceptance for our rEEG Analytical
Reports, we will not be able to sustain or grow our revenues.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND OUR STOCK PRICE COULD
DECLINE OR FLUCTUATE IF OUR RESULTS DO NOT MEET THE EXPECTATION OF ANALYSTS OR
INVESTORS.
Management expects that we will experience substantial variations in
our operating results from quarter to quarter. We believe that the factors which
influence this variability of quarterly results include:
o the use of and demand for rEEG Analytical Reports and other
products and/or services that we may offer in the future that
are based on our patented methodology.
o the effectiveness of new marketing and sales programs.
o turnover among our employees.
4
o changes in management.
o the introduction of products or services that are viewed in
the marketplace as substitutes for the services we provide.
o communications published by industry organizations or other
professional entities in the psychiatric and physician
community that are unfavorable to our business.
o the introduction of regulations which impose additional costs
on or impede our business.
o the timing and amount of our expenses, particularly expenses
associated with the marketing and promotion of our services,
the training of physicians and psychiatrists in the use of our
rEEG Analytical Reports, and research and development.
As a result of fluctuations in our revenue and operating expenses that
may occur, management believes that period-to-period comparisons of our results
of operations are not a good indication of our future performance. It is
possible that in some future quarter or quarters, our operating results will be
below the expectations of securities analysts or investors. In that case, our
common stock price could fluctuate significantly or decline.
IF THE ESTIMATES WE MAKE, AND THE ASSUMPTIONS ON WHICH WE RELY IN PREPARING OUR
FINANCIAL STATEMENTS PROVE INACCURATE, OUR ACTUAL RESULTS MAY VARY FROM THOSE
REFLECTED IN OUR FINANCIAL STATEMENTS.
Our financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires us to make estimates and judgments that
affect the reported amounts of our assets, liabilities, revenues and expenses,
the amounts of charges accrued by us and related disclosure of contingent assets
and liabilities. This includes estimates and judgments regarding revenue
recognition, allowances for doubtful accounts, valuation of derivatives,
warrants and other equity transactions. We base our estimates and judgments on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances at the time such estimates and judgments were
made. There can be no assurance, however, that our estimates and judgments, or
the assumptions underlying them, will be correct.
IF WE EXPAND OUR OPERATIONS MORE AGGRESSIVELY THAN WE ANTICIPATE, WE WILL NEED
ADDITIONAL FUNDING TO SUPPORT OUR OPERATIONS AND CAPITAL EXPENDITURES, WHICH MAY
NOT BE AVAILABLE TO US AND WHICH LACK OF AVAILABILITY COULD ADVERSELY AFFECT OUR
BUSINESS.
We have not generated significant revenues or become profitable, may
never do so, and may not generate sufficient working capital to cover costs of
operations. We intend to fund our operations and capital expenditures from
revenues and our cash on hand. We believe that we will have sufficient funds to
finance the cost of our operations, our operating and management infrastructure,
and planned expansion for the next 15 months. However, in the event we expand
our operations more aggressively than we currently anticipate, we may need
additional capital sooner than anticipated for this purpose. In addition, we may
need additional funds sooner than anticipated to pursue business opportunities
(such as acquisitions of complementary businesses), to react to unforeseen
difficulties, such as the need to defend or enforce our intellectual property
rights, to respond to competitive pressures, or to obtain regulatory approvals
needed to market our services and/or products.
We currently have no committed sources of additional capital, and there
can be no assurance that any financing arrangements will be available in amounts
or on terms acceptable to us, if at all.
5
Furthermore, the sale of additional equity or convertible debt securities may
result in additional dilution to existing stockholders. If adequate additional
funds are not available, we may be required to delay, reduce the scope of or
eliminate material parts of the implementation of our business strategy. This
limitation could substantially harm our business, results of operations and
financial condition.
OUR INDUSTRY IS HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE TO COMPETE
SUCCESSFULLY, WHICH COULD RESULT IN PRICE REDUCTIONS AND DECREASED DEMAND FOR
OUR PRODUCTS.
The healthcare business in general, and the behavioral health treatment
business in particular, are highly competitive. In the event that we are unable
to convince physicians, psychiatrists and patients of the efficacy of our
products and services, individuals seeking treatment for behavioral health
disorders may seek alternative treatment methods, which could negatively impact
our sales and profitability.
OUR rEEG TECHNOLOGY MAY NOT BE AS USEFUL AS WE BELIEVE IT TO BE, WHICH COULD
LIMIT OR PREVENT US FROM GROWING OUR REVENUES.
Our belief in the efficacy of our rEEG technology is based on a limited
number of studies. Such results may not be statistically significant, and may
not be indicative of the long-term future efficacy of the information we
provide. Controlled scientific studies, including those that have been announced
and that are planned for the future, may yield results that are unfavorable or
demonstrate that our services, including our rEEG Analytical Reports, are not
clinically useful. While we have not experienced such problems to date, if the
initially indicated results cannot be successfully replicated or maintained over
time, utilization of services based on our rEEG technology, including the
delivery of our rEEG Analytical Reports, could decline substantially and
therefore harm our operating results and stock price.
DATA RELATING TO OUR PRODUCTS AND SERVICES MAY BE INTERPRETED UNFAVORABLY, WHICH
COULD ADVERSELY AFFECT OUR REVENUES AND EARNINGS.
While we have been able to generate initial interest in our rEEG
Analytical Reports among a limited number of psychiatrists and physicians, there
can be no assurance that our efforts or the efforts of others will be successful
in increasing the acceptance of our rEEG Analytical Reports. Marketplace
acceptance of our rEEG Analytical reports may largely depend upon healthcare
providers' interpretation of our limited data, the results of pending studies,
or upon reviews and reports that may be given by independent researchers. In the
event that health care providers interpret data relating to our rEEG technology
unfavorably, and if our marketing and promotional efforts are not as successful
as we expect them to be, our revenues and earnings will be harmed.
IF WE DO NOT MAINTAIN AND EXPAND OUR RELATIONSHIPS IN THE PSYCHIATRIC AND
PHYSICIAN COMMUNITY, OUR GROWTH WILL BE LIMITED AND OUR BUSINESS COULD BE
HARMED. IF PSYCHIATRISTS AND OTHER PHYSICIANS DO NOT RECOMMEND AND ENDORSE OUR
PRODUCTS AND SERVICES, OUR SALES MAY DECLINE OR WE MAY BE UNABLE TO INCREASE OUR
SALES, AND IN SUCH INSTANCES OUR PROFITABILITY WOULD BE HARMED.
Purchases by psychiatrists and physicians of our rEEG Analytical
Reports currently account for substantially all of our revenue. Consequently,
our relationships with psychiatrists and physicians are critical to our
continued growth. We believe that these relationships are based on the quality
and ease of use of our rEEG Analytical Reports, our commitment to the behavioral
health market, our marketing efforts, and our presence at tradeshows such as the
American Psychiatric Association annual meeting. Any actual or perceived
diminution in our reputation or the quality of our rEEG Analytical Reports, or
our failure or inability to maintain our commitment to the behavioral health
market and our other marketing and product promotion efforts could damage our
current relationships, or prevent us from
6
forming new relationships, with psychiatrists and other physicians and cause our
growth to be limited and our business to be harmed.
To sell our rEEG Analytical Reports, psychiatric professionals must
recommend and endorse them. We may not obtain the necessary recommendations or
endorsements from this community. Acceptance of our rEEG Analytical Reports
depends on educating psychiatrists and physicians as to the benefits, clinical
efficacy, ease of use, revenue opportunity, and cost-effectiveness of our rEEG
Analytical Reports and on training the medical community to properly understand
and utilize our rEEG Analytical Reports. If we are not successful in obtaining
the recommendations or endorsements of psychiatrists and other physicians for
our rEEG Analytical Reports, our sales may decline or we may be unable to
increase our sales and profitability.
NEGATIVE PUBLICITY OR UNFAVORABLE MEDIA COVERAGE COULD DAMAGE OUR REPUTATION AND
HARM OUR OPERATIONS.
In the event that the marketplace perceives our rEEG Analytical Reports
as not offering the benefits which we believe they offer, we may receive
significant negative publicity. This publicity may result in litigation and
increased regulation and governmental review. If we were to receive such
negative publicity or unfavorable media attention, whether warranted or
unwarranted, our ability to market our rEEG Analytical Reports would be
adversely affected, pharmaceutical companies may be reluctant to pursue
strategic initiatives with us relating to the development of new products and
services based on our rEEG technology, we may be required to change our products
and services and become subject to increased regulatory burdens, and we may be
required to pay large judgments or fines. Any combination of these factors could
further increase our cost of doing business and adversely affect our financial
position, results of operations and cash flows.
IF WE DO NOT SUCCESSFULLY GENERATE ADDITIONAL PRODUCTS AND SERVICES FROM OUR
PATENTED METHODOLOGY AND PROPRIETARY DATABASE, OR IF SUCH PRODUCTS AND SERVICES
ARE DEVELOPED BUT NOT SUCCESSFULLY COMMERCIALIZED, THEN WE COULD LOSE REVENUE
OPPORTUNITIES.
Currently, our primary business is the sale of rEEG Analytical Reports
to psychiatrists and physicians based on our rEEG methodology and proprietary
database. In the future, we may utilize our patented methodology and proprietary
database to produce pharmaceutical advancements and developments. For instance,
we may use our patented methodology and proprietary database to identify new
medications that are promising in the treatment of behavioral health disorders,
identify new uses of medications which have been previously approved, and
identify new patient populations that are responsive to medications in clinical
trials that have previously failed to show efficacy in United States Food & Drug
Administration (FDA) approved clinical trials. The development of new
pharmaceutical applications that are based on our patented methodology and
proprietary database will be costly, since we will be subject to additional
regulations, including the need to conduct expensive and time consuming clinical
trials.
In addition, to successfully monetize our pharmaceutical opportunity,
we will need to enter into strategic alliances with biotechnology or
pharmaceutical companies that have the ability to bring to market a medication,
an ability which we currently do not have. We maintain no pharmaceutical
manufacturing, marketing or sales organization, nor do we plan to build one in
the foreseeable future. Therefore, we are reliant upon approaching and
successfully negotiating attractive terms with a partner who has these
capabilities. No guarantee can be made that we can do this on attractive terms.
If we are unable to find strategic partners for our pharmaceutical opportunity,
our revenues may not grow as quickly as we desire, which could lower our stock
price.
7
IN THE EVENT THAT WE PURSUE OUR PHARMACEUTICAL OPPORTUNITIES, WE OR ANY
DEVELOPMENT PARTNERS THAT WE PARTNER WITH WILL LIKELY NEED TO CONDUCT CLINICAL
TRIALS. IF SUCH CLINICAL TRIALS ARE DELAYED OR UNSUCCESSFUL, IT COULD HAVE AN
ADVERSE EFFECT ON OUR BUSINESS.
We have no experience conducting clinical trials of psychiatric
medications and in the event we conduct clinical trials, we will rely on outside
parties, including academic investigators, outside consultants and contract
research organizations to conduct these trials on our behalf. We will rely on
these parties to assist in the recruitment of sites for participation in
clinical trials, to maintain positive relations with these sites, and to ensure
that these sites conduct the trials in accordance with the protocol and our
instructions. If these parties renege on their obligations to us, our clinical
trials may be delayed or unsuccessful.
In the event we conduct clinical trials, we cannot predict whether we
will encounter problems that will cause us or regulatory authorities to delay or
suspend our clinical trials or delay the analysis of data from our completed or
ongoing clinical trials. In addition, we cannot assure you that we will be
successful in reaching the endpoints in these trials, or if we do, that the FDA
or other regulatory agencies will accept the results.
Any of the following could delay the completion of clinical trials, or
result in a failure of these trials to support our business, which would have an
adverse effect on our business:
o delays or the inability to obtain required approvals from
institutional review boards or other governing entities at
clinical sites selected for participation in our clinical
trials,
o delays in enrolling patients into clinical trials,
o lower than anticipated retention rates of patients in clinical
trials,
o negative results from clinical trials for any of our potential
products, and
o failure of our clinical trials to demonstrate the efficacy or
clinical utility of our potential products.
If we determine that the costs associated with attaining regulatory
approval of a product exceed the potential financial benefits or if the
projected development timeline is inconsistent with our determination of when we
need to get the product to market, we may chose to stop a clinical trial and/or
development of a product.
IF WE DO NOT DEVELOP AND IMPLEMENT A SUCCESSFUL SALES AND MARKETING STRATEGY, WE
MAY NOT EXPAND OUR BUSINESS SUFFICIENTLY TO COVER OUR EXPENSES.
We currently rely on our employees to market and promote our rEEG
Analytical Reports. In the event that we experience high turnover among our
employees, and new employees do not acquire the skills to sell our rEEG
Analytical Reports in a timely and successful manner, we may not be able to
sustain and grow our revenue.
In addition, in order to grow our business, we will need to develop and
introduce new sales and marketing programs and clinical education programs to
promote the use of our rEEG Analytical Reports by psychiatrists and physicians.
If we do not implement these new sales and marketing and education programs in a
timely and successful manner, we may not be able to achieve the level of market
awareness and sales required to expand our business.
8
WE MAY FAIL TO SUCCESSFULLY MANAGE AND MAINTAIN THE GROWTH OF OUR BUSINESS,
WHICH COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
As we continue expanding our commercial operations, this expansion
could place significant strain on our management, operational, and financial
resources. To manage future growth, we will need to continue to hire, train, and
manage additional employees, particularly a specially trained sales force to
market our rEEG Analytical Reports.
In addition, we have maintained a small financial and accounting staff,
and our reporting obligations as a public company, as well as our need to comply
with the requirements of the Sarbanes-Oxley Act of 2002, and the rules and
regulations of the SEC will continue to place significant demands on our
financial and accounting staff, on our financial, accounting and information
systems and on our internal controls. As we grow, we will need to add additional
accounting staff and continue to improve our financial, accounting and
information systems and internal controls in order to fulfill our reporting
responsibilities and to support expected growth in our business. Our current and
planned personnel, systems, procedures and controls may not be adequate to
support our anticipated growth or management may not be able to effectively
hire, train, retain, motivate and manage required personnel. Our failure to
manage growth effectively could limit our ability to achieve our marketing and
commercialization goals or to satisfy our reporting and other obligations as a
public company.
WE MAY INCUR SIGNIFICANT EXPENSES OR BE PREVENTED FROM COMMERCIALIZING OR
DEVELOPING PRODUCTS AS A RESULT OF AN INTELLECTUAL PROPERTY INFRINGEMENT CLAIM.
Our commercial success depends, in part, on our ability to operate
without infringing the patents and proprietary rights of third parties.
Infringement proceedings are long, costly and time-consuming and their outcome
is uncertain.
If we become involved in any patent infringement litigation,
interference or other administrative proceedings related to our intellectual
property, we will incur substantial expenses and the time and effort of our
management and scientific personnel, will be significantly diverted. As a result
of such litigation or proceedings, we could lose our proprietary position, and
be restricted from selling, manufacturing or distributing the affected
product(s), incur substantial damage awards, including punitive damages, or be
required to seek third party licenses at terms that may be unattractive, or we
may fail to acquire the license.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WHICH IS THE
CORE OF OUR BUSINESS.
We consider the protection of our intellectual property to be critical
to our business prospects. We currently have two issued U.S. patents, and we
have filed separate patent applications in multiple foreign jurisdictions.
In the future, if we fail to file patent applications in a timely
manner, or in the event we elect not to file a patent application because of the
costs associated with patent prosecution, we may lose patent protection that we
may have otherwise obtained. The loss of any proprietary rights which are
obtainable under patent laws may result in the loss of a competitive advantage
over present or potential competitors, with a resulting decrease in revenues and
profitability for us.
With respect to the applications we have filed, there is no guarantee
that the applications will result in issued patents, and further, any patents
that do issue may be too narrow in scope to adequately protect our intellectual
property and provide us with a competitive advantage. Competitors and others
9
may design around aspects of our technology, or alternatively may independently
develop similar or more advanced technologies that can be used in the treatment
of behavioral health disorders that fall outside the scope of our claimed
subject matter.
In addition, even if we are issued additional patents covering our
products, we cannot predict with certainty whether or not we will be able to
enforce our proprietary rights, and whether our patents will provide us with
adequate protection against competitors. We may be forced to engage in costly
and time consuming litigation or reexamination proceedings to protect our
intellectual property rights, and our opponents in such proceedings may have,
and be willing to expend, substantially greater resources than we are able to.
In addition, the results of such proceedings may result in our patents being
invalidated or reduced in scope. These developments could cause a decrease in
our operating income and reduce our available cash flow, which could harm our
business and cause our stock price to decline.
We also utilize processes and technology that constitute trade secrets,
such as our outcomes database, and we must implement appropriate levels of
security for those trade secrets to secure the protection of applicable laws,
which we may not do effectively. In addition, the laws of many foreign countries
do not protect proprietary rights as fully as the laws of the United States.
While we have not had any significant issues to date, the loss of any
of our trade secrets or proprietary rights which may be protected under the
foregoing intellectual property safeguards may result in the loss of our
competitive advantage over present and potential competitors.
CONFIDENTIALITY AGREEMENTS WITH EMPLOYEES, LICENSEES AND OTHERS MAY NOT
ADEQUATELY PREVENT DISCLOSURE OF TRADE SECRETS AND OTHER PROPRIETARY INFORMATION
In order to protect our proprietary technology and processes, we rely
in part on confidentiality provisions in our agreements with employees,
licensees, treating physicians and psychiatrists and others. These agreements
may not effectively prevent disclosure of confidential information and may not
provide an adequate remedy in the event of unauthorized disclosure of
confidential information. Moreover, policing compliance with our confidentiality
agreements and non-disclosure agreements, and detecting unauthorized use of our
technology is difficult, and we may be unable to determine whether piracy of our
technology has occurred. In addition, others may independently discover trade
secrets and proprietary information. Costly and time-consuming litigation could
be necessary to enforce and determine the scope of our proprietary rights, and
failure to obtain or maintain trade secret protection could adversely affect our
competitive business position.
ALTHOUGH WE BELIEVE WE ARE NOT CURRENTLY SUBJECT TO REGULATORY APPROVAL FOR THE
SALE OF OUR rEEG ANALYTICAL REPORTS, REGULATIONS ARE CONSTANTLY CHANGING, AND IN
THE FUTURE OUR BUSINESS MAY BE SUBJECT TO REGULATION.
Currently, we do not believe that sales of our rEEG Analytical Reports
are subject to regulatory approval. However, federal, state and foreign laws and
regulations relating to the sale of our rEEG Analytical Reports are subject to
future changes, as are administrative interpretations of regulatory agencies. If
we fail to comply with applicable federal, state or foreign laws or regulations,
we could be subject to enforcement actions, including injunctions preventing us
from conducting our business, withdrawal of clearances or approvals and civil
and criminal penalties. In the event that federal, state, and foreign laws and
regulations change, we may need to incur additional costs to seek government
approvals in order to sell our rEEG Analytical Reports. There is no guarantee
that we will be able to obtain such approvals in a timely manner or at all, and
as a result, our revenues from our rEEG Analytical Reports may be reduced, or
potentially eliminated.
10
IN THE FUTURE, WE INTEND TO SEEK REGULATORY APPROVAL FOR MEDICATIONS OR
COMBINATIONS OF MEDICATIONS FOR NEW INDICATIONS, AND THERE IS NO GUARANTEE THAT
WE WILL RECEIVE SUCH APPROVALS.
We intend to seek approval for medications or combinations of
medications for new indications, either with corporate partners, or potentially,
on our own. We are currently not authorized to market such medications in any
jurisdiction, and we may never receive such authorization. The development and
commercialization of medications for new indications is subject to extensive
regulation by the U.S. Federal government, principally through the FDA and other
federal, state and governmental authorities elsewhere. Prior to marketing any
central nervous system medication, and in many cases prior to being able to
successfully partner a central nervous system medication, we will have to
conduct extensive clinical trials at our own expense to determine safety and
efficacy of the indication that we are pursuing. We have no prior experience, as
a company, in conducting clinical trials. Clinical trials are expensive and can
take years to complete, and have uncertain outcomes. In addition, the regulatory
and approval procedures vary from country to country, and additional testing may
be required in some jurisdictions. It may take several years to complete the
clinical trials, and a product may fail at any stage of testing. Difficulties
and risks associated with clinical trials may result in our, or our partners'
inability to achieve regulatory approval to market medications for central
nervous system disorders. The FDA, other regulatory agencies, our collaborators,
or we may suspend or terminate clinical trials at any time.
Delays or failures in obtaining regulatory approval may delay or
prevent the commercialization of any product that we may develop for new
indications, diminish any competitive advantage, reduce or eliminate revenues,
milestone payments or royalties from collaborators, and adversely affect our
ability to attract new collaborators. The results of earlier clinical trials do
not necessarily predict the results of later clinical trials. Medications in
later clinical trials may fail to show desired safety and efficacy traits in the
indication we are seeking approval for, despite prior success in clinical trials
for other indications. Even if we and/or our collaborators and partners believe
the data collected from such clinical trials are promising, such data may not
support approval by the FDA or any other regulatory authorities. In addition,
the FDA or other regulatory authority may interpret the data differently than we
do, which could delay, limit or prevent regulatory approval. We expect to rely,
in part, on clinical trials that were performed by third-party physicians. These
trial results may not be predictive of the results of clinical trials we intend
to perform for new indications. In addition, the results of prior clinical
trials may not now be acceptable to the FDA or other regulatory authorities
because the data may be incomplete, outdated, or otherwise unacceptable for
inclusions in ours or our partners' regulatory submissions for approval of
medications for new indications.
IN THE EVENT WE OBTAIN REGULATORY APPROVAL FOR NEW INDICATIONS FOR EXISTING
MEDICATIONS, WE WILL STILL BE SUBJECT TO EXTENSIVE REGULATION BY THE FDA AND
OTHER AGENCIES, AND IF WE FAIL TO COMPLY WITH SUCH REGULATIONS, THE SALE OF OUR
PRODUCTS MAY BE RESTRICTED.
If we, or our collaborators, obtain regulatory approval for new
indications for existing medications, we will still be subject to extensive
regulation by the FDA and/or other regulatory agencies. We and our collaborators
will be required to conduct extensive post-market surveillance of products. Our,
or our collaborators', failure to comply with applicable FDA and other
regulatory requirements, or the later discovery of unknown problems, may result
in restrictions on the marketing or sale of such products that will negatively
impact sales and/or collaboration revenue, and may result in denial of authority
to market the medication product(s).
11
IF WE DO NOT RETAIN OUR SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES, WE MAY NOT BE
ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY.
Our future success depends on the on the ability, experience and
performance of our senior management and our key professional personnel. Our
success therefore depends to a significant extent on retaining the services of
Leonard Brandt, our President, Chief Executive Officer, and Secretary, Horace
Hertz, our Chief Financial Officer, and others. Because of their ability and
experience, if we lose one or more of the members of our senior management or
other key employees, our ability to successfully implement our business strategy
could be seriously harmed.
We do not carry key man life insurance on any of our key employees. We
do not have employment agreements in place with our executives and key
employees, and each may terminate their employment upon notice and without cause
or good reason. While we believe our relationships with our executives are good
and do not anticipate any of them leaving in the near future, the loss of the
services of Leonard Brandt or any other key member of management could have a
material adverse effect on our ability to manage our business.
IF WE DO NOT ATTRACT AND RETAIN SKILLED PERSONNEL OR IF WE DO NOT MAINTAIN GOOD
RELATIONSHIPS WITH OUR EMPLOYEES, WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS.
Our products and services are based on a complex database of
information. Accordingly, we require skilled medical, scientific and
administrative personnel to sell and support our products and services. Our
future success will depend largely on our ability to continue to hire, train,
retain and motivate additional skilled personnel, particularly sales
representatives who are responsible for customer education and training and
customer support, as well as personnel with experience in clinical testing and
matters relating to obtaining regulatory approvals. If we are not able to
attract and retain skilled personnel, we will not be able to continue our
development and commercialization activities.
In addition, we may be subject to claims that we engage in
discriminatory or inappropriate practices with respect to our hiring,
termination, promotion and compensation processes for our employees. Such
claims, with or without merit, could be time consuming, distracting and
expensive to defend, could divert attention of our management from other tasks
important to the success of our business and could adversely affect our
reputation as an employer.
IN THE FUTURE WE COULD BE SUBJECT TO PERSONAL INJURY CLAIMS, WHICH COULD RESULT
IN SUBSTANTIAL LIABILITIES THAT MAY EXCEED OUR INSURANCE COVERAGE.
All significant medical treatments and procedures, including treatment
that is facilitated through the use of our rEEG Analytical Reports, involve the
risk of serious injury or death. While we do not treat patients or determine
whether treatment that is guided by rEEG Analytical Reports that we provide is
appropriate for any particular patient, and have not been the subject of any
personal injury claims for patients treated by providers using our rEEG
Analytical Reports, our business entails an inherent risk of claims for personal
injuries, which are subject to the attendant risk of substantial damage awards.
We cannot control whether individual physicians and psychiatrists will properly
select patients, apply the appropriate standard of care, or conform to our
procedures in determining how to treat their patients. A significant source of
potential liability is negligence or alleged negligence by physicians treating
patients with the aid of the rEEG Analytical Reports that we provide. There can
be no assurance that a future claim or claims will not be successful or,
including the cost of legal defense, will not exceed the limits of available
insurance coverage.
12
We currently have general liability and medical professional liability
insurance coverage for up to $5 million per year for personal injury claims. We
may not be able to maintain adequate liability insurance, in accordance with
standard industry practice, with appropriate coverage based on the nature and
risks of our business, at acceptable costs and on favorable terms. Insurance
carriers are often reluctant to provide liability insurance for new healthcare
services companies and products due to the limited claims history for such
companies and products. In addition, based on current insurance markets, we
expect that liability insurance will be more difficult to obtain and that
premiums will increase over time and as the volume of patients treated by
physicians that are guided by our rEEG Analytical Reports increases. In the
event of litigation, regardless of its merit or eventual outcome, or an award
against us during a time when we have no available insurance or insufficient
insurance, we may sustain significant losses of our operating capital which may
substantially reduce stockholder equity in the company.
IF GOVERNMENT AND THIRD-PARTY PAYERS FAIL TO PROVIDE COVERAGE AND ADEQUATE
PAYMENT RATES FOR TREATMENTS THAT ARE GUIDED BY OUR rEEG ANALYTICAL REPORTS, OUR
REVENUE AND PROSPECTS FOR PROFITABILITY MAY BE HARMED.
Our future revenue growth will depend in part upon the availability of
reimbursement from third-party payers for psychiatrists and physicians who use
our rEEG Analytical Reports to guide the treatment of their patients. Such
third-party payers include government health programs such as Medicare and
Medicaid, managed care providers, private health insurers and other
organizations. These third-party payers are increasingly attempting to contain
healthcare costs by demanding price discounts or rebates and limiting both
coverage on which procedures they will pay for and the amounts that they will
pay for new procedures. As a result, they may not cover or provide adequate
payment for treatments that are guided by our rEEG Analytical Reports, which
will discourage psychiatrists and physicians from utilizing the information
services we provide. We may need to conduct studies to demonstrate the
cost-effectiveness of treatments that are guided by our products and services to
such payers' satisfaction. Such studies might require us to commit a significant
amount of management time and financial and other resources. Adequate
third-party reimbursement might not be available to enable us to realize an
appropriate return on investment in research and product development, and the
lack of such reimbursement could have a material adverse effect on our
operations and could adversely affect our revenues and earnings.
OUR BUSINESS PROSPECTS AND PROFITABILITY COULD BE NEGATIVELY IMPACTED IF WE HAVE
OVER-ESTIMATED THE DEMAND FOR OUR rEEG ANALYTICAL REPORTS.
We are focused on the market for behavioral health disorders. The
projected demand for our rEEG Analytical Reports could materially differ from
actual demand if our assumptions regarding this market and its trends and
acceptance of our rEEG Analytical Reports by the psychiatric community prove to
be incorrect or do not materialize or if other products or services gain more
widespread acceptance, which in each case would adversely affect our business
prospects and profitability.
WE ARE SUBJECT TO EVOLVING AND EXPENSIVE CORPORATE GOVERNANCE REGULATIONS AND
REQUIREMENTS. OUR FAILURE TO ADEQUATELY ADHERE TO THESE REQUIREMENTS OR THE
FAILURE OR CIRCUMVENTION OF OUR CONTROLS AND PROCEDURES COULD SERIOUSLY HARM OUR
BUSINESS.
Because we are a publicly traded company we are subject to certain
federal, state and other rules and regulations, including applicable
requirements of the Sarbanes-Oxley Act of 2002. Compliance with these evolving
regulations is costly and requires a significant diversion of management time
and attention, particularly with regard to our disclosure controls and
procedures and our internal control over financial reporting. Although we have
reviewed our disclosure and internal controls and procedures in order to
determine whether they are effective, our controls and procedures may not be
able to prevent errors or
13
frauds in the future. Faulty judgments, simple errors or mistakes, or the
failure of our personnel to adhere to established controls and procedures may
make it difficult for us to ensure that the objectives of the control system are
met. A failure of our controls and procedures to detect other than
inconsequential errors or fraud could seriously harm our business and results of
operations.
OUR SENIOR MANAGEMENT'S LIMITED RECENT EXPERIENCE MANAGING A PUBLICLY TRADED
COMPANY MAY DIVERT MANAGEMENT'S ATTENTION FROM OPERATIONS AND HARM OUR BUSINESS.
Our management team has relatively limited recent experience managing a
publicly traded company and complying with federal securities laws, including
compliance with recently adopted disclosure requirements on a timely basis. Our
management will be required to design and implement appropriate programs and
policies in responding to increased legal, regulatory compliance and reporting
requirements, and any failure to do so could lead to the imposition of fines and
penalties and harm our business.
RISKS RELATED TO OUR INDUSTRY
THE HEALTHCARE INDUSTRY IN WHICH WE OPERATE IS SUBJECT TO SUBSTANTIAL REGULATION
BY STATE AND FEDERAL AUTHORITIES, WHICH COULD HINDER, DELAY OR PREVENT US FROM
COMMERCIALIZING OUR PRODUCTS AND SERVICES.
Healthcare companies are subject to extensive and complex federal,
state and local laws, regulations and judicial decisions governing various
matters such as the licensing and certification of facilities and personnel, the
conduct of operations, billing policies and practices, policies and practices
with regard to patient privacy and confidentiality, and prohibitions on payments
for the referral of business and self-referrals. There are federal and state
laws, regulations and judicial decisions that govern patient referrals,
physician financial relationships, submission of healthcare claims and
inducement to beneficiaries of federal healthcare programs. Many states prohibit
business corporations from practicing medicine, employing or maintaining control
over physicians who practice medicine, or engaging in certain business
practices, such as splitting fees with healthcare providers. Many healthcare
laws and regulations applicable to our business are complex, applied broadly and
subject to interpretation by courts and government agencies. Our failure, or the
failure of physicians and psychiatrists to whom we sell our rEEG Analytical
Reports, to comply with these healthcare laws and regulations could create
liability for us and negatively impact our business.
In addition, the FDA, regulates development, testing, labeling,
manufacturing, marketing, promotion, distribution, record-keeping and reporting
requirements for prescription drugs. Compliance with laws and regulations
enforced by the FDA and other regulatory agencies may be required in relation to
future products or services developed or used by us. Failure to comply with
applicable laws and regulations may result in various adverse consequences,
including withdrawal of our products and services from the market, or the
imposition of civil or criminal sanctions.
We believe that this industry will continue to be subject to increasing
regulation, political and legal action and pricing pressures, the scope and
effect of which we cannot predict. Legislation is continuously being proposed,
enacted and interpreted at the federal, state and local levels to regulate
healthcare delivery and relationships between and among participants in the
healthcare industry. Any such changes could prevent us from marketing some or
all of our products and services for a period of time or permanently.
14
WE MAY BE SUBJECT TO REGULATORY AND INVESTIGATIVE PROCEEDINGS, WHICH MAY FIND
THAT OUR POLICIES AND PROCEDURES DO NOT FULLY COMPLY WITH COMPLEX AND CHANGING
HEALTHCARE REGULATIONS.
While we have established policies and procedures that we believe will
be sufficient to ensure that we operate in substantial compliance with
applicable laws, regulations and requirements, the criteria are often vague and
subject to change and interpretation. We may become the subject of regulatory or
other investigations or proceedings, and our interpretations of applicable laws
and regulations may be challenged. The defense of any such challenge could
result in substantial cost and a diversion of management's time and attention.
Thus, any such challenge could have a material adverse effect on our business,
regardless of whether it ultimately is successful. If we fail to comply with any
applicable laws, or a determination is made that we have failed to comply with
these laws, our financial condition and results of operations could be adversely
affected.
FAILURE TO COMPLY WITH THE FEDERAL TRADE COMMISSION ACT OR SIMILAR STATE LAWS
COULD RESULT IN SANCTIONS OR LIMIT THE CLAIMS WE CAN MAKE.
The Company's promotional activities and materials, including
advertising to consumers and physicians, and materials provided to third parties
for their use in promoting our products and services, are regulated by the
Federal Trade Commission (FTC) under the FTC Act, which prohibits unfair and
deceptive acts and practices, including claims which are false, misleading or
inadequately substantiated. The FTC typically requires competent and reliable
scientific tests or studies to substantiate express or implied claims that a
product or service is effective. If the FTC were to interpret our promotional
materials as making express or implied claims that our products and services are
effective for the treatment of mental illness, it may find that we do not have
adequate substantiation for such claims. Failure to comply with the FTC Act or
similar laws enforced by state attorneys general and other state and local
officials could result in administrative or judicial orders limiting or
eliminating the claims we can make about our products and services, and other
sanctions including fines.
OUR BUSINESS PRACTICES MAY BE FOUND TO CONSTITUTE ILLEGAL FEE-SPLITTING OR
CORPORATE PRACTICE OF MEDICINE, WHICH MAY LEAD TO PENALTIES AND ADVERSELY AFFECT
OUR BUSINESS.
Many states, including California, in which our principal executive
offices are located, have laws that prohibit business corporations, such as us,
from practicing medicine, exercising control over medical judgments or decisions
of physicians, or engaging in certain arrangements, such as employment or
fee-splitting, with physicians. Courts, regulatory authorities or other parties,
including physicians, may assert that we are engaged in the unlawful corporate
practice of medicine by providing administrative and ancillary services in
connection with our rEEG Analytical Reports, or that selling our rEEG Analytical
Reports for a portion of the patient fees constitutes improper fee-splitting, in
which case we could be subject to civil and criminal penalties, our contracts
could be found legally invalid and unenforceable, in whole or in part, or we
could be required to restructure our contractual arrangements. There can be no
assurance that this will not occur or, if it does, that we would be able to
restructure our contractual arrangements on favorable terms.
OUR BUSINESS PRACTICES MAY BE FOUND TO VIOLATE ANTI-KICKBACK, SELF-REFERRAL OR
FALSE CLAIMS LAWS, WHICH MAY LEAD TO PENALTIES AND ADVERSELY AFFECT OUR
BUSINESS.
The healthcare industry is subject to extensive federal and state
regulation with respect to financial relationships and "kickbacks" involving
healthcare providers, physician self-referral arrangements, filing of false
claims and other fraud and abuse issues. Federal anti-kickback laws and
regulations prohibit certain offers, payments or receipts of remuneration in
return for (i) referring patients covered by Medicare, Medicaid or other federal
health care program, or (ii) purchasing, leasing, ordering
15
or arranging for or recommending any service, good, item or facility for which
payment may be made by a federal health care program. In addition, federal
physician self-referral legislation, commonly known as the Stark law, generally
prohibits a physician from ordering certain services reimbursable by Medicare,
Medicaid or other federal healthcare program from any entity with which the
physician has a financial relationship. In addition, many states have similar
laws, some of which are not limited to services reimbursed by federal healthcare
programs. Other federal and state laws govern the submission of claims for
reimbursement, or false claims laws. One of the most prominent of these laws is
the federal False Claims Act, and violations of other laws, such as the
anti-kickback laws or the FDA prohibitions against promotion of off-label uses
of medications, may also be prosecuted as violations of the False Claims Act.
While we believe we have structured our relationships to comply with
all applicable requirements, federal or state authorities may claim that our fee
arrangements, agreements and relationships with contractors and physicians
violate these anti-kickback, self-referral or false claims laws and regulations.
These laws are broadly worded and have been broadly interpreted by courts. It is
often difficult to predict how these laws will be applied, and they potentially
subject many typical business arrangements to government investigation and
prosecution, which can be costly and time consuming. Violations of these laws
are punishable by monetary fines, civil and criminal penalties, exclusion from
participation in government-sponsored health care programs and forfeiture of
amounts collected in violation of such laws. Some states also have similar
anti-kickback and self-referral laws, imposing substantial penalties for
violations. If our business practices are found to violate any of these
provisions, we may be unable to continue with our relationships or implement our
business plans, which would have an adverse effect on our business and results
of operations.
WE MAY BE SUBJECT TO HEALTHCARE ANTI-FRAUD INITIATIVES, WHICH MAY LEAD TO
PENALTIES AND ADVERSELY AFFECT OUR BUSINESS.
State and federal governments are devoting increased attention and
resources to anti-fraud initiatives against healthcare providers, taking an
expansive definition of fraud that includes receiving fees in connection with a
healthcare business that is found to violate any of the complex regulations
described above. While to our knowledge we have not been the subject of any
anti-fraud investigations, if such a claim were made defending our business
practices could be time consuming and expensive, and an adverse finding could
result in substantial penalties or require us to restructure our operations,
which we may not be able to do successfully.
OUR USE AND DISCLOSURE OF PATIENT INFORMATION IS SUBJECT TO PRIVACY AND SECURITY
REGULATIONS, WHICH MAY RESULT IN INCREASED COSTS
In conducting research or providing administrative services to
healthcare providers in connection with the use of our rEEG Analytical Reports,
we may collect, use, maintain and transmit patient information in ways that will
be subject to many of the numerous state, federal and international laws and
regulations governing the collection, dissemination, use and confidentiality of
patient-identifiable health information, including the federal Health Insurance
Portability and Accountability Act (HIPAA) and related rules. The three rules
that were promulgated pursuant to HIPAA that could most significantly affect our
business are the Standards for Electronic Transactions, or Transactions Rule;
the Standards for Privacy of Individually Identifiable Health Information, or
Privacy Rule; and the Health Insurance Reform: Security Standards, or Security
Rule. HIPAA applies to covered entities, which include most healthcare
facilities and health plans that may contract for the use of our services. The
HIPAA rules require covered entities to bind contractors like us to compliance
with certain burdensome HIPAA rule requirements.
16
The HIPAA Transactions Rule establishes format and data content
standards for eight of the most common healthcare transactions. If we perform
billing and collection services on behalf of psychiatrists and physicians, we
may be engaging in one of more of these standard transactions and will be
required to conduct those transactions in compliance with the required
standards. The HIPAA Privacy Rule restricts the use and disclosure of patient
information, requires entities to safeguard that information and to provide
certain rights to individuals with respect to that information. The HIPAA
Security Rule establishes elaborate requirements for safeguarding patient
information transmitted or stored electronically. We may be required to make
costly system purchases and modifications to comply with the HIPAA rule
requirements that are imposed on us and our failure to comply may result in
liability and adversely affect our business.
Numerous other federal and state laws protect the confidentiality of
personal and patient information. These laws in many cases are not preempted by
the HIPAA rules and may be subject to varying interpretations by courts and
government agencies, creating complex compliance issues for us and the
psychiatrists and physicians who purchase our services, and potentially exposing
us to additional expense, adverse publicity and liability. Other countries also
have, or are developing, laws governing the collection, use and transmission of
personal or patient information and these laws could create liability for us or
increase our cost of doing business.
RISKS RELATING TO INVESTMENT IN OUR COMMON STOCK
WE HAVE A LIMITED TRADING VOLUME AND SHARES ELIGIBLE FOR FUTURE SALE BY OUR
CURRENT STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE.
Bid and ask prices for shares of our Common Stock are quoted on NASD's
OTC Bulletin Board under the symbol CNSO.OB. There is currently no broadly
followed, established trading market for our Common Stock. While we are hopeful
that the Company will command the interest of a greater number of investors, an
established trading market for our shares of Common Stock may never develop or
be maintained. Active trading markets generally result in lower price volatility
and more efficient execution of buy and sell orders. The absence of an active
trading market reduces the liquidity of our Common Stock. We have had little or
no trading volume in our Common Stock. As a result of this lack of trading
activity, the quoted price for our Common Stock on NASD's OTC Bulletin Board is
not necessarily a reliable indicator of its fair market value. Further, if we
cease to be quoted, holders would find it more difficult to dispose of, or to
obtain accurate quotations as to the market value of, our Common Stock, and the
market value of our Common Stock would likely decline.
IF AND WHEN A TRADING MARKET FOR OUR COMMON STOCK DEVELOPS, THE MARKET PRICE OF
OUR COMMON STOCK IS LIKELY TO BE HIGHLY VOLATILE AND SUBJECT TO WIDE
FLUCTUATIONS, AND YOU MAY BE UNABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE
AT WHICH YOU ACQUIRED THEM.
The market price of our Common Stock is likely to be highly volatile
and could be subject to wide fluctuations in response to a number of factors
that are beyond our control, including announcements of new products or services
by our competitors. In addition, the market price of the Common Stock could be
subject to wide fluctuations in response to a variety of factors, including:
o quarterly variations in our revenues and operating expenses;
o developments in the financial markets and worldwide or
regional economies;
o announcements of innovations or new products or services by us
or our competitors;
o announcements by the government relating to regulations that
govern our industry;
o significant sales of our Common Stock or other securities in
the open market;
17
o variations in interest rates;
o changes in the market valuations of other comparable
companies; and
o changes in accounting principles.
In the past, stockholders have often instituted securities class action
litigation after periods of volatility in the market price of a company's
securities. If a stockholder were to file any such class action suit against us,
we would incur substantial legal fees and our management's attention and
resources would be diverted from operating our business to respond to the
litigation, which could harm our business.
SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD CAUSE
OUR STOCK PRICE TO FALL.
Upon the effectiveness of the Registration Statement, a significant
number of our shares of Common Stock will become eligible for sale, including up
to 6,504,765 shares sold in the Private Placement, up to 2,627,939 shares of our
Common Stock underlying warrants that were issued in our Private Placement,
83,333 shares issued to the placement agent of the Private Placement and up to
767,101 shares held by certain of our stockholders that were issued and
outstanding immediately prior to the Merger. The sale of these shares could
depress the market price of our Common Stock. A reduced market price for our
shares could make it more difficult to raise funds through future offering of
Common Stock.
The holders of these shares, to the extent such shares are not
registered on the Registration Statement, as well as holders of our Common Stock
issued to holders of CNSR California Series A Preferred Stock and holders of
CNSR California Series B Preferred Stock, and certain holders of CNSR California
Common Stock in the Merger, and shares of our Common Stock held by the Placement
Agent or issuable to the Placement Agent upon exercise of the Placement Agent
Warrants, shall have piggy-back registration rights with respect to such Shares
effective September 7, 2007, and demand registration rights with respect to such
Shares effective twelve (12) months following the closing of the Private
Placement.
Moreover, as additional shares of Common Stock become available for
resale in the open market (including Shares issuable upon the exercise of the
Company's outstanding options and warrants), the supply of our publicly traded
shares will increase, which could decrease its price.
Some of our shares may also be offered from time to time in the open
market pursuant to Rule 144, and these sales may have a depressive effect on the
market for our shares. In general, a person who has held restricted shares for a
period of one year may, upon filing with the Securities & Exchange Commission
(the "SEC") a notification on Form 144, sell into the market shares up to an
amount equal to 1% of the outstanding shares.
THE SALE OF SECURITIES BY US IN ANY EQUITY OR DEBT FINANCING COULD RESULT IN
DILUTION TO OUR EXISTING STOCKHOLDERS AND HAVE A MATERIAL ADVERSE EFFECT ON OUR
EARNINGS.
Any sale of Common Stock by us in a future private placement could
result in dilution to our existing stockholders as a direct result of our
issuance of additional shares of our capital stock. In addition, our business
strategy may include expansion through internal growth, by acquiring
complementary businesses, by acquiring or licensing additional products and
services, or by establishing strategic relationships with targeted customers and
suppliers. In order to do so, or to finance the cost of our other activities, we
may issue additional equity securities that could dilute our stockholders' stock
ownership. We may also assume additional debt and incur impairment losses
related to goodwill and other tangible assets if we acquire another company and
this could negatively impact our earnings and results of operations.
18
THE TRADING OF OUR COMMON STOCK ON THE OVER-THE-COUNTER BULLETIN BOARD AND THE
POTENTIAL DESIGNATION OF OUR COMMON STOCK AS A "PENNY STOCK" COULD IMPACT THE
TRADING MARKET FOR OUR COMMON STOCK.
Our securities, as traded on the Over-the-Counter Bulletin Board, may
be subject to SEC rules that impose special sales practice requirements on
broker-dealers who sell these securities to persons other than established
customers or accredited investors. For the purposes of the rule, the phrase
"accredited investors" means, in general terms, institutions with assets in
excess of $5,000,000, or individuals having a net worth in excess of $1,000,000
or having an annual income that exceeds $200,000 (or that, when combined with a
spouse's income, exceeds $300,000). For transactions covered by the rule, the
broker-dealer must make a special suitability determination for the purchaser
and receive the purchaser's written agreement to the transaction before the
sale. Consequently, the rule may affect the ability of broker-dealers to sell
our securities and also may affect the ability of purchasers to sell their
securities in any market that might develop therefore.
In addition, the SEC has adopted a number of rules to regulate "penny
stock" that restrict transactions involving these securities. Such rules include
Rules 3a51-1, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6, 15g-7, and 15g-9 under
the Securities and Exchange Act of 1934, as amended. These rules may have the
effect of reducing the liquidity of penny stocks. "Penny stocks" generally are
equity securities with a price of less than $5.00 per share (other than
securities registered on certain national securities exchanges or quoted on the
NASDAQ Stock Market if current price and volume information with respect to
transactions in such securities is provided by the exchange or system). Because
our securities may constitute "penny stock" within the meaning of the rules, the
rules would apply to us and to our securities. If our securities become subject
to the penny stock rules, our stockholders may find it more difficult to sell
their securities.
Stockholders should be aware that, according to SEC, the market for
penny stocks has suffered in recent years from patterns of fraud and abuse. Such
patterns include (i) control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer; (ii)
manipulation of prices through prearranged matching of purchases and sales and
false and misleading press releases; (iii) "boiler room" practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (iv) excessive and undisclosed bid-ask differentials and markups
by selling broker-dealers; and (v) the wholesale dumping of the same securities
by promoters and broker-dealers after prices have been manipulated to a desired
level, resulting in investor losses. Our management is aware of the abuses that
have occurred historically in the penny stock market. Although we do not expect
to be in a position to dictate the behavior of the market or of broker-dealers
who participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities.
WE HAVE NOT PAID DIVIDENDS IN THE PAST AND DO NOT EXPECT TO PAY DIVIDENDS FOR
THE FORESEEABLE FUTURE, AND ANY RETURN ON INVESTMENT MAY BE LIMITED TO POTENTIAL
FUTURE APPRECIATION ON THE VALUE OF OUR COMMON STOCK.
We currently intend to retain any future earnings to support the
development and expansion of our business and do not anticipate paying cash
dividends in the foreseeable future. Our payment of any future dividends will be
at the discretion of our Board of Directors after taking into account various
factors, including without limitation, our financial condition, operating
results, cash needs, growth plans and the terms of any credit agreements that we
may be a party to at the time. To the extent we do not pay dividends, our stock
may be less valuable because a return on investment will only occur if and to
the extent our stock price appreciates, which may never occur. In addition,
investors must rely on sales of their Common Stock after price appreciation as
the only way to realize their investment, and if the price
19
of our stock does not appreciate, then there will be no return on investment.
Investors seeking cash dividends should not purchase our Common Stock.
OUR OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS CAN EXERT SIGNIFICANT
INFLUENCE OVER US AND MAY MAKE DECISIONS THAT ARE NOT IN THE BEST INTERESTS OF
ALL STOCKHOLDERS.
After the closing of the Merger and Private Placement, our officers,
directors and principal stockholders (greater than 5% stockholders) collectively
control approximately 83% of our issued and outstanding Common Stock. As a
result, these stockholders are able to affect the outcome of, or exert
significant influence over, all matters requiring stockholder approval,
including the election and removal of directors and any change in control. In
particular, this concentration of ownership of our Common Stock could have the
effect of delaying or preventing a change of control of us or otherwise
discouraging or preventing a potential acquirer from attempting to obtain
control of us. This, in turn, could have a negative effect on the market price
of our Common Stock. It could also prevent our stockholders from realizing a
premium over the market prices for their shares of Common Stock. Moreover, the
interests of this concentration of ownership may not always coincide with our
interests or the interests of other stockholders, and accordingly, they could
cause us to enter into transactions or agreements that we would not otherwise
consider.
TRANSACTIONS ENGAGED IN BY OUR LARGEST STOCKHOLDERS, OUR DIRECTORS OR EXECUTIVES
INVOLVING OUR COMMON STOCK MAY HAVE AN ADVERSE EFFECT ON THE PRICE OF OUR STOCK.
After the closing of the Merger and Private Placement, our officers,
directors and principal stockholders (greater than 5% stockholders) collectively
control approximately 83% of our issued and outstanding Common Stock. Subsequent
sales of our shares by these stockholders could have the effect of lowering our
stock price. The perceived risk associated with the possible sale of a large
number of shares by these stockholders, or the adoption of significant short
positions by hedge funds or other significant investors, could cause some of our
stockholders to sell their stock, thus causing the price of our stock to
decline. In addition, actual or anticipated downward pressure on our stock price
due to actual or anticipated sales of stock by our directors or officers could
cause other institutions or individuals to engage in short sales of our Common
Stock, which may further cause the price of our stock to decline.
From time to time our directors and executive officers may sell shares
of our common stock on the open market. These sales will be publicly disclosed
in filings made with the SEC. In the future, our directors and executive
officers may sell a significant number of shares for a variety of reasons
unrelated to the performance of our business. Our stockholders may perceive
these sales as a reflection on management's view of the business and result in
some stockholders selling their shares of our common stock. These sales could
cause the price of our stock to drop.
ANTI-TAKEOVER PROVISIONS MAY LIMIT THE ABILITY OF ANOTHER PARTY TO ACQUIRE US,
WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
Delaware law contains provisions that could discourage, delay or
prevent a third party from acquiring us, even if doing so may be beneficial to
our stockholders. In addition, these provisions could limit the price investors
would be willing to pay in the future for shares of our Common Stock.
20
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," contains "forward-looking statements" that include
information relating to future events, future financial performance, strategies,
expectations, competitive environment, regulation and availability of resources.
These forward-looking statements include, without limitation, statements
regarding: proposed new products or services; our statements concerning
litigation or other matters; statements concerning projections, predictions,
expectations, estimates or forecasts for our business, financial and operating
results and future economic performance; statements of management's goals and
objectives; trends affecting our financial condition, results of operations or
future prospects; our financing plans or growth strategies; and other similar
expressions concerning matters that are not historical facts. Words such as
"may," "will," "should," "could," "would," "predicts," "potential," "continue,"
"expects," "anticipates," "future," "intends," "plans," "believes" and
"estimates," and similar expressions, as well as statements in future tense,
identify forward-looking statements.
Forward-looking statements should not be read as a guarantee of future
performance or results, and will not necessarily be accurate indications of the
times at, or by which, that performance or those results will be achieved.
Forward-looking statements are based on information available at the time they
are made and/or management's good faith belief as of that time with respect to
future events, and are subject to risks and uncertainties that could cause
actual performance or results to differ materially from those expressed in or
suggested by the forward-looking statements. Important factors that could cause
these differences include, but are not limited to:
o our inability to raise additional funds to support operations
and capital expenditures;
o our inability to achieve greater and broader market acceptance
of our products and services in existing and new market
segments;
o our inability to successfully compete against existing and
future competitors;
o our inability to manage and maintain the growth of our
business;
o our inability to protect our intellectual property rights; and
o other factors discussed under the headings "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business."
Forward-looking statements speak only as of the date they are made. You
should not put undue reliance on any forward-looking statements. We assume no
obligation to update forward-looking statements to reflect actual results,
changes in assumptions or changes in other factors affecting forward-looking
information, except to the extent required by applicable securities laws. If we
do update one or more forward-looking statements, no inference should be drawn
that we will make additional updates with respect to those or other
forward-looking statements.
21
CORPORATE BACKGROUND AND MERGER TRANSACTION
CORPORATE HISTORY
CNS Response, Inc., a Delaware corporation, was originally incorporated
on July 10, 1984, under the name Mammon Oil & Gas, Inc. in the state of Utah. In
February 1986, our shareholders approved proposals to change our business
direction to the business of health care including research, development and
marketing, and a name change to Volt Research, Inc. From August 1986 to August
1988, we engaged in operating clinics dedicated to Retin-A skin therapy. In
August 1988, our management decided to phase out our clinic operations and
concentrate on selling our expertise and skin care products directly to
physicians. On January 1, 2004, we discontinued our business activities and
operations and, since that date until our acquisition of NBD Marketing, Inc.,
ProspectWorks, Inc., SalesWare, Inc. and xSellsys, Inc. (collectively "Acquired
Companies") in June 2004, we had no revenues or earnings from operations.
In a series of transactions consummated in June 2004, we acquired all
of the outstanding capital stock of NBD Marketing, Inc., a California
corporation, or NBD, and SalesWare Inc., a Nevada corporation, or SalesWare, and
formed an acquisition subsidiary, xSellsys, Inc., a California corporation to
acquire substantially all of the assets and liabilities of CRM SalesWare, Inc.,
a California corporation. As a result of the consummation of the above
transactions, SalesWare, NBD, and xSellsys became our wholly-owned subsidiaries
and ProspectWorks, Inc., a Nevada corporation and a subsidiary of NBD,
ProspectWorks, became an indirect, wholly-owned subsidiary of the Company. In
connection with the acquisition of SalesWare, Inc., on August 2, 2004, we
changed our corporate name to "SalesTactix, Inc."
On October 6, 2004, the Acquired Companies, William Noonan, Vincent
Michael Keyes III, and Thomas Ketchum filed a complaint in Orange County
Superior Court, Case No. 04CC00669 against us, Scott Absher, George LeFevre and
Mark Absher. On November 15, 2004, we entered into a settlement agreement with
the plaintiffs whereby (i) the acquisition agreements by and among the parties
were rescinded including an asset purchase agreement and certain stock purchase
agreements; (ii) certain assets owned by SalesTaxtix, Inc. and xSellsys were
transferred to certain plaintiffs; (iii) certain trademarks and tradenames were
transferred to CRM SalesWare; and (iv) our outstanding shares owned by the
plaintiffs were canceled. The Settlement Agreement essentially unwound the
acquisition and restored the parties to their prior positions, as if the
acquisitions had never occurred. The claim was dismissed in the fourth quarter
of 2004 pursuant to the terms of the settlement agreement. In connection with
the settlement agreement, we changed our name to Strativation, Inc. in September
2005. After this time, we existed as a "shell company" with nominal assets whose
sole business was to identify, evaluate and investigate various companies to
acquire or with which to merge.
On July 18, 2006, we entered into a stock purchase agreement with
seventeen accredited investors pursuant to which we issued 3,800,000 shares of
our common stock (76,000 shares after accounting for our one-for-fifty reverse
stock split which became effective on January 10, 2007) in consideration for an
aggregate of $237,669.00 in cash. In addition, these investors acquired shares
in private transactions with certain of our stockholders, and acquired a
majority stake in our issued and outstanding shares. In connection with these
transactions, effective July 18, 2006, Mr. Scott Absher and Mr. George LeFevre
resigned as officers and members of the board of directors, and Mr. Silas
Philips was appointed our Chief Executive Officer, Chief Financial Officer,
Secretary, and sole director.
On January 11, 2007, we entered into a Shares For Debt Agreement (the
"Shares For Debt Agreement") with Richardson & Patel LLP ("R&P"), pursuant to
which we agreed to issue and R&P agreed to accept 645,846 restricted shares of
our common stock (the "Shares") as full and complete settlement of a portion of
the total outstanding debt in the amount of $261,201.84 that we owed to R&P for
legal services (the "Partial Debt"). On January 15, 2007, the company and R&P
agreed to amend and
22
restate the Shares for Debt Agreement (the "Amended and Restated Shares for Debt
Agreement") to increase the number of Shares to be issued in settlement of such
Partial Debt to 656,103 restricted shares of our common stock.
MERGER WITH CNS RESPONSE, INC.
On January 16, 2007, we entered into an Agreement and Plan of Merger
with CNS Response, Inc., a California corporation (or CNSR California), and CNS
Merger Corporation, a California corporation and our wholly-owned subsidiary
that was formed to facilitate the acquisition of CNSR California. On March 7,
2007, the merger with CNSR California closed, CNSR California became our
wholly-owned subsidiary, and we changed our name from Strativation, Inc. to CNS
Response, Inc..
PRINCIPAL TERMS OF THE MERGER
At the Effective Time of the Merger (as defined in the Merger
Agreement, as amended on February 23, 2007), MergerCo was merged with and into
CNSR California, the separate existence of MergerCo ceased, and CNSR California
continued as the surviving corporation at the subsidiary level. We issued an
aggregate of 17,744,625 shares of our common stock to the stockholders of CNSR
California in exchange for 100% ownership of CNSR California. Additionally, we
assumed an aggregate of 8,407,517 options to purchase shares of common stock and
warrants to purchase shares of common stock on the same terms and conditions as
previously issued by CNSR California. Pursuant to the merger agreement, our
former sole director and executive officer, Silas Phillips, resigned as a
director and executive officer of our company effective as of the closing of the
Merger, and the directors and officers of CNSR California were appointed to
serve as directors and officer of our company. Except for the Merger Agreement,
as amended, and the transactions contemplated by that agreement, neither CNSR
California, nor the directors and officers of CNSR California serving prior to
the consummation of the Merger, nor any of their associates, had any material
relationship with us, or any of our directors and officers, or any of our
associates prior to the merger. Following the Merger, the business conducted by
the company is the business conducted by CNSR California.
Immediately prior to the closing of the Merger, we had outstanding
868,823 shares of common stock. Immediately after the closing of the Merger, and
without taking into consideration the Private Placement offering described
below, we had 18,613,448 outstanding shares of common stock, and options and
warrants to purchase 8,407,517 shares of common stock.
PRIVATE PLACEMENT FINANCING
On March 7, 2007, simultaneous with the closing of the Merger, we
received gross proceeds of approximately $7.0 million from the first closing of
a private placement transaction (the "Private Placement") with institutional
investors and other high net worth individuals ("Investors"). Pursuant to
Subscription Agreements entered into with these Investors, we sold 5,840,375
Investment Units, at $1.20 per Investment Unit. Each "Investment Unit" consists
of one share of our common stock, and a five year non-callable warrant to
purchase three-tenths of one share of our common Stock, at an exercise price of
$1.80 per share (the "Investor Warrant"). On May 16, 2007, we completed a second
closing of the Private Placement for an additional 664,390 Investment Units. The
additional gross proceeds to us amounted to $797,300.
We agreed to file a registration statement covering the resale of the
common stock and the common stock underlying the warrants sold in the Private
Placement within 75 days of the closing of the Merger pursuant to the
Subscription Agreement entered into with each Investor.
23
After commissions and expenses, we received net proceeds of
approximately $6.9 million in the Private Placement.
Brean Murray Carret & Co. ("Brean Murray") acted as placement agent and
corporate finance advisor in connection with the Private Placement. For their
services as placement agent and financial advisor, pursuant to the terms of an
Engagement Agreement between CNSR California and Brean Murray, Brean Murray
received a retainer in the form of 83,333 shares of our common stock (having a
deemed value of $100,000) upon the closing of the Private Placement. We also
paid Brean Murray a fee equal to 8% of the funds raised in the Private
Placement, or approximately $624,500 of the gross proceeds from the financing.
In addition, Brean Murray received warrants (the "Placement Agent Warrants") to
purchase shares of our common stock in amounts equal to (i) 8% of the shares of
common stock sold by Brean Murray in the Private Placement (520,381 warrants at
an exercise price of $1.44 per share), and (ii) 8% of the shares underlying the
Investor Warrants sold by Brean Murray in the Private Placement (156,114
warrants at an exercise price of $1.80 per share). The Placement Agent Warrants
are fully vested and have a term of 5 years. We also paid $87,700 in costs, fees
and expenses incurred by Brean Murray in connection with the Private Placement.
We expressly assumed CNSR California's agreement with Brean Murray upon the
closing of the Merger. Pursuant to this agreement, Brean Murray has a right of
first refusal to represent us in certain corporate finance transactions for a
period of one year following the closing of the Private Placement.
REGISTRATION RIGHTS AGREEMENTS
Under the terms of the Subscription Agreements between us and the
Investors in the Private Placement, we are obligated to file a Registration
Statement on Form SB-2 with the Securities and Exchange Commission (the "SEC")
within 75 days following the closing (the "Registration Statement") to permit
the resale of the shares of common stock sold in the Private Placement and
purchasable under the warrants sold in the Private Placement. The Subscription
Agreements also require us to use our reasonable best efforts to obtain the
effectiveness of the Registration Statement not later than 150 days after the
closing of the Private Placement, subject to certain exceptions. After obtaining
the effectiveness of the Registration Statement, we are further obligated to use
our reasonable best efforts to maintain the effectiveness of the Registration
Statement until all such shares registered thereby may be sold without
restriction pursuant to Rule 144(k) promulgated under the Securities Act of
1933, except that investors may not be able to sell their shares under the
Registration Statement during periods when we may be required to update the
information contained in that Registration Statement under applicable securities
laws. If we fail to satisfy our obligations for obtaining effectiveness of the
Registration Statement within 150 days after the closing of the Private
Placement we must pay liquidated cash damages to the investors in the offering
in an aggregate amount equal to 1% of the Investment Unit purchase price for
each share registered, per month that elapses after such failure until the
earlier of (a) the date the Registration Statement is filed or becomes
effective, as applicable, or (b) the date that is one year from the closing of
the Private Placement.
Under the terms of a Registration Rights Agreement entered into between
us and the majority stockholders of our common stock immediately prior to the
Merger, we are also obligated to include up to 767,101 shares of our common
stock on the Registration Statement described above. Our majority stockholders
have identical registration rights to those provided to the investors, except
they do not have the right to liquidated damages as provided in the Subscription
Agreements.
In addition to the registration rights described above, the holders of
the shares (i) sold in the Private Placement, (ii) issuable upon exercise of the
Investor Warrants, (iii) held by the our majority stockholders prior to the
Merger, (iv) issuable upon exercise of the Placement Agent Warrants or otherwise
under the Engagement Agreement with the Placement Agent, and (v) issued upon
conversion of
24
CNSR California Series A Preferred Stock, CNSR California Series B Preferred
Stock and certain shares of CNSR California Common Stock under the terms of the
Merger Agreement, each have piggy-back registration rights with respect to such
shares effective September 7, 2007, and demand registration rights with respect
to such shares effective March 7, 2008.
This prospectus relates to the resale of common stock and common stock
underlying warrants issued in connection with the Private Placement financing
that closed concurrently with the merger, as well as shares of our common stock
(i) held by our majority stockholders prior to the Merger and (ii) issuable upon
exercise of the Placement Agent Warrants or otherwise under the Engagement
Agreement with the Placement Agent. Pursuant to our obligations under the
subscription agreements between us and the investors in the private placement
financing, we filed with the SEC a registration statement on Form SB-2 with
respect to the common stock offered by this prospectus.
CNSR CALIFORNIA FUNDINGS PRIOR TO THE MERGER
Since its inception, CNSR California has raised approximately $8.2
million in equity financing. This amount includes the Senior Secured Debt
Financings, Settlement Agreement Financing, Mezzanine Financing, and the Note
Conversion Transaction discussed below.
SENIOR SECURED DEBT FINANCING
From January 2000 through July 2006 CNSR California was primarily
financed through the sale of promissory notes secured by substantially all of
the assets of CNSR California and warrants to purchase CNSR California common
stock pursuant to the terms of Note Warrant and Purchase Agreements between
investors and CNSR California. Through 2006, CNSR California received proceeds
of approximately $3,120,000 from the sale of these notes and warrants.
Substantially all of these notes were converted into CNSR California common
stock in October 2006. See the section below captioned "NOTE CONVERSION
TRANSACTION."
NOTE CONVERSION TRANSACTION
In October 2006, CNSR California and the holders of certain promissory
notes agreed to convert such notes with an aggregate outstanding balance of
$3,061,700 and related accrued and unpaid interest of $1,005,300 at September
30, 2006, into 5,189,294 shares of CNSR California's Series A-1 Preferred Stock,
and 804,221 shares of CNSR California's Series A-2 Preferred Stock. At the
closing of the Merger, the aforementioned shares converted into an aggregate of
5,993,515 shares of our common stock.
SETTLEMENT AGREEMENT FINANCING
In August and September 2006, certain employees and consultants to whom
CNSR California owed an aggregate of $3,199,400 forgave approximately 80% of the
debt and accepted 5,834,117 shares of CNSR California's common stock, and
warrants and options to purchase an aggregate of 270,638 shares of CNSR
California's common stock at $0.59 per share in full settlement of CNSR
California's remaining obligations. At the closing of the Merger, the
aforementioned shares and warrants were converted into 5,834,117 shares of our
common stock and warrants and options to purchase an aggregate of 270,638 shares
of our common stock at $0.59 per share.
MEZZANINE FINANCING
In October 2006, CNSR California sold 1,905,978 units (each, a
"Mezzanine Unit") in a private financing resulting in net proceeds of
$1,925,000. Each Mezzanine Unit consisted of one share of CNSR California's
Series B Preferred Stock and a 5-year warrant to purchase 0.6 shares of CNSR
California's
25
common stock at $1.51 per share. At the closing of the Merger, the
aforementioned shares and warrants were converted into 1,905,978 shares of our
common stock and a warrant to purchase an aggregate of 1,143,587 shares of our
common stock at $1.51 per share on or before October 6, 2011.
TRANSACTIONS SURROUNDING THE MERGER
REVERSE MERGER TRANSACTION FEE
Pursuant to the terms of the Merger Agreement, we paid an advisory fee
of $475,000 to Richardson & Patel, LLP, former counsel to Strativation, Inc.
(now CNS Response, Inc.) and our largest shareholder immediately prior to the
Merger, in connection with the Merger upon the first closing of the Private
Placement.
CNS RESPONSE, INC. STOCKHOLDER INDEMNIFICATION
Under the terms of the Merger Agreement and an arrangement with our
majority shareholders immediately prior to the Merger, these stockholders have
agreed to indemnify us against certain third party claims made against us
related to our operation from the time they became stockholders through the
consummation of the Merger.
CONVERSION OF NUPHARM DATABASE, LLC PROMISSORY NOTE
In connection with the consummation of an asset purchase transaction in
January 2000, by and between Mill City/CNS, LLC and NuPharm, Mill City issued to
NuPharm Database, LLC a certain Promissory Note dated January 11, 2000 (the
"Original NuPharm Note") pursuant to which Mill City was obligated to pay
NuPharm an aggregate principal amount of $299,900 together with interest
pursuant to the payment schedule set forth in the Original NuPharm Note. In
January 2000, Mill City contributed substantially all of its assets, including
those securing the Original Note, to CNSR California, and CNSR California
assumed certain debts and obligations of Mill City, including Mill City's
obligations under the Original NuPharm Note.
In October 2006, CNSR California entered into an agreement with NuPharm
to cancel the Original NuPharm Note in consideration for the extension of the
expiration date of a Warrant to purchase CNSR California Common Stock held by
NuPharm and a new promissory note in the principal amount of $287,400 (the "New
NuPharm Note"). Upon the closing of the Private Placement and Merger, the
principal and accrued interest through December 31, 2006 on the New NuPharm Note
automatically converted into 244,509 shares of our Common Stock.
Immediately upon extension of the of the NuPharm Warrant, NuPharm
exercised the NuPharm Warrant to purchase 2,800,000 shares of CNSR California
common stock for total cash proceeds of $147,700. At the closing of the Merger,
the aforementioned shares converted into an aggregate of 2,800,000 shares of our
common stock. Subsequently, NuPharm distributed its shares of our common stock
to the following stockholders: Stephen C. Suffin, Meyer L. Proler, W. Hamlin
Emory, Masco, a California corporation, Carlton M. Cadwell and John Cadwell.
RESULT OF THE MERGER AND PRIVATE PLACEMENT TRANSACTIONS
After the completion of the Private Placement and the Merger, we have
an aggregate of 25,303,302 shares of common stock outstanding, with the former
CNSR California shareholders and the investors in the Private Placement owning
in the aggregate 24,434,479 shares of our common stock, which represents
approximately 96.6% of our issued and outstanding shares of common stock. Our
26
stockholders immediately prior to the Merger and Private Placement owned
approximately 3.4% of our outstanding common stock (or, 868,823 shares of our
common stock) immediately after completion of these transactions.
The issuance of our shares of common stock in the Merger was exempt
from registration under the Securities Act of 1933, as amended (the "Securities
Act"), pursuant to Section 4(2) thereof and an exemption from registration
contained in Regulation D. The issuance of shares of common stock and the
warrants to the Investors in the Private Placement, and the issuance of the
Placement Agent Warrants were completed pursuant to an exemption from
registration contained in Regulation D. The shares of our common stock and
shares of common stock issuable pursuant to the issued warrants may not be
offered or sold in the United States unless they are registered under the
Securities Act, or an exemption from the registration requirements of the
Securities Act is available.
27
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares to be offered
by the selling stockholders. The proceeds from the sale of each selling
stockholder's common stock will belong to that selling stockholder.
MARKET FOR COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
Our common stock is currently listed for trading on the OTCBB under the
symbol CNSO.OB. The following table sets forth, for the periods indicated, the
high and low bid information for Common Stock as determined from sporadic
quotations on the OTC Bulletin Board. The following quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.
HIGH LOW
FISCAL YEAR 2005 --------------- ---------------
January 1 to March 31 ........... $ 0.10 ($5.00*) $0.045 ($2.25*)
April 1 to June 30 .............. $ 0.10 ($5.00*) $0.035 ($1.75*)
July 1 to September 30 .......... $0.065 ($3.25*) $ 0.03 ($1.50*)
HIGH LOW
FISCAL YEAR 2006 --------------- ---------------
October 1 to December 31 ........ $ 0.09 ($4.50*) $0.036 (1.80*)
January 1 to March 31 ........... $ 0.07 ($3.50*) $ 0.06 ($3.00*)
April 1 to June 30 .............. $ 0.08 ($4.00*) $ 0.06 ($3.00*)
July 1 to September 30 .......... $ 0.17 ($8.50*) $ 0.07 ($3.50*)
HIGH LOW
FISCAL YEAR 2007 --------------- ---------------
October 1 to December 31...... $ 0.17 ($8.50*) $ 0.01 (0.50*)
January 1 to March 31......... $ 4.50* $ 0.101*
* Adjusted price reflecting the 1:50 reverse stock split that became
effective January 10, 2007
On May 17, 2007, the closing sales price of Common Stock as reported on
the OTC Bulletin Board was $1.65 per share. As of May 17, 2007, there were
approximately 375 holders of record of our Common Stock. Our transfer agent is
American Stock Transfer and Trust Company.
DIVIDENDS
We have not paid or declared cash distributions or dividends on our
common stock. CNSR California has never paid dividends on its common stock. We
do not intend to pay cash dividends on our common stock in the foreseeable
future. We currently intend to retain all earnings, if and when generated, to
finance our operations. The declaration of cash dividends in the future will be
determined by the board of directors based upon our earnings, financial
condition, capital requirements and other relevant factors.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THIS DISCUSSION SUMMARIZES THE SIGNIFICANT FACTORS AFFECTING THE
OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS OF CNS
RESPONSE, INC. FOR THE SIX MONTHS ENDED MARCH 31, 2007 AND 2006, AND FOR THE
FISCAL YEARS ENDED SEPTEMBER 30, 2006 AND 2005. THE FOLLOWING DISCUSSION OF OUR
RESULTS OF OPERATIONS AND FINANCIAL CONDITION SHOULD BE READ TOGETHER WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS INCLUDED
ELSEWHERE IN THIS PROSPECTUS AND OTHER INFORMATION INCORPORATED BY REFERENCE IN
THIS PROSPECTUS, IF ANY. EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS
DISCUSSED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ARE FORWARD LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES AND ARE BASED UPON JUDGMENTS CONCERNING VARIOUS FACTORS THAT ARE
BEYOND OUR CONTROL. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS
ANTICIPATED IN ANY FORWARD-LOOKING STATEMENTS AS A RESULT OF A VARIETY OF
FACTORS, INCLUDING THOSE DISCUSSED IN "RISK FACTORS," AND ELSEWHERE IN THIS
PROSPECTUS.
OVERVIEW
We are a life sciences company focused on the commercialization of a
patented system that guides psychiatrists and other physicians to determine a
proper treatment for patients with behavioral (psychiatric, and/or addictive)
disorders. We also intend to identify, develop and commercialize new indications
of approved drugs and drug candidates for this patient population.
We have developed an extensive proprietary database (the "CNS
Database") consisting of approximately 13,000 clinical outcomes across 2,000
patients who had psychiatric or addictive problems. For each patient, we have
compiled electrocephalographic ("EEG") scans, symptoms, course of treatment and
outcomes often across multiple treatments from multiple psychiatrists and
physicians. Using this database, our technology compares a patient's EEG scan to
the outcomes in the database and ranks treatment options based on treatment
success of patients having similar neurophysiology.
Trademarked as Referenced-EEG ("rEEG"), this patented technology allows
CNS to create and provide simple reports that specifically guide physicians to
treatment strategies based on the patient's own physiology. The vast majority of
these patients were considered long-term "treatment-resistant", the most
challenging, high-risk and expensive category to treat.
rEEG identifies relevant neurophysiology that is variant from the norm
and identifies medications that have successfully treated database patients
having similar aberrant physiology. It does this by comparing a patient's
standard digital EEG to a normative database. This identifies the presence of
any pathophysiology. The rEEG process then compares the stratified set of
patients with similar pathophysiology to our CNS Database and reports on
relative medication success for this stratified group. Upon completion, the
physician is provided the analysis in a report (our "rEEG Analytical Report")
detailing and ranking classes of agents (and specific agents within the class)
by treatment success.
We believe the key factors that will drive broader adoption of rEEG
will be acceptance by healthcare providers of its clinical benefits,
demonstration of the cost-effectiveness of using our test, reimbursement by
third-party payors, expansion of our sales force and increased marketing
efforts.
29
Since our inception, we have generated significant net losses. As of
March 31, 2007, we had an accumulated deficit of $9.5 million. We incurred
operating losses of $1,470,000 for the six months ended March 31, 2007. We
expect our net losses to continue for at least the next several years. We
anticipate that a substantial portion of our capital resources and efforts will
be focused on research and development, scale up our commercial organization,
and other general corporate purposes. Research and development projects include
the completion of clinical trials, the enhancement of our database and the
identification of new medication that are often combinations of approved drugs.
Our historical operations before March 7, 2007 reflect only the
operations of CNS Response, Inc., a California corporation (or CNSR California).
Before March 7, 2007, we existed as a "shell company" with nominal assets whose
sole business was to identify, evaluate and investigate various companies to
acquire or with which to merger. On March 7, 2007, we consummated a merger
transaction in which we acquired all of the shares of CNSR California.
Concurrently with the closing of the merger we completed a private placement
financing and certain other transactions related to the merger. Upon completion
of the merger and the private placement financing, CNSR California became our
wholly-owned subsidiary, and the former stockholders of CNSR California and the
investors in the private placement financing received in the aggregate
24,434,479 shares of our common stock, or approximately 96% of our issued and
outstanding shares of common stock. CNSR California was formed and commenced its
business in 2000. Our merger with CNSR California was accounted for as a reverse
merger with CNSR California deemed to be the accounting acquirer and us the
legal acquirer.
FINANCIAL OPERATIONS OVERVIEW
REVENUES
We derive our revenues from the sale of rEEG Analytical Reports to
physicians and operate in one industry segment. Physicians are generally billed
upon delivery of an rEEG Analytical Report. The list prices of our rEEG
Analytical Reports to physicians range from $200 to $800 with $400 being the
most frequent charge.
COST OF REVENUES
Cost of revenues represents the cost of direct labor, the amortization
of the purchased database and costs associated with external processing,
analysis and consulting review necessary to render an individualized test
result. Costs associated with performing our tests are expensed as the tests are
performed. We are currently evaluating the feasibility of hiring our own
personnel to perform most of the processing and analysis necessary to render a
report.
RESEARCH AND DEVELOPMENT
Research and development expenses primarily represent costs incurred to
design and conduct clinical studies, improve rEEG processing, add data to our
database, improve analytical techniques and advance application of the
methodology to additional clinical diagnosis. We charge all research and
development expenses to operations as they are incurred.
SALES AND MARKETING
Our selling and marketing expenses consist primarily of personnel costs
and the costs of educating physicians, laboratory personnel and other healthcare
professionals regarding our product.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses consist primarily of personnel
related costs, legal costs, accounting costs and other professional and
administrative costs.
30
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES
This discussion and analysis of our financial condition and results of
operations is based on our financial statements, which have been prepared in
accordance with U.S. generally accepted accounting principles. The preparation
of these financial statements requires management to make estimates and
judgments that affect the reported amounts of assets, liabilities and expenses
and the disclosure of contingent assets and liabilities at the date of the
financial statements, as well as revenues and expenses during the reporting
periods. We evaluate our estimates and judgments on an ongoing basis. We base
our estimates on historical experience and on various other factors we believe
are reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results could therefore differ
materially from those estimates under different assumptions or conditions.
Our significant accounting policies are described in the notes to our
financial statements included elsewhere in this prospectus. We believe the
following critical accounting policies reflect our more significant estimates
and assumptions used in the preparation of our financial statements.
Revenue Recognition
We have generated limited revenues since our inception. Revenues for
our product are recognized when an rEEG Analytical Report is delivered to a
Client-Physician.
Stock-based Compensation Expense
Stock-based compensation expense, which is a non-cash charge, results
from stock option grants. Pursuant to SFAS No. 123(R), compensation cost is
measured at the grant date based on the calculated fair value of the award. We
recognize stock-based compensation expense on a straight-line basis over the
vesting period of the underlying option. The amount of stock-based compensation
expense expected to be amortized in future periods may decrease if unvested
options are subsequently cancelled or may increase if future option grants are
made.
COMPARISON OF SIX MONTHS ENDED MARCH 31, 2007 AND
SIX MONTHS ENDED MARCH 31, 2006
The following table presents consolidated statement of operations data
for each of the periods indicated as a percentage of revenues.
SIX MONTHS SIX MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2007 2006
------------ ------------
Revenues ..................................... 100 % 100 %
Cost of revenues ............................. 68 88
------------ ------------
Gross profit ................................. 32 12
Research and development ..................... 400 238
Sales and marketing .......................... 42 83
General and administrative expenses .......... 776 310
Operating loss ............................... (1286) (719)
Other expense, net ........................... 1187 619
------------ ------------
Net loss ..................................... (1304)% (809)%
============ ============
31
REVENUES
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Revenues ......................... $ 112,700 $ 85,800 31%
The increase in revenues resulted from the adoption of rEEG by an
additional eleven physicians. The number of rEEG Analytical Reports delivered
during the sixth month period ended March 31, 2007 increased from 215 in 2006 to
300 in 2007 while the average price per report dropped from $400 to $375. We do
not intend to expand our sales and marketing efforts until the completion of a
clinical study currently being conducted by respected professionals in the field
of psychiatry. Accordingly, we anticipate that revenues will not increase
materially until fiscal 2008.
COST OF REVENUES
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Cost of revenues.................. $ 76,600 $ 75,700 1%
Cost of revenues consists of payroll costs, consulting costs, charges
relating to the amortization of the CNS Database, and other miscellaneous
charges. Cost of revenues remained flat for the six month period ended March 31,
2007 as compared to the six month period ended March 31, 2006, with increases in
payroll costs and consulting costs being offset by a decrease in amortization
costs associated with the CNS Database. We expect costs of revenues will
increase as an absolute number as we deliver more rEEG Analytical Reports.
However, we expect cost of revenues to decrease as a percentage of revenues as
we improve our operating efficiency.
RESEARCH AND DEVELOPMENT
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Research and development.......... $ 451,200 $ 204,200 121%
Research and development expenses consist of clinical studies, costs to
identify indications of approved drugs and drug candidates, projects for
training doctors in the use of rEEG, consulting fees, payroll costs, expenses
related to database enhancements, and other miscellaneous costs. Research and
development costs increased for the six month period ended March 31, 2007 from
the six month period ended March 31, 2006 primarily as a result of increases in
expenses associated with clinical studies, costs incurred to identify
indications of approved drugs and drug candidates, expenses in relation to
projects for training doctors in the use of rEEG technology, and payroll costs.
The increase in expenses relating to clinical studies is attributable to our
expansion and acceleration of the completion of a clinical study with the goal
of driving market acceptance of our rEEG technology. Training costs increased as
the Company undertook projects to improve its training capabilities. Payroll
costs increased as we hired an additional
32
employee in research and development and increased the salary of an existing
employee. We expect research and development expenses to continue to increase as
we attempt to accelerate the identification of approved drugs and drug
candidates, complete studies to validate the efficacy of our product, acquire
new data for our database, enhance our system and hire additional employees.
SALES AND MARKETING
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Sales and marketing............... $ 47,500 $ 71,300 (33%)
For the six months ended March 31, 2007, sales and marketing expenses
were $47,500 consisting of payroll costs of $37,700 and other marketing costs of
$9,800. For the six months ended March 31, 2006 sales and marketing expenses
were $71,300 consisting solely of payroll costs. The decrease in payroll costs
is attributable to the termination of a salesperson in April 2006. We expect
sales and marketing expenses to increase substantially as we increase our
marketing efforts and expand our sales force.
GENERAL AND ADMINISTRATIVE EXPENSES
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
General and administrative
expenses........................ $ 874,700 $ 265,900 229%
General and administrative expenses for the six months ended March 31,
2007 and 2006 primarily related to salaries and professional fees. As a
percentage of net sales, general and administrative expenses increased from 310%
for the six months ended March 31, 2006 to 776% for the six months ended March
31, 2007. The increase in general and administrative expenses for the six month
period ended March 31, 2007 primarily related to a $475,000 advisory fee paid to
Richardson & Pattel, LLP in connection with our merger transaction, and will not
recur. General and administrative costs were also higher for the six month
period ended March 31, 2007 as we hired our Chief Financial Officer as well as
an office manager. Legal and accounting costs also increased as the result of
costs incurred in connection with the merger and as a result of costs associated
with being a public reporting company. Rent increased as the company moved to
larger facilities in October 2006. Insurance expenses also increased as a result
of higher premiums on our insurance policy for directors and officers, as did
miscellaneous expenses. The increase in general and administrative expenses was
offset by a decrease in consulting fees since we outsourced fewer tasks in the
period. We expect general and administrative costs to continue to increase as we
expand our staff and incur costs associated with being a public reporting
company, including costs associated with filing our Registration Statement on
Form SB-2, which we expect to occur in the third quarter.
33
INTEREST EXPENSE
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Interest (Income) Expense......... $ 193,200 $ 163,000 18%
For the six months ended March 31, 2007, interest expense was $193,200
and consisted of $189,800 relating to interest expense from the ascribed value
of a warrant issued to NuPharm Database, LLC, interest expense from promissory
notes and other interest bearing accounts of $13,300 offset by interest income
of $9,900. For the six months ended March 31, 2006 interest expense was $163,000
and consisted of interest expense form promissory notes and other interest
bearing accounts of $163,200 offset by interest income of $200. Interest expense
relating to the warrant will not recur as the entire balance of unamortized
prepaid interest was expensed in connection with our merger. We expect interest
expense relating to convertible debt and other interest bearing accounts to
continue to decrease as substantially all convertible debt and other interest
bearing accounts have either been repaid or converted into the Company's stock.
We expect interest income to increase due to funds available from the private
placement.
OTHER INCOME
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Other Income...................... $ 61,700 $ 0 *
* Not meaningful
Other income for the six months ended March 31, 2007 was $61,700 and
consisted of gains from settlement of payables. Other income for the six months
ended March 31, 2006 was zero. The increase in other income is attributable to
the settlement of accounts payable at a discount to the recorded amounts.
NET LOSS
SIX MONTHS ENDED MARCH 31,
--------------------------- PERCENT
2007 2006 CHANGE
------------ ------------ ------------
Net loss.......................... $ (1,469,600) $ (694,300) 112%
Our increase in net loss is due primarily to the advisory fee of
$475,000 paid to Richardson & Pattel, LLP in connection with our merger
transaction, increases in our research and development costs, increases in other
general and administrative expenses, as well as our interest expenses. Our net
loss as a percentage of net sales for the six months ended March 31, 2007
increased to 1304% as compared to 809% of net sales for the six months ended
March 31, 2006. We expect to incur net losses for the next few years as we
continue to improve our rEEG technology and reaffirm its validity through
clinical studies, attempt to accelerate the identification of approved drugs and
drug candidates, increase the penetration of our products in the marketplace,
and hire additional personnel.
34
RESULTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 2006 AND 2005
The following table presents consolidated statement of operations data
for each of the periods indicated as a percentage of revenues.
YEAR ENDED SEPTEMBER 30,
-----------------------------
2006 2005
------------ ------------
Revenues ..................................... 100% 100%
Cost of revenues ......................... 100 129
Research and development ................. 44 46
Sales and marketing ...................... 21 42
General and administrative expenses ...... 952 637
Total operating expenses ................. 1117 854
Operating loss ............................... (1017) (754)
Other income (expense)
Interest expense, net .................... (223) (260)
Gain (loss) on derivative
instruments .......................... 672 (167)
Gain on troubled debt
restructuring ........................ 615 --
Total other income
(expense) .......................... 1064 (426)
Income (Loss) before income
taxes ...................................... 48 (1181)
Income taxes ................................. 1 1
------------ ------------
Net income (loss) ............................ 47% (1181)%
============ ============
REVENUES
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Revenues ......................... $ 175,500 $ 127,400 38%
Revenues were $175,500 for the year ended September 30, 2006 as
compared to $127,400 for the comparable period in 2005. The increase in revenues
resulted from the adoption of rEEG by additional physicians. To drive broader
adoption of rEEG we have undertaken a clinical study to validate the efficacy of
rEEG, and intend to increase our marketing efforts and expand our sales force.
35
COST OF REVENUES
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Cost of revenues.................. $ 175,900 $ 165,100 7%
For the year ended September 30, 2006, cost of revenues was $175,900,
consisting primarily of direct labor costs of $50,200, consulting fees of
$41,500 and amortization of the purchased database of $79,800. For the year
ended September 30, 2005, cost of revenues was $165,100 consisting primarily of
direct labor costs of $50,200, consulting fees of $25,000 and amortization of
the purchased database of $79,800. We expect costs of revenues will increase as
an absolute number as the volume of rEEGs processed increases; however, cost of
revenues will decrease as a percentage of revenues due to operating efficiencies
and as a result of the cost of the purchased database being fully amortized in
the first quarter of our fiscal year ending September 30, 2007.
RESEARCH AND DEVELOPMENT
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Research and development.......... $ 76,700 $ 58,500 31%
Research and development expenses were $76,700 for the year ended
September 30, 2006 as compared to $58,500 for the comparable period in 2005. The
increase in research and development expenses resulted from increased consulting
fees incurred in 2006 primarily related to the design of clinical studies. We
expect research and development expenses to increase as we complete studies to
validate the efficacy of our product, acquire new data for our database, enhance
our system and hire additional employees.
SALES AND MARKETING
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Sales and marketing............... $ 36,000 $ 52,900 (32%)
Sales and marketing expenses were $36,000 for the year ended September
30, 2006 as compared to $52,900 for the comparable period in 2005. The decrease
in sales and marketing expenses resulted from a decrease in sales consultants in
2006. We expect sales and marketing to increase as we increase our marketing
efforts and expand our sales.
36
GENERAL AND ADMINISTRATIVE
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
General and administrative
expenses........................ $ 1,671,100 $ 811,800 106%
General and administrative expenses were $1,671,100 for the year ended
September 30, 2006 as compared to $811,800 for the comparable period in 2005.
The increase in general and administrative resulted from an increase in payroll
costs of $420,300, an increase in legal and accounting costs of $248,400 and an
increase in consulting fees of $123,900. We expect general and administrative
costs to increase as we expand our staff and incur costs associated with being a
public company.
INTEREST EXPENSE
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Interest (Income) Expense......... $ 390,600 $ 330,700 18%
Interest expense was $390,600 for the year ended September 30, 2006 as
compared to $330,700 for the comparable period in 2005. The increase in interest
expense resulted from an increase in interest-bearing debt including convertible
promissory notes, deferred salaries and unreimbursed expenses. We expect
interest expenses to decrease, as substantially all of our interest-bearing debt
was repaid or converted into equity in October 2006.
GAIN (LOSS) ON DERIVATIVE INSTRUMENTS
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Gain (loss) on derivative
instruments..................... $ 1,178,500 $ (212,500) *
* Not meaningful
Gain on derivative instruments was $1,178,500 for the year ended
September 30, 2006 compared to a loss of $212,500 for the comparable period in
2005. In accordance with generally accepted accounting principles, we treated
the beneficial conversion feature associated with the convertible promissory
notes and all non-employee warrants exercisable during the period the notes were
potentially convertible into an unlimited number of common shares as liabilities
at their fair value. The fair value of the beneficial conversion feature and the
warrants were estimated using the Black-Scholes option pricing model. The fair
value of the beneficial conversion feature and the warrants and options was
recomputed each reporting period with the change in fair value recorded as a
gain or loss on derivative instruments.
37
GAIN ON TROUBLED DEBT RESTRUCTURING
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Gain on troubled debt
restructuring................... $ 1,079,700 $ 0 *
* Not meaningful
Gain on troubled debt restructuring was $1,079,700 for the year ended
September 30, 2006 as compared to zero in the comparable period for 2005. At
September 30, 2005, we owed certain employees and consultants deferred
compensation, accrued consulting fees, other compensation-related liabilities
and accrued interest thereon aggregating $2,480,900. Due to financial
difficulties experienced by the company, in August and September 2006, certain
employees and consultants to whom the company owed an aggregate of $3,199,400
accepted 5,834,117 shares of CNSR California's common stock (of which 182,952
were restricted), and warrants and options to purchase an aggregate of 270,638
shares of CNSR California's common stock at $0.59 per share in full settlement
of our obligations. On the date of transfer, the amounts due to employees and
consultants exceeded the aggregate fair value of the shares, warrants and
options transferred by $2,467,700. The gain attributable to employees considered
related parties of $1,388,000 has been treated as a capital transaction and
included in additional paid-in capital in the accompanying financial statements.
The remaining gain of $1,079,700 has been included in operations in the
accompanying financial statements.
NET INCOME (LOSS)
YEAR ENDED SEPTEMBER 30,
--------------------------- PERCENT
2006 2005 CHANGE
------------ ------------ ------------
Net loss.......................... $ 82,600 $ (1,504,900) *
*Not meaningful
The decrease in net loss is due primarily to the gains on troubled debt
restructuring and on derivative instruments offset by increases in general and
administrative expenses.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2007, we had cash and cash equivalents of approximately
$6.4 million and a working capital balance of approximately $3.7 million. As of
March 31, 2006, we had cash and cash equivalents of approximately $205,000 and a
working capital deficit of approximately $5.4 million. Our positive cash balance
results primarily from financing activities. Through March 31, 2007, we have
received proceeds of $3,116,000 from the issuance of convertible promissory
notes, $220,400 from the issuance of common stock to employees in connection
with expenses paid by such employees on behalf of the Company, $1.9 million from
the sale of preferred stock, and $6.1 million from the sale of common stock to
institutional investors and other high net worth individuals.
We expect to continue to incur substantial operating losses in the
future and to make capital expenditures to keep pace with the expansion of our
research and development programs and to scale up our commercial operations. We
expect that our existing cash will be used to fund working capital and for
capital expenditures and other general corporate purposes. The amount and timing
of actual expenditures may vary significantly depending upon a number of
factors, such as the progress of our product
38
development, regulatory requirements, commercialization efforts and the amount
of cash used by operations.
We believe that our existing cash and cash equivalents will be
sufficient to fund our minimum working capital and capital expenditure needs for
at least the next twelve months. However, if our working capital requirements or
capital expenditures are greater than we expect, or if we expand our business by
acquiring complementary businesses or assets, we may need to raise additional
debt or equity financing. We are continually evaluating various financing
strategies to be used to expand our business and fund future growth. There can
be no assurance that additional debt or equity financing will be available on
acceptable terms or at all. We currently do not have any material commitments
for capital expenditures.
OPERATING ACTIVITIES
For the six months ended March 31, 2007, net cash used in operating
activities was $1.6 million and consisted of net loss of $1.5 million and net
cash used by operating assets and liabilities of $0.3 million offset by non-cash
items of $0.2 million. Operating assets and liabilities consisted primarily of
increases in accounts receivables and prepaid expenses and decreases in accounts
payable. Non-cash items consisted primarily of non-cash interest expense offset
by other income.
For the six months ended March 31, 2006, net cash used in operating
activities was $243,200 and consisted of net loss of $694,300 offset by net cash
provided by operating assets and liabilities of $411,200, offset by non cash
items of $39,900. Operating assets and liabilities consisted primarily of
increases in accounts payable, accrued liabilities, deferred compensation,
accrued consulting and accrued interest.
In fiscal 2006, net cash used in operating activities was $597,600 and
consisted of net income of $82,600, and cash provided by operating assets and
liabilities of $1.1 million offset by non-cash items of $1.8 million. Operating
assets and liabilities consisted primarily of increases in accounts payable,
accrued liabilities, deferred compensation, accrued consulting and accrued
interest. Non-cash items consisted of gains on derivative instruments of $1.1
million and gains on troubled-debt restructuring of $1.1 million offset by
stock-based compensation of $369,900 and amortization of intangibles of $79,800.
In fiscal 2005, net cash used in operating activities was $233,000 and
consisted of net loss of $1.5 million offset by cash provided by operating
assets and liabilities of $961,600 and non-cash items of $310,300. Operating
assets and liabilities consisted primarily of increases in accounts payable,
accrued liabilities, deferred compensation, accrued consulting and accrued
interest. Non-cash items consisted primarily of a loss on derivative instrument
of $212,500 and amortization of intangibles of $79,800
INVESTING ACTIVITIES
For the six months ended March 31, 2007, net cash used in investing
activities was $7,100 and consisted of a loan to employee and an increase in
deposits. For the six months ended March 31, 2006, there were no investing
activities.
In fiscal 2006, net cash used in investing activities was $175,900 and
consisted of loans to officer and employees. In fiscal 2005, there were no
investing activities.
39
FINANCING ACTIVITIES
For the six months ended March 31, 2007, net cash provided by financing
activities was $7.8 million and consisted primarily of proceeds from the sale of
preferred stock of $1.7 million and from the sale of common stock of $6.1
million. For the six months ended March 31, 2006, there were no financing
activities.
In fiscal 2006, net cash provided by financing activities was $500,000
and consisted of the issuances of convertible promissory notes. In fiscal 2005,
net cash provided by financing activities was $499,500 and consisted of the
issuances of convertible promissory notes.
INCOME TAXES
Since inception, we have incurred operating losses and, accordingly,
have not recorded a provision for federal income taxes for any periods
presented. As of September 30, 2006, we had net operating loss carryforwards for
federal income tax purposes of $4,627,600. If not utilized, the federal net
operating loss carryforwards will expire beginning in 2021. Utilization of net
operating loss and credit carryforwards may be subject to a substantial annual
limitation due to restrictions contained in the Internal Revenue Code that are
applicable if we experience an "ownership change". The annual limitation may
result in the expiration of our net operating loss and tax credit carryforwards
before they can be used.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
As of March 31, 2007, we had no significant contractual obligations. In
addition, at March 31, 2007, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
40
BUSINESS
WITH RESPECT TO THIS DISCUSSION, THE TERMS "WE" "US" "OUR" "CNS" AND
THE "COMPANY" REFER TO CNS RESPONSE, INC., A DELAWARE CORPORATION AND ITS
WHOLLY-OWNED SUBSIDIARY CNS RESPONSE, INC., A CALIFORNIA CORPORATION ("CNSR
CALIFORNIA").
GENERAL
Founded in 2000, and located in Costa Mesa, California, our business is
focused on the commercialization of a patented system that aids physicians in
the identification and determination of appropriate and effective medications
for patients with certain behavioral (mental or addictive) disorders. Our
technology provides medical professionals with medication sensitivity data for a
subject patient based upon the identification and correlation of treatment
outcome information from other patients with similar neurophysiologic
characteristics which are contained in a proprietary outcomes database. This
methodology, called "Referenced-EEG" or "rEEG" represents an innovative approach
to identifying effective medications for patients suffering from debilitating
behavioral disorders. Referenced-EEG and rEEG are registered trademarks of CNSR.
Traditionally, prescription of medication for the treatment of
behavioral disorders (such as depression, bipolar disorders, eating disorders,
addiction, anxiety disorders, ADHD and schizophrenia) has been primarily based
on symptomatic factors, while the underlying physiology and pathology of the
disorder is rarely able to be analyzed, often resulting in multiple ineffective,
costly, and often lengthy, courses of treatment before effective medications are
identified. Some patients never find effective medications. We believe that rEEG
offers an improvement upon traditional methods for determining an effective
course of medication because rEEG is designed to correlate the success of
courses of medication and medication combinations, with the neurophysiological
characteristics of a particular patient.
In addition to its utility in providing psychiatrists and other
physicians with medication sensitivity guidance, rEEG provides us with
significant opportunities in the area of pharmaceutical development. rEEG, in
combination with the information contained in the rEEG database, has the
potential to be able to identify novel uses for, and novel combinations of,
neuropsychiatric medications currently on the market and in late stages of
clinical development, as well as aid in the identification of neurophysiologic
characteristics of clinical subjects that may be successfully treated with
neuropsychiatric medications in the clinical testing stage. We intend to enter
into relationships with established drug and biotechnology companies to further
explore these opportunities.
The initial technology, upon which rEEG is based, was originally
developed by an M.D. Pathologist/ Psychiatrist as well as a clinical
Psychiatrist in response to observations within their practice. They partnered
and formalized their activities into NuPharm Database, LLC, for the purpose of
facilitating investment in 1999. At the time of its formation, these founding
physicians assigned all of their rights in the technology to NuPharm.
CNSR California was incorporated in California on January 11, 2000, for
the purpose of acquiring and commercializing the rEEG technology. The patent
application for the primary technology was acquired from Mill City/CNSR, LLC, a
Minnesota limited liability Company in January 2000 pursuant to the terms of a
Contribution and Subscription Agreement which provided for the issuance of
1,000,000 shares of CNSR's common stock to Mill City in exchange for all of its
assets. Mill City had previously acquired all of NuPharm's assets pursuant to an
Asset Purchase Agreement.
41
THE CHALLENGE AND THE OPPORTUNITY
The "CNS" in CNS Response, Inc. refers to the central nervous system,
the largest part of the nervous system and includes the brain and spinal cord -
organs fundamental to behavioral control. Often referred to as mental illness,
behavioral disorders have accounted for 7.4% of the total increase in health
care spending from 1987-2000, and they are second among the 15 conditions that
contributed the most to rising health care spending over this period (behind
only heart disease at 8.1%).(1)
More than one out of five adolescents, adults or senior adults,
representing more than 60 million people collectively, have mental or addictive
illness, an epidemic by any measure.(2) In any given year, only half of this
population receives some care for their problem.(3) The market for
pharmaceuticals to treat central nervous system disorders in the United States
is measured at more than $44 billion ($68 billion worldwide) or 23% of total
annual pharmaceutical sales.(4) Unfortunately, the vast majority of these
expenditures are not based on blood tests, CT scans, or any objective
measurement of the system being treated. Dr. Steven Hyman, Director of the
National Institute of Mental Health from 1996 to 2002 stated:
"IN MOST BRANCHES OF MEDICINE, PHYSICIANS CAN BASE THEIR
DIAGNOSIS ON OBJECTIVE TESTS: A DOCTOR CAN EXAMINE X-RAYS TO
SEE IF A BONE IS BROKEN, FOR EXAMPLE, OR CAN EXTRACT TISSUE
SAMPLES TO SEARCH FOR CANCER CELLS. BUT FOR SOME COMMON AND
SERIOUS PSYCHIATRIC DISORDERS, DIAGNOSES ARE STILL BASED
ENTIRELY ON THE PATIENT'S OWN REPORT OF SYMPTOMS AND THE
DOCTOR'S OBSERVATIONS OF THE PATIENT'S BEHAVIOR." (5)
Collectively, the industry has been waiting to understand the
physiology of behavioral disorders, with the hope of finding an approach that
utilized objective patient data with prescriptive therapy.
Fueling the increase in spending are patients deemed to be
"Treatment-Resistant," typically defined as failing two or more trials of
standard of care therapies of adequate dose and duration. Treatment costs for
such patients are exceedingly high. For example, those in treatment-resistant
depression reach $10,000 annually for patients treated on an outpatient basis
only, and more than $40,000 annually for those treated on an inpatient basis.(6)
Based on conversations with managed behavioral health care organization (MBHO)
executives, the Company estimates that approximately 10% of patients represent
35-40% of MBHOs' patient costs, with the overwhelming majority deemed
treatment-resistant cases. MBHOs manage an estimated 210 million lives in the
U.S. alone, with 115 million covered by four organizations: Magellan, Value
Options, United Behavioral Health and CIGNA Behavioral Health.(7)
Historically, the practice of psychiatric medicine has been operated
subjectively, with treatment decisions involving powerful neuropsychiatric
medications being prescribed with little or no understanding of the underlying
physiology of each patient.(8) Modern medicine has been successful in
establishing etiology and finding effective therapy for only a relatively small
group of mental
- ----------
(1) Moran, Mark, MANY MORE PEOPLE SEEKING MH TREATMENT SINCE 1980S. Psychiatric
News 39-19 at 15 (October 1, 2004).
(2) See SUPRA note 4 at xii.
(3) Id. at viii.
(4) See SUPRA note 2.
(5) Hyman, Steven. E., DIAGNOSING DISORDERS:PSYCHIATRIC ILLNESSES ARE OFTEN HARD
TO RECOGNIZE, BUT GENETIC TESTING AND NEUROIMAGING COULD SOMEDAY BE USED TO
IMPROVE DETECTION, Scientific American, (3): 96-103 (September 2003).
(6) Crown, W.H., Finkelstein, S., Berndt, E.R., Ling, D., Poret, A.W., Rush,
A.J., and Russell, J.M.. THE IMPACT OF TREATMENT-RESISTANT DEPRESSION ON HEALTH
CARE UTILIZATION AND COSTS, 63(11):963-71 (November 2002).
(7) Open Minds Yearbook of Managed Behavioral Health Market Share in the United
States, 1998-1999, at 10-12 (Gettysburg, PA. 1999).
(8) Gardner, R., SOCIOPHYSIOLOGY AS THE BASIC SCIENCE OF PSYCHIATRY, Journal
Theoretical Medicine and Bioethics, 18-4 at 335-356 (December, 1997).
42
abnormalities(9) and has, therefore, necessarily had to rely on symptomatic
diagnoses to make course of treatment decisions. The prevalence of the
prescription of multiple courses of ineffective medications for patients
suffering from mental disorders, coupled with the attendant economic
inefficiencies of the practice of Psychiatry in this manner demands a logical
alternative.
Behavioral disorders are common in the United States and
internationally. An estimated 26.2 percent of Americans ages 18 and older --
about one in four adults -- suffer from a diagnosable mental disorder in a given
year.(10) The market for pharmaceuticals to treat central nervous system
disorders is more than $42 billion in the United States and is the largest
market segment of pharmaceutical sales, surpassing pharmaceuticals to treat
cardiac disease, cancer and diabetes.(11) Traditionally, prescription of
medication for the treatment of these disorders has been based on symptoms,
while the underlying physiology and pathology of the disease has rarely been
addressed. This can result in multiple ineffective, costly and often lengthy
courses of treatment before effective medications are identified, if at all.
OUR SOLUTION
rEEG is a historical outcomes-based information treatment tool
personalized to the functional imbalance of a patient's brain. We believe rEEG
to be the first broad-based objective, quantitative, neurophysiologic biomarker
system for facilitating appropriate and effective treatment for patients
suffering from behavioral (mental or addictive) disorders. In the past year,
psychiatrists in twelve states have used this system to guide treatment of their
treatment-resistant patients.
With a rEEG report, a physician (a "Client-Physician") can obtain
neuropsychiatric medication sensitivity and resistance data for individuals that
have brain abnormalities (abnormalities of electrical power distribution in the
brain) similar to that of their patient. The compelling clinical results and
economics demonstrated in multiple studies completed by either CNSR or
independent parties provide the basis from which, we believe, rEEG will become a
standard for guidance of psychiatric treatment of treatment-resistant patients.
See Section captioned "OUR BUSINESS - rEEG CLINICAL TRIALS" for a review of
existing clinical data.
Over the course of the last twenty years the Company and its scientific
founders have collected treatment outcomes for patients using various
medications where the patients' brain function was first measured with an EEG.
CNSR has correlated the EEG features with courses of treatment and outcomes
information provided by Client-Physicians. This information has been
subsequently assembled and organized into a proprietary database that we refer
to as the "rEEG Outcomes Database". As of November 8, 2006, the rEEG Outcomes
Database contained outcomes for over 2000 patients and more than 13,000
treatment trials of medications on these patients.
Using the rEEG analysis method and the information contained in the
rEEG Outcomes Database, CNSR can provide a report (an "rEEG Analytical Report")
to a Client-Physician identifying medication groups (such as antidepressants,
stimulants, anticonvulsants and beta blockers), medication subgroups such as
antidepressant subgroups of SSRI's (selective serotonin reuptake inhibitors, an
example of which is Prozac), TCA's (tricyclic antidepressants, an example of
which is Desipramine), SNRI's (serotonin-
- ----------
(9) Breggin, P., R., M.D., Toxic Psychiatry: Why Therapy, Empathy and Love Must
Replace the Drugs, Electroshock, and Biochemical Theories of the "New
Psychiatry", at 291 (St. Martin's Press, 1991).
(10) National Institute of Mental Health, The Numbers Count: Mental Disorders In
America (2006), http://www.nimh.nih.gov/publicat/numbers.cfm#Intro.
(11) IMS Health (NYSE: RX), IMS Retail Drug Monitor April 2006,
http://www.imshealth.com/vgn/images/portal/cit_40000873/56/43/78335031IMS%20
Retail%20Drug%20Monitor%20April2006.pdf.
43
norepinephrine reuptake inhibitors, an example of which is Cymbalta). Further,
and most importantly, CNSR's statistical models in combination with the rEEG
Outcomes Database indicates which specific medications within these subgroups
(such as Zoloft, Prozac, Elavil, Wellbutrin, Effexor) are the most effective for
patients whose EEGs evidence similar characteristics to that of the subject
patient.
Psychiatric treatment guided by rEEG has been shown, in independent
studies, to be significantly more efficacious than previous treatment practices.
See Section captioned "OUR BUSINESS - rEEG CLINICAL TRIALS." Physicians that
have utilized such reports to inform their treatment strategies identify such
reports as `essential' or `significantly helpful' in approximately 75% of
patients treated based upon the information contained in the rEEG Analytical
Report. The vast majority of subject patients for whom we have created rEEG
Analytical Reports have been identified by their physicians as
"treatment-resistant," generally understood to be the most challenging,
high-risk and expensive category of patients to treat.(12) Typically, less than
25% of such patients find success in their next treatment efforts.(13)
Management believes that rEEG provides Client-Physicians with a unique tool that
can dramatically improve treatment outcome based on a patient's own
neurophysiology.
rEEG METHOD
CNSR's rEEG method consists of the following four integrated components:
Quantitative Quantitative
Digital EEG + Normative + rEEG Outcomes + EEG/ Medication
Analysis Analysis
1. Digital Electrocephalogram ("EEG")
The first step in the rEEG process is a standard digital EEG recording.
An EEG is a non-invasive, painless procedure where a cap of twenty
electrodes records the electrical output of the brain while the patient
is awake, but resting with their eyes closed. The recording normally
takes between 20 and 45 minutes. An EEG is a common, standardized
procedure in neurology, often used in diagnosis of epilepsy or other
neurological disorders such as brain tumor, stroke, encephalopathy etc.
2. Quantitative Normative Analysis
The electrical output at each of the twenty leads is "Fast Fourier"
transformed (a mathematical technique useful in wave analysis) into a
spectrum of electrical power output at various frequency ranges. One
standard approach transforms these waves into defined frequency ranges,
or bands, labeled Delta, Theta, Alpha and Beta. Output of these four
levels of frequency can be compared among the twenty leads. Standard
comparisons include electrical power of each of these bands on an
absolute and relative power basis (% of the total power output). Also,
comparison of various leads can be made for symmetry and coherence (a
measure of the phase of the energy output). Each of these measurements
(or groups of measurements) in a patient can be compared to values for
asymptomatic people (norms) of the same age and noted when they are
outside of standard normal ranges.
- ----------
(12) Dewan, M.J., and Pies, R.W., The Difficult-to-Treat Psychiatric Patient, at
37, American Psychiatric Publishing, Inc. (September 2002).
(13) Rush, A.J., Trivedi, M.H., Wisniewski, S.R., Nierenberg, A.A., Stewart,
J.W., Wadren, D., Niederehe, G., Thase, M.E., Labori, P.W., Lebowitz, B.D.,
McGrath, P.J., Rosenbaum, J.F., Sackheim, H.A., Kupfer, D.J., Luther, J., and
Fava, M., ACUTE AND LONGER-TERM OUTCOMES IN DEPRESSED OUTPATIENTS REQUIRING ONE
OR SEVERAL TREATMENT steps: A STAR*D REPORT. Am. J. Psychiatry; 163: 11,
1905-1917.
44
Analysis of the rEEG outcomes database has shown that certain abnormal
indications identifiable in an EEG (individually or in combination) are
indicators of probable response to different medication classes and
individual medications. We refer to these as "biomarkers". We have
identified a significant group of biomarkers that have shown relevance
and we calculate their value for each patient. We then examine the
history of treatment response to specific medications for patients with
similar patterns of abnormality in these biomarkers and compute a
projected sensitivity analysis for the current patient using any of the
specific medications or medication classes where we have sufficient
statistical power.
3. Quantitative rEEG Outcomes Analysis
A core element of rEEG is the rEEG Outcomes Database. This proprietary
database consists primarily of patient digital EEGs, medication
histories and outcomes collected over a 20 year period. An "outcome"
can be defined as a specific measure of change in behavior obtained
while taking specific medications. The rEEG Outcomes Database allows
for statistical correlation of more than 1,100 individual QEEG measures
against medication success, and includes more than 13,000 treatment
episodes with outcomes.
4. EEG / Medication Correlations - Computation of Proprietary
Variables and application of Correlation Engine
Currently, the rEEG Outcomes Database allows the Company to analyze
outcomes related to twenty-seven different medications from the classes
of antidepressants, stimulants, anticonvulsants, beta-blockers and food
supplements. The Company is continually growing the database and adding
additional medications as they become statistically relevant. There are
currently seventy-eight medications marketed in the U.S. for
depression, anxiety disorders, bipolar disorder, schizophrenia,
obsessive-compulsive disorder (OCD), attention-deficit hyperactivity
disorder (ADHD), post-traumatic stress disorder (PTSD), panic disorder,
and insomnia. This does not include sixty-one medications now marketed
in the United States for the treatment of Alzheimer's, Parkinson's
Disease, migraines and Epilepsy.(14)
TREATMENT DECISIONS MADE BY LICENSED PROFESSIONALS
We do not currently operate our own healthcare facilities, employ our
own treating physicians or provide medical advice or treatment to patients. The
Client-Physicians that contract for our rEEG Analytical Reports own their own
facilities or professional licenses, and control and are responsible for the
clinical activities provided on their premises. Patients receive medical care in
accordance with orders from their attending physicians. Physicians who contract
for rEEG Analytical Reports are responsible for exercising their independent
medical judgment in determining the specific application of the information
contained in the rEEG Analytical Reports, and the appropriate course of care for
each patient. Following the prescription of any medication, the
Client-Physicians are presumed to administer and provide continuing care
treatment.
PROCESS FLOW
The flow chart below details the process of inception to rEEG
Analytical Report delivery. Currently, upon receipt of the EEG, a rEEG
Analytical Report is generally delivered to the referring physician 3-4 days. We
expect that through efficiency improvements, turnaround will be reduced to next
day.
- ----------
(14) Drug Reference for FDA Approved Psychiatric Drugs,
http://neurotransmitter.net/drug_reference.html.
45
PATIENT/PHYSICIAN CNS RESPONSE NEUROLOGIST
________________________ _______________________
| EEG Recording in Field |_\| Transfer to CNS |
| | /| (Secure) |______________
|________________________| |_______________________| |
| |
___________V___________ _________ V__________
| Artifacting | | Neurologist Review |
| (remove eye blinks, | | (confirming that |
| muscle twitches, etc.)|/__| Patient is suitable |
| |\ | for rEEG) |
|_______________________| |_____________________|
|
___________V___________
| Quantitative |
| Normative |
| Analysis |
|_______________________|
|
___________V___________
| Computation of |
| Proprietary Variables |
|_______________________|
|
___________V___________
| |
| Correlation Engine |
|_______________________|
|
________________________ ___________V___________
| Receive rEEG Report | | rEEG Report |
| (Utilize for |/_| Generation |
| Treatment) |\ | and Review |
|________________________| |_______________________|
The chart above shows that the first step in the process is collection
of a digital EEG from the patient. This may be done at the physician's office or
off-site at a testing center. Some physicians own their own equipment for
testing while others arrange for technicians to visit their offices for patient
appointments. This data is then typically transferred to a secure Health
Insurance Portability and Accountability Act ("HIPPA") compliant FTP (File
Transfer Protocol) Internet site, although it can also be sent via overnight
delivery service. Another early step in the process is artifacting. This is the
process of selecting segments of the QEEG record for analysis that are free of
electrical distortions caused by muscle movement. Also, early in the process is
a conventional review of the EEG by a neurologist or neurophysiologist. This
serves as a quality control step to review the overall quality of the recording
and determine whether it is acceptable for rEEG processing. Also at this time,
the neurologist/neurophysiologist will author a review of the conventional EEG.
This will appear on CNSR's Type I rEEG Report.
OUR TECHNOLOGY AND INTELLECTUAL PROPERTY
rEEG PATENTS
We have two issued U.S. Patents which together provide CNSR with the
right to exclude others from using the rEEG technology. In addition, these
patents cover the analytical methodology utilized by CNSR with any form of
neurophysiology measurement including SPECT (Single Photon Emission Computed
Tomography), fMRI (Functional Magnetic Resonance Imaging), PET (Positron
Emission Tomography), CAT (Computerized Axial Tomography), and MEG
(Magnetoencephalography)). We do not currently have data on the utility of such
alternate measurements, but we believe they may, in the future, prove to be
useful to guide therapy in a manner similar to rEEG. We have also filed patent
applications for our technology in various foreign jurisdictions.
rEEG TRADEMARKS
We have filed trademark applications in the United States for the
following marks: "Referenced-EEG" and "rEEG". We will continue to expand our
brand names and our proprietary trademarks worldwide as our operations expand.
46
rEEG OUTCOMES DATABASE
The rEEG Outcomes Database consists of approximately 13,000 clinical
outcomes across 2,000 patients who had psychiatric or addictive problems. The
CNSR Outcomes database is maintained in two parts:
1. The QEEG Database
The QEEG Database includes EEG recordings and neurometric data derived
from analysis of these recordings. This data is collectively known as
the QEEG Data. QEEG or "Quantitative EEG" is a standard measure that
adds modern computer and statistical analyses to traditional EEG
studies.
2. The Clinical Outcomes Database
The Clinical Outcomes Database consists of physician provided
assessments of the clinical outcomes of patients and their associated
medications. The clinical outcomes of patients are generally recorded
using an industry-standard outcome rating scale, such as the Clinical
Global Impression Global Improvement scale ("CGI-I"). The CGI-I
requires a clinician to rate how much the patient's illness has
improved or worsened relative to a baseline state. A patient's illness
is compared to change over time and rated as: very much improved, much
improved, minimally improved, no change, minimally worse, much worse,
or very much worse. In addition, CNSR may utilize specialized scales
applicable to specific disorders, including the Beck Depression
Inventory and Ham-D scales (Hamilton Depression Rating Scale) for
depression and anxiety.
The format of the data is standardized and that standard is enforced at
the time of capture by a software application. Outcome data is input
into the database by the treating physician or in some cases, their
office staff. Each Client-Physician has access to his/her own patient
data through the software tool that captures clinical outcome data.
We consider the rEEG Outcomes Database to be a valuable trade secret
and are diligent about protecting such information. The rEEG Outcomes Database
is stored on a secure server and only a limited number of employees have access
to it. Any individual that is provided with access to the database is required
to enter into a strict confidentiality agreement.
OUR CURRENT OPERATIONS - LABORATORY INFORMATION SERVICES
We provide rEEG analysis in a relationship analogous to the support
other physicians have from a reference laboratory or radiology center.
Physicians send us the QEEG data, and we return an analytical report for a
standard charge. This revenue model requires minimal training or impact on their
current operation and is one that physicians readily understand. In some cases,
we also provide the actual patient testing for acquisition of the QEEG data.
Our revenues are currently derived primarily from our Laboratory
Information Services business.
We currently offer rEEG Analytical Reports produced by our laboratory
based on QEEG data supplied by the physician or an independent testing service.
There are two primary types of analysis available.
47
TYPE I ANALYSIS
Type I analysis provides medication sensitivity information based on
statistical probability of improved outcomes against
neurophyisiologically similar patients. It is considered the baseline
measurement where the patient is preferably tested in an unmedicated
state, which means the patient abstains from taking neuropsychiatric
medications that cross the blood-brain barrier and act on the brain for
5 half-lives (can vary from 1 day for Ambien to 5 weeks for Prozac).
TYPE II ANALYSIS
Type II analysis provides medication sensitivity information based on
the changes to the patient's neurophysiology presumed to be from the
intervening treatment. It is, therefore, measured while the patient is
medicated.
Laboratory Information Services are either: 1) billed to the
Client-Physician or 2) billed to the Patient directly. Currently, the vast
majority of the rEEG Analytical Reports produced are billed to the
Client-Physician. We bill our Client-Physicians on a monthly basis.
Typically, after a 90 day medication regime guided by the Type I rEEG,
a Type II rEEG will be ordered if the desired outcome has not been achieved.
This follow-up analyzes changes post-medication in the patient's physiology, and
facilitates the preparation of an rEEG Report with data useful for determining
medication dose adjustment, alternative medicine selection or additional
medication augmentation. Because our Type I analysis has shown strong efficacy
in guiding successful medication of subject patient's disorders, we expect that
requests for Type II analysis will remain at their current levels.
OUR CURRENT MARKETS
CURRENT APPLIED DISORDERS
In the last 12 months, physicians in twelve states have used rEEG in
their practice. A series of eight studies involving rEEG have been conducted
over the last several years cumulating 500 patients. See Section captioned
"Clinical Validation." All studies, which involved most major categories of
psychiatric disorders (except for schizophrenia), have shown rEEG to be
demonstrably effective in guiding treatment. To date, these studies have
addressed the efficacy of rEEG with respect to the following behavioral
disorders:
o ATTENTIONAL DISORDERS (INCLUDING ATTENTION DEFICIT DISORDER
("ADD")/ATTENTION DEFICIT HYPERACTIVITY DISORDER ("ADHD"));
o ANXIETY DISORDERS;
o DEPRESSIVE DISORDERS;
o BIPOLAR DISORDERS;
o IMPULSE CONTROL DISORDERS;
o POST TRAUMATIC STRESS DISORDER;
o COMPULSIVE AND OBSESSIVE DISORDERS;
o EATING DISORDERS (INCLUDING ANOREXIA NERVOSA AND BULIMIA
NERVOSA); AND
o ADDICTIVE DISORDERS (INCLUDING DRUG AND ALCOHOL ABUSE)
48
PRIVATE PAYERS
Currently, a large majority of our rEEG Analytical Reports are paid for
directly by patients.
Insurance coverage for treatment of behavioral disorders varies
significantly. Many health plans limit coverage for mental health benefits by
imposing co-payments, deductibles or limits on outpatient visits that are more
restrictive than those placed on physical illness. Many times these benefits do
not extend to addiction treatment. Lack of or limitations on insurance coverage
or exhaustion of insurance coverage often result in patients needing to pay
privately for treatment of behavioral disorders.
Another reason patients pay privately is that access to plan
psychiatrists may be limited, requiring patients to seek non-plan psychiatrists
that only accept direct patient payment. Occasionally, a patient receiving care
from a health plan psychiatrist may become disappointed with the amount of time
they are able to spend with that physician. They may prefer to pay privately in
order to obtain more physician time and attention.
Because of the nature of a behavioral disorder, many patients seek out
private pay psychiatrists as a result of a desire for greater anonymity. Some
patients are concerned about filing reimbursement claims with their employer's
health benefit program, especially in cases where they may not want their
employer to know of their affliction (e.g. addiction, Attention Deficit
Disorder, Obsessive-compulsive Disorder, Impulse Control Disorder).
Still other patients are seeking the best quality of care without
concern for reimbursement. Psychiatrists that accept private pay generally are
able to receive a higher hourly rate from private pay patients than most health
plan provide. As a psychiatrist develops a reputation for quality service they
may be able to focus their practice on private pay patients to a greater degree.
It is this reputation for quality service that may attract some of the patients
seeking best quality of care.
For these reasons and more there are a large number of psychiatrists
that accept only patients paying privately for their services. CNSR has
estimated that these psychiatrists treat approximately 40% of the treatment
resistant patients, which comprises 2 million people in any given year or a
potential annual market of $1.2 billion with present pricing.
MANAGED BEHAVIORAL HEALTH ORGANIZATIONS/MANAGED CARE PAYERS
Currently, only a small portion of our rEEG Analytical Reports are paid
for by insurers or managed healthcare companies.
Many insurance/managed health care companies and many self-insuring
employers providing behavioral health benefits seek to manage these services and
expenditures through separate entities (MBHOs) that focus exclusively on
managing the mental health benefit. MBHOs are separate entities such as Magellan
Health Services or ValueOptions, Inc. or subsidiaries of larger healthcare
management organizations such as United Behavioral Health or CIGNA Behavioral
Health.
MBHOs have developed contracted networks of behavioral health
specialists to service the needs of their insured members. Various policies for
patients and providers help to efficiently deliver the behavioral health
benefit. Employers that contract with MBHOs don't necessarily seek the lowest
cost of care. Often, the employer's goals are to minimize absenteeism,
disruption to their processes or time lost as a result of employee disabilities
and prefer to contract with MBHO's that can deliver a better quality of care,
accomplishing these goals. Employers may contract directly with an MBHO or
utilize MBHO's as part of the total health care managed care contract.
49
Based on our conversations with MBHO managers, we estimate that a small
subset (10%-15%) of those that seek treatment in any year account for a
disproportionately high percentage (30%-45%) of the total medical costs paid out
by MBHOs. These are typically the treatment resistant patients. In addition to
being burdensome on the MBHO's, these patients are also typically more expensive
to their primary health insurer as compared to other patients because of their
higher use of emergency room services, pharmaceuticals (which are often not
managed by the MBHO), and use of medical services associated with physical
ailments.
We estimate over 1 million patients covered by MBHOs in any given year
are candidates for rEEG Report guidance. At present pricing this represents an
annual market opportunity of $600 million.
TOTAL MARKET PERSPECTIVE
A 2004 Harris Interactive Poll stated that "an estimated 59 million
people, or more than one in four U.S. adults, have received some form of mental
health treatment in the past two years. The vast majority of these people -- an
estimated 48 million -- are being treated with prescription medication.
Medications are clearly the dominant form of mental health treatment in America,
the survey found" (as reported in HEALTH DAY NEWS, May 5, 2004). The poll also
estimated another 24 million people needed but were not getting help because
they had given up on treatment or never pursued treatment. We estimate our
market opportunity for our Laboratory Information Services with respect to
central nervous system disorders to be in excess of $1.5 billion.
PRICING
We typically charge $400.00 to physicians for a Type I rEEG Report, our
standard report, which reflects EEG data obtained while a patient is off of
medications. Occasionally, physicians encounter patients that cannot tolerate
the discontinuation of their current medications to have a standard Type I test.
For these patients, we have a special report, Type I(m), which reflects EEG data
obtained while the patient is medicated with a medication that is in the rEEG
Outcomes Database. By estimating the likely EEG effect from the medication, we
can estimate the rEEG parameters of an unmedicated brain and issue a report
based on such estimation. Pricing to the physician for Type I(m) reports are
$800.
Type II testing is for patients that have a baseline Type I test on
record and have been medicated. A Type II rEEG Report compares changes in
neurophysiology from the Type I test data. We currently charge $200.00 for a
Type II rEEG Report.
Because the primary tasks of rEEG analysis are computer automated,
direct costs of processing are relatively low. Currently, CNSR contracts with a
neurophysiologist to supply a conventional review of and commentary on a
patient's EEG test. CNSR also contracts with outside services to select
artifact-free (an eye-blink and the corresponding electrical signal from same is
an example of an artifact) sections of the recording suitable for rEEG analysis.
These services constitute the majority of the direct costs associated with
processing a rEEG Type I analysis. We plan to bring both of these functions
in-house during 2007, thereby reducing our costs per test, and improving our
margins.
CLINICAL VALIDATION
As summarized in a 2005 American Psychiatric Association Poster,
reviewing results of rEEG guided treatment in prospective, retrospective,
comparative studies and independent physician case series, fairly consistent
results were reported. Generally, rEEG guided therapy, when used in conjunction
with other standard clinical information has shown the ability to guide
physicians to successful outcomes in 70% or more of mostly treatment resistant
patients. Various studies in the literature would suggest the
50
current standard of care for treatment success with treatment resistant patients
is less than half that rate, and in some cases only 10-15%.(15)
COMPLETED INDEPENDENT STUDIES AND TRIALS
- -------------------- ----------------------- -------------------- ----------------------
Veterans Association CIGNA Treatment- Davis-Atlanta
ADD/Depression Study Blind Prospective Major Resistnat Field Trial Case Study
100 Patients Depression Study 56 Patients 15 Patients
13 Patients
rEEG-Guided Efficacy rEEG-Guided Efficacy rEEG-Guided Efficacy rEEG-Guided Efficacy
>80% 83% 70% 100%
- -------------------- ----------------------- -------------------- ----------------------
Monte Nido Hamilton-Newport Beach Hoffman-Denver L'Abri Dual Diagnosis
Eating Disorder Case Case Series Case Series San Diego Case Series
Series 34 Patients 15 Patients 58 Patients
81 Patients
rEEG-Guided Efficacy rEEG-Guided Efficacy rEEG-Guided Efficacy rEEG-Guided Efficacy
83% 78% 73% 93%
- -------------------- ----------------------- -------------------- ----------------------
ADD/DEPRESSION STUDY
- --------------------------------------------------------------------------------
Prospective study with retrospective analysis.
EFFICACY: >80%
Date: 1995. The initial formalized trial consisted of 100 patients of
which 46 were diagnosed with ADD and 54 with depression. Conventional
thought would have anticipated that the ADD patients would have
responded to the stimulants and the depressed patients would have
responded to the antidepressants. In this study, those that failed to
respond to conventional treatment were treated with non-conventional
medications. rEEG correctly identified which patients would respond to
which medications over 80% of the time. This study was published in
Clinical Electroencephalography.(16)
VETERANS ADMINISTRATION BLINDED PROSPECTIVE MAJOR DEPRESSION STUDY
- --------------------------------------------------------------------------------
Randomized, Prospective, Double-Blind Study
Date: 1997-1999. A pilot prospective study of severe and long-term
Veterans Administration patients diagnosed with major depressive
disorders was conducted under the direction of Dr Art Kling, former
Vice-Chairman of the Department of Psychiatry at UCLA. The trial
consisted of 13 patients, all diagnosed with depression with average
illness duration of 16 years. As measured by all indices used, all
patients but one in the rEEG guided treatment group showed significant
improvement (86%). In the control group, where patients were treated
without the benefit of rEEG, only one of the patients significantly
improved based upon physician-guided medication selection (17%), and as
it turned out, this patient received the class of medication that rEEG
predicted would most benefit the patient need even though this
knowledge was not available to the physicians in the control group.
This study has been submitted for publication.
- ----------
(15) DUNNER, D.L., RUSH, A.J., RUSSELL, J.M., BURKE, M., WOODARD, S., WINGARD,
P., and ALLEN, J., PROSPECTIVE, LONG-TERM, MULTICENTER STUDY OF THE NATURALISTIC
OUTCOMES OF PATIENTS WITH TREATMENT-RESISTANT DEPRESSION. J CLIN PSYCHIATRY.
67(5):688-95 (May 2006).
(16) Suffin, S. C. and Emory, W. H., CLINICAL ELECTROENCEPHALOGRAPHY, 26(2),
1995.
51
TREATMENT-RESISTANT PATIENT FIELD TRIAL - CIGNA CO-SPONSORSHIP
- --------------------------------------------------------------------------------
A pilot study conducted between 2000 and 2002 with CIGNA Behavioral
Health and its network of Atlanta psychiatrists included 56
treatment-resistant patients. All patients had previously failed at
least two trials of medication treatments. Utilizing rEEG guidance, 69%
of patients were reportedly responsive to identified treatments.
PHYSICIAN CASE SERIES
- --------------------------------------------------------------------------------
Six physicians in five different clinical settings covering a wide
variety of diagnoses and ages have now reported on treatment results
aided by the use of rEEG in their clinics. The physicians received no
remuneration of any kind from CNSR and, in most cases, paid or had
their patients pay for the test and rEEG analysis. After reporting on
their results, a number of these physicians developed a strong desire
to instruct other physicians in the use of rEEG, and they have now
become regional medical directors with responsibility for training
other physicians. These physicians generally reported patient outcomes
on the seven-point scale, Clinical Global Improvement Index. Most also
reported their subjective assessment of the helpfulness of rEEG in
treatment of each patient on a seven-point scale, Clinical Helpfulness
Index. These patients had a wide variety of disorders but were
generally unresponsive to previous treatment efforts. We are pleased
that virtually all reported case series have shown compelling treatment
results with 70% to 90% of patients achieving MUCH IMPROVED or VERY
MUCH IMPROVED rankings. Equally important, similar levels were reported
in the rEEG Helpfulness Index (SIGNIFICANTLY HELPFUL or ESSENTIAL).
MONTE NIDO RESIDENTIAL TREATMENT CENTER
- --------------------------------------------------------------------------------
Monte Nido is a small in-patient treatment clinic in Malibu,
California, treating patients suffering from significant eating
disorders, primarily anorexia nervosa or bulimia. Dr. W. Hamlin Emory
is Medical Director of this facility. An initial analysis of treatment
results of 81 patients with pharmacotherapy based on rEEG was compared
to 10 patients treated by physicians without rEEG and 13 patients who
had rEEG testing but decided against medication. 83% of the rEEG guided
patient achieved SIGNIFICANT or MARKED improvement. None of the
patients in the other two groups achieved this level of improvement.
These results were published in a Scientific Poster at the National
Institute of Mental Health annual meeting, New Clinical Drug Evaluation
Unit Symposium of 2004. The Monte Nido Residential Treatment Center is
now seeking long term outcome data through patient surveys. We are
looking forward to learning of these results. The initial study was
described in a report in 2001.
HAMILTON-NEWPORT BEACH CASE SERIES
- --------------------------------------------------------------------------------
Conducted by Dr. Jim Hamilton, a Physician in Newport Beach, CA. In
this study, 34 treatment-resistant patients medicated based on
information provided in rEEG Analytical Reports were followed and
rated. 19 of the 34 patients had addictive disorders. Only 28 of the 34
cases were analyzed due to the fact that the balance were not available
for follow-up. Of the 28 analyzed, in 22 of these 28 cases rEEG was
judged to be essential or very helpful in their treatment. In 14 out of
these 28 cases, where the rEEG was judged essential, Dr. Hamilton
reported that rEEG had directed him "to combinations of medicines that
one would never find, or would take years to find after nothing else
had worked." In the 19 addiction cases, 4 were lost to follow-up, but
in the 15 that were followed, rEEG was judged essential or very helpful
in 14 (79%) of the cases.
52
HOFFMAN-DENVER CASE SERIES
- --------------------------------------------------------------------------------
Conducted by Daniel Hoffman, M.D., now a Company Medical Director, with
a practice in Denver, CO. This study was conducted prior to Dr. Hoffman
becoming the National Medical Director for the Company. In this study,
rEEG Analytical Reports were provided for 74 treatment-resistant
patients who were then followed, and were rated on both the CGI scale
and the "Helpfulness" Index. In 56 (74%) of these cases, rEEG was
judged to be essential or very helpful in their treatment. A like
percentage reported a much improved or very much improved on the
Clinical Global Improvement index.
DAVIS-ATLANTA CASE SERIES
- --------------------------------------------------------------------------------
Conducted by T. Albert Davis, M.D., Medical Director at the Florence
McDonnell Center in Atlanta. This was Dr. Davis's initial study of 15
patients that he treated with the aid of rEEG Analytical Reports. All
15 patients were reported as having successful outcomes with 7 rated as
Very Much Improved and 8 rated Much Improved on the CGI scale. In
Helpfulness, rEEG was rated essential for 9 of these patients and
moderately helpful for six of these patients.
RANCHO L'ABRI DUAL DIAGNOSIS
- --------------------------------------------------------------------------------
In this study, 58 "dual diagnosis" (addiction and co-morbid mental
illness) patients were treated at Rancho L'Abri, San Diego, one of the
most respected in-patient treatment facilities in Southern California.
The physicians of Rancho L'Abri described their experience with rEEG in
a scientific poster at the 2005 American Psychiatry Association annual
meeting. The poster described both CGI rating of Very Much Improved or
Much Improved and Helpfulness rating of Essential or Very Helpful in
over 90% of the patients for whom it was used.
OUR BUSINESS PLAN - LABORATORY INFORMATION SERVICES
Our Strategy
Our strategy is to provide rEEG analysis in a relationship with a
physician that is analogous to that of a reference laboratory. In each
geographic market, we plan to support this service with a full-time market
manager, identified EEG testing sites and a part-time Regional Medical Director.
The Regional Medical Director will provide local medical leadership and
training, local market communications, a site for physicians to refer
particularly challenging cases and support of family physicians needing
specialty consults.
In the next year, we plan to execute initiatives designed to allow for
dramatic introduction of rEEG to both treating physicians and their patients in
calendar year 2008. We envision this introduction will have elements of pushing
demand for rEEG via physician education and pulling demand for rEEG through
consumer education. The physician introduction will be accomplished through
development of an in-house direct sales force along with professional journal
and trade show introduction. The consumer introduction will utilize the major
broadcast, print and electronic news media.
Certain initiatives which are being considered for 2007 and 2008 include:
53
1. EXPAND OUR GROUP OF CLIENT-PHYSICIANS TO INCLUDE MOST MAJOR US CITIES.
This key infrastructure development is one element necessary for rapid
penetration. rEEG Analytical Reports often stimulate the identification
of treatment strategies that most physicians would not typically
consider. Physicians often are inexperienced in these treatment
strategies, and they also may be unfamiliar with combinations of
medicines that may be suggested by our rEEG Analytical Reports. It is
valuable for physicians who are not familiar with our rEEG Analytical
Reports to have an experienced colleague guide them through initial
treatments that are facilitated by the use of our rEEG Analytical
Reports. For physicians that are unfamiliar with our rEEG Analytical
Reports, their success is dependent on their ability to understand our
rEEG Analytical Reports and integrate them as another tool of insight
to be used in conjunction with their existing training.
2. CONDUCT THREE PILOT PROGRAMS WITH MANAGED CARE PAYERS. We believe that
adoption of rEEG for reimbursement is best accomplished through
demonstration of its clinical and economic impact with patients in a
health plan. In at least one of these pilot programs, CNSR will seek to
pay for independent economic and outcome analysis that CNSR will have
the right to publish. We are currently in discussions with three MBHOs
to conduct our pilot programs.
3. COMPLETE CURRENT MULTI-SITE AND CONDUCT ADDITIONAL ACADEMIC TRIALS.
CNSR is beginning a six site, 100 patient, academic controlled,
blinded, and randomized study of patients suffering from treatment
resistant depression. The study will be conducted at Stanford,
Cambridge Hospital-Harvard, University of California - Irvine,
University of California - San Diego, University of Texas - San Antonio
and University of British Columbia. This study has been designed with
significant care by many academicians including members of our advisory
board. Because of the involvement of respected academic centers, we
believe that the results of the study will be published, and widely
disseminated. In addition, we plan to conduct at least two additional
clinical trials. We are also advancing designs in dual-diagnosis
addiction and bulimia, a treatment resistant depression study of
different design and a unique study amongst high performing but
challenged college students.
4. IMPROVE SYSTEM TURN-AROUND TO NEXT DAY AND ADD CAPACITY TO COVER
PROJECTED VOLUME. We plan to increase the usefulness of our service by
returning reports to physicians one day after patient data is submitted
to us. To accomplish this task, we will need to improve the
coordination of functions related to rEEG analysis that we currently
outsource. Our longer term goal is to advance rEEG turn-around time to
be "while-you-wait."
5. ENHANCE REPORTS TO PROVIDE QUANTITATIVE BIOMARKER DATA AND DEVELOP
PHYSICIAN TRAINING AND CERTIFICATION PROCESS. We plan to advance our
training programs this year with the aid of a training CD-ROM which is
currently in development. In addition, our next generation rEEG report
is anticipated to provide technical data on the set of rEEG biomarkers
in a manner that will allow trained physicians to better consider
treatment options and integrate their knowledge of clinical assessment
and historical treatment experience with the rEEG biomarker data. Our
training program will aid physicians' use and understanding of our rEEG
Analytical Reports. The training process will have the added advantage
of communicating to patients and their families that a participating
physician has completed rEEG training, and is competent in the use of
rEEG Analytical Reports to guide treatment.
6. EXPAND REPORTED MEDICATIONS TO INCLUDE ANTIPSYCHOTICS. Antipsychotics
are the only significant class of psychotropic medications for which
rEEG does not currently offer treatment guidance. Psychosis is one of
the most severe mental illness and is also one of the
54
most difficult to treat. We plan to conduct studies to determine if our
rEEG Analytical Reports are useful in guiding the treatment of
psychosis, especially schizophrenia. We have two initiatives to
accomplish this objective. The first is a grant from the Washington
Technology Center and Washington State University, and the second is
with a group in China.
7. ADD KEY LEADERSHIP IN MEDICINE AND MARKETING. We plan to continue to
hire, train, retain and motivate additional skilled personnel,
particularly managers with experience in growing healthcare companies,
sales representatives who are responsible for customer education and
training and customer support, as well as personnel with experience in
clinical testing and matters relating to obtaining regulatory
approvals.
MARKET INTRODUCTION
After accomplishing our immediate goals of building the regional
medical leadership and reaching agreement for pilot trials with MBHOs,
aggressive national introduction will occur with establishment of that regional
leadership, establishment of an introductory sales force, and prepublication
release of our treatment-resistant depression or other key study data.
PUSH: By accessing thought leaders in psychiatry at the national and
community level, publicizing the clinical benefits in professional and consumer
media, and relying on our own dedicated sales force to educate psychiatrists we
believe that the compelling benefits and economic efficiency of rEEG guidance
will provide large scale physician trial.
Our main promotional strategy with physicians will continue to be "try
it, you'll like it - no charge". Because of the low variable cost of producing
rEEG Analytical Reports, we can offer free trials to physicians to encourage
them to begin to experience the benefits of rEEG. Our current program offers
Physicians five (5) free Type I reports with their only commitment being the
completion of a consultative review with one of our regional medical directors
for each report. We encourage physicians to select their most hard to treat
patients for these free trials. It is our expectation that no matter how well
conducted our academic trials, physicians need to experience rEEG for
themselves. One physician has written a letter to CNSR stating, "I DON'T KNOW
THAT I COULD GO BACK TO PRACTICING BLINDED PSYCHIATRY. UNTIL YOU EXPERIENCE HOW
DIFFERENT IT FEELS TO PRACTICE THIS WAY, I COULD SEE SKEPTICISM FROM OTHERS." We
believe physician trial is the key to adoption of rEEG.
PULL: We intend to utilize major print, broadcast and electronic news
media to explain the benefits of rEEG directly to patients. We believe that
these media are the most effective and cost-efficient means to pull-in consumer
demand for rEEG and that we have an unusual opportunity to develop a large reach
at an early stage that can stimulate dynamic demand.
This demand will also encourage physicians to seek early understanding
of rEEG and our goal of trial. Assisting patients to find early adopting
physicians by providing identification of trained physicians on our web site
will likely provide another win- win for patients, physicians and CNSR.
NEW MARKETS
ADDITIONAL APPLICABLE DISORDERS
While physicians have historically classified central nervous system
disorders as psychiatric or neurological, the diseases themselves could be
characterized as disorders of the same organ system,
55
primarily the brain. The utility of using of neurophysiological data to guide
treatment of the brain in connection with psychiatric disorders may well extend
to neurological disorders.
For example, we currently have significant information in our rEEG
Outcomes Database with respect to the effectiveness of anticonvulsants for
patients with certain biomarkers. We intend to explore the utility of our
biomarkers for guiding use of medications, including anticonvulsants, for their
primary indication of seizure disorders, as well as their utility in pain
management for which they are also often prescribed.
ADDITIONAL APPLICATIONS BEYOND TREATMENT-RESISTANCE
Due to the success of rEEG with treatment-resistant patients, we
believe that rEEG has the potential to become a useful tool for psychiatrists in
treating patients that do not qualify as treatment resistant. For example, it is
generally acknowledged that children have a wide range of reactions to
anti-depressants and, in fact, anti-depressants in many cases actually harm
instead of help them. The ability to avoid prescribing anti-depressants for
children that may have a physiological predisposition to react negatively would
reduce suffering for both the children, and their families, and facilitate the
identification of a successful strategy earlier in the process. In addition,
adolescents, who are typically intolerant of the long process of medication,
would be especially good candidates for rEEG guided therapy.
CENTERS OF EXCELLENCE
It is our intention to work with our Client-Physicians, and our medical
advisors to support, possibly with financial resources, the establishment of
practices and/or clinics that specialize in the use of rEEG guided therapy. We
believe that a network of such practices, which we call "Centers of Excellence,"
will provide opportunities for physician training and additional clinical trials
and demonstrations of the value of rEEG technology. It is our goal to make these
Centers of Excellence a destination for treatment-resistant patients and a
resource for care managers of the MBHOs, and, in time, a network of such Centers
may be in a position to contract for a disease management program with the
managed care industry.
GOVERNMENT
The market for our Laboratory Information Services potentially includes
state hospitals, wards of the state in specialty care homes for persistently and
seriously ill and jails. 2,186,230 prisoners were held in Federal or State
prisons or in local jails as of mid 2005.(17) Rates of severe mental illness in
this population are reportedly as high as 24%.(18) We are not currently pursuing
this market, in part because there is a substantial incidence of Schizophrenia
in this population and we do not yet have sufficient data to provide treatment
guidance for Schizophrenic patients.
We believe the incarcerated population returning to society may be a
particularly good market for rEEG. We have not yet explored the opportunity to
address this population but are interested in studying whether rEEG guided
treatment might add enough improvement in efficiency and effectiveness to alter
the recidivism rate.
- ----------
(17) U.S. Dept. of Justice- Bureau of Justice Statistics,
http://www.ojp.usdoj.gov/bjs/prisons.htm.
(18) Daly, R., PRISON MENTAL HEALTH CRISIS CONTINUES TO GROW, Psychiatry News,
40-20 at 1 (October 20, 2006).
56
RESEARCH AND DEVELOPMENT
We will continue to enhance, refine and improve the accuracy of our
CNSR Database and rEEG through expansion of the number of medications covered by
our rEEG Analytical Reports, expansion of our biomarkers, refinement of our
biomarker system, and by reducing the time to turnaround a report to the
physician. Other specific research and development goals consist of:
o Developing enhanced Type II Analyses that have increased value and content; o
Addition of other CNSR agents, and possibly cardiac agents; o Developing an
automated Type I (m) for patients on a single well characterized medication;
o Advancing our research to understand the total balance analysis that
can be used for monitoring or a more global scale; and
o Improved graphical presentation of results.
OUR BUSINESS PLAN - PHARMACEUTICAL DEVELOPMENT AND ADVANCEMENT
Although we intend to emphasize our Laboratory Information Services
during the next twelve (12) months, we plan to increase our involvement with the
pharmaceutical industry in the future.
OUR STRATEGY
Our strategy in the next year is the initiation of marketing of rEEG to
selected potential pharmaceutical development partners. Evaluation of such
opportunities by potential partners is complicated by many issues including
state of intellectual property, regulatory approval for marketing and the
trial(s) necessary, medication delivery and packaging requirements of the
medications, therapeutic synergy of the combination, market needs in selected
indications and related competitive advantage, estimated market size, production
costs, current physician familiarity with the individual agents and other
considerations.
A secondary goal is to explore the business opportunity in aiding in
resuscitating opportunities for psychiatric medications that are no longer being
pursued by their developers despite the fact that such medications demonstrated
significant efficacy for subgroups of patients in clinical trials. We believe
that, by using our system of rEEG biomarkers, we can aid in identifying patient
populations that are more likely to respond to a particular medication based on
their common physiological characteristics. We are interested in exploring
cooperative relationships, which utilize our technology and rEEG Outcomes
Database to aid in the development and clinical trials of efficacious
medications that previously had failed to adequately demonstrate that efficacy
in late stage trials.
We intend to leverage our capabilities and technology to develop a
pharmaceutical business from four sources:
COMBINATION OF OFF-PATENT AGENTS FORMULATED INTO SINGLE PILL FIXED-DOSE
COMBINATIONS.
Our data has demonstrated that some patient electrophysiological
abnormalities are more frequently observed than others. Most of the frequent
abnormalities take more than one agent to bring the patient to an
electrophysiological normal state. This is not surprising, as the individual
agents were never developed from an electrophysiological normalizing
perspective. We have identified a number of high frequency abnormalities that
appear to be most effectively addressed by a combination of medications. We have
filed patent applications on two categories of combinations and expect to file
more. Our current focus is for opportunities in bulimia, treatment-resistant
depression and addiction.
57
PARTNERING WITH PHARMACEUTICAL DEVELOPERS TO "RESCUE" NEW AGENTS IN
DEVELOPMENT.
New Chemical Entities (NCEs) that have been shown to be safe, but not
efficacious in late stage clinical trials present opportunities to partner or
acquire and re-license. Specifically, our interest is focused on a group of
agents that can generally be described as having (a) completed pre-clinical
formulation, toxicology, pilot production development, and all required animal
studies, (b) completed Phase I human safety studies, (c) completed Phase II
human dosing studies and possibly conducted initial Phase III pivotal efficacy
studies. These agents will have shown themselves to be generally safe without
debilitating adverse affects but have been discontinued in development due to
their failure to show compelling efficacy in either Phase II or Phase III
studies.
We estimate that there are approximately 200 central nervous system
compounds which are sitting idle at large pharmaceutical companies after failing
Phase II or Phase III trial.(19) We have completed a review of 53 such agents
that fit the described criteria and initially has focused on eight which are
thought to be worthy of consideration for licensing. Five other agents have been
identified as to be worth in-licensing pursuit for United States development.
These are agents that have been approved in overseas markets but not in the
United States. While they may not have been adequately differentiated, or the
regulatory expense may not have seemed justifiable for the potential market
opportunity, we believe that these agents belong to classes that have been
generally under utilized for additional significant indications. We believe that
for some medications, our rEEG biomarker system will be able to identify
patients with a high likelihood of responding well to these medications based on
the presence of rEEG-defined biomarkers.
We believe our rEEG biomarker system can be used to effect:
o Reduction of placebo responders in a clinical trial by
focusing on treatment resistant patients or eliminating
patients demonstrating normal neurophysiologic function and
balance;
o An increase in treatment group responders by selecting
patients for trial inclusion based on the presence of specific
rEEG defined neurophysiology.
AMELIORATING THE CNSR SIDE EFFECTS OF MEDICATIONS USED FOR OTHER MEDICAL
PURPOSES.
"Cancer fog" is a colloquial term used to describe the response of a
patient or care-givers response to the stresses and perhaps the medications
associated with cancer therapeutics. For patients, these effects appear to be
particularly specific to certain chemotherapeutic agents.
To the extent these agents cause a specific common alteration in
neurophysiological function, rEEG should be able to note and identify this. This
should allow the creation of a counteracting medication antidote for people
suffering from a neuropsychiatric condition following primary therapy.
- ----------
(19) Jarvis, L. M. TEACHING AN OLD DRUG NEW TRICKS: GENE LOGIC IS CONVINCING BIG
PHARMA TO TAKE ANOTHER LOOK AT ABANDONED DRUGS. Chemical and Engineering News,
84-7 at 52,54-55 (February 13, 2006).
58
COMPARABLE COMPANIES, COMPETITION AND INDUSTRY DEVELOPMENTS
INDUSTRY DEVELOPMENTS
We are not aware of any reference laboratories that service Psychiatry
with tools or information to direct therapy, although the following firms are
using neurophysiological data in an attempt to diagnose certain disorders and,
in some cases, monitor or confirm therapy:
o LEXICOR INC. (www.lexicor.com) uses EEG to diagnose ADHD
o NEURONETIX (www.neuronetix.com) uses tools to diagnose Autism,
Dyslexia and Alzheimer's
o AMEN CLINIC - uses SPECT for diagnosis and monitoring of
therapy
o NEUROGNOSTICS - uses FMRI for confirmation of therapeutic
efficacy
We are not aware of any companies using neurophysiological data to
guide therapy in conjunction with a neurophysiology outcomes database.
COMPARABLE COMPANIES
Although there are no companies offering a service similar to that
offered by CNSR, the following companies might be noted as comparable through
some commonalities:
o ASPECT MEDICAL SYSTEMS, INC. (Nasdaq: ASPM), an EEG anesthesia
monitoring company, is developing a specific EEG measurement
system that indicates a patient's likely response to some
antidepressant medications. Boston Scientific invested $25
million in a joint venture to accelerate this effort. Patients
must be measured prior to and after taking medication.
Publicly available knowledge suggests that the technology may
validate a patient's treatment but does not guide specific
treatment. Initial trials have shown efficacy in correlating a
patient's ultimate response to antidepressants. The revenue
model appears to involve sale of equipment and a per-patient
charge. The company is now conducting trials.
o HYTHIAM, INC. (Nasdaq: HYTM). Though perhaps more of an
analogous company than a competitor, Hythiam is a public
company introducing a proprietary addiction detoxification
procedure that purports to address physiologic needs of
addicts and impact on-going recovery. The company charges a
$15,000 fee for stimulant abusers and $12,000 for alcohol
abusers. Since CNSR does not provide guidance regarding
detoxification of addictions (only their post-detoxification
treatment), Hythiam is not a direct competitor.
o BRAIN RESOURCE COMPANY (www.brainresource.com), a development
stage Australian public company developing EEG and other
physiology data on patients with behavioral illness through a
network of physician data relationships. Their revenue model
includes physician services and sale of systems and services
to pharmaceutical development companies in the CNSR field.
o GENOMIC HEALTH, INC. (NasdaqGM: GHDX) This public company
provides analogous services to those of CNSR for patients
suffering from cancer.
59
EMERGING TECHNOLOGIES
The entire field of neuropsychiatry is undergoing dramatic changes as a
result of the introduction of new technologies. Many of these changes are driven
by medical device companies including:
o CYBERONICS, INC. (Nasdaq: CYBX). Cyberonics has developed an
implantable Vagus Nerve Stimulation device approved for
treatment-resistant depression. This device has received
pre-marketing approval from the Food and Drug Agency for
patients and is believed to be under reimbursement review by
insurance payers.
o MEDTRONIC, INC. (NYSE: MDT). Medtronic has an implantable deep
brain stimulation device (DBS) in development which is similar
to their device approved for Parkinson's treatment.
o NEURONETICS (www.neuronetics.com). Neuronetics has developed a
trans-cranial magnetic stimulation (rTMS) device which is
designed to be applied externally in a series of treatments
over several weeks. The company is expected to file FDA
registration soon.
We view these developing treatment options as expensive augmentations
to existing therapies for treatment-resistant patients. From this perspective,
these devices can be considered as competitive therapeutic treatment options to
medications. To the best of our knowledge, rEEG-guided therapy provides a higher
probability of treatment success at a significantly lower cost than device-based
solutions, which gives us a competitive advantage in the marketplace.
GOVERNMENT REGULATION
Currently, we do not believe that sales of our Laboratory Information
Services, including our rEEG Analytical Reports, are subject to regulatory
approval. However, federal and state laws and regulations relating to the sale
of our Laboratory Information Services are subject to future changes, as are
administrative interpretations of regulatory agencies. In the event that federal
and state laws and regulations change, we may need to incur additional costs to
seek government approvals for the sale of our Laboratory Information Services.
In the future, we intend to seek approval for medications or
combinations of medications for new indications, either with corporate partners,
or potentially, on our own. The development and commercialization of medications
for new indications is subject to extensive regulation by the U.S. Federal
government, principally through the FDA and other federal, state and
governmental authorities elsewhere. Prior to marketing any central nervous
system medication, and in many cases prior to being able to successfully partner
a central nervous system medication, we will have to conduct extensive clinical
trials at our own expense to determine safety and efficacy of the indication
that we are pursuing.
60
DESCRIPTION OF PROPERTY
We currently lease our office space under a lease agreement which
expires in November of 2007. The facility is approximately 1900 sq. ft, and is
located in Costa Mesa, California. It is from this facility that we conduct all
of our executive and administrative functions. We believe our space is adequate
for our current needs and that suitable additional or substitute space will be
available to accommodate the foreseeable expansion of our operations. Our
telephone number is (949) 248-5461.
EMPLOYEES
As of May 17, 2007, we had 7 full-time employees. Since inception, we
have never had a work stoppage, and our employees are not represented by a labor
union. We consider our relationships with our employees to be positive.
LEGAL PROCEEDINGS
From time to time, we may be involved in litigation relating to claims
arising out of our operations in the normal course of business. We are not
currently party to any legal proceedings, the adverse outcome of which, in our
management's opinion, individually or in the aggregate, that would have a
material adverse effect on our results of operations or financial position.
61
MANAGEMENT
The following table sets forth the name, age and position of each of
our executive officers and directors as of May 17, 2007. The following
individuals served as executive officers and directors of CNSR California before
our merger with CNSR California, and became our executive officers and directors
upon completion of the merger on March 7, 2007.
NAME AGE POSITION
- -------------------- --- ---------------------------------------------
Leonard J. Brandt 50 Chairman of the Board, President,
Chief Executive Officer and Secretary
Horace Hertz 57 Chief Financial Officer
David B. Jones 63 Director
Jerome Vaccaro, M.D. 51 Director
LEONARD J. BRANDT, DIRECTOR, PRESIDENT, CHIEF EXECUTIVE OFFICER, SECRETARY &
FOUNDER
Leonard J. Brandt is a founder of CNSR California, and has served as
its President and Chief Executive Officer, and as member of its Board of
Directors since its inception in 2000. Mr. Brandt started his career with
Norwest Venture Capital in 1980. In 1983 he became Vice President of Norwest
Growth Fund and General Partner of Norwest Venture Partners, where he served
until 1990. In this capacity he was primarily responsible for the firm's
investments in the healthcare industry, including several involving the
behavioral health industry. In 1995 Mr. Brandt founded Time Segment Publishing,
Inc and was its President until 1999. In 1999, Mr. Brandt co-founded Embro
Vascular, LLC, a provider of technology for least-invasive harvesting of the
saphenous vein for heart-bypass surgery. He also individually provided
consulting to early stage ventures from 1993 until he co-founded Mill City
Venture Consulting in 1998. Mill City Venture Consulting was initially an
advisor to NuPharm, Inc., the predecessor of CNSR California. Mr. Brandt has
been a United States member of the government of New Zealand Trade and
Enterprise Advisory Board since 2005. Len holds a Bachelor of Science degree
from the College of Commerce at University of Illinois and a Masters of Business
Administration from Harvard University.
HORACE HERTZ, CHIEF FINANCIAL OFFICER
Horace Hertz has served as Chief Financial Officer of CNSR California
since October 15, 2006. From August 2003 to September 2006, Mr. Hertz served as
the Chief Operating Officer and Chief Financial Officer of Bankers Integration
Group, a financial information company. From April 2002 to August 2003, Mr.
Hertz served as Chief Financial Officer of Infacare Pharmaceutical Corporation,
a medication development company. From April 2, 2001 to April 2002, Mr. Hertz
served as Interim Chief Executive Officer of Maxoptix, Inc., a hardware company
undergoing a restructuring. Prior to that Mr. Hertz served as a Chief Financial
Officer for a NASDAQ-listed public company, Aspeon, Inc, a manufacturer of
hardware, for 3 years. Mr. Hertz, a Certified Public Accountant, was a partner
of Deloitte & Touche, LLP from 1974 to 1991 and has a Masters Degree in
Mathematics from the University of California at Irvine.
DAVID B. JONES, DIRECTOR
David B. Jones has been a director of CNSR California since July 2006,
has been a Managing Partner of Odyssey Venture Partners II, L.P. since 2003.
From 1997 to 2003, he served as Chairman and Chief Executive Officer of Dartron,
Inc., a computer accessories manufacturer. From 1985 to 1997, he was a general
partner of InterVen Partners, a venture capital firm with offices in Southern
California and Portland, Oregon. From 1979 to 1985, he was President and Chief
Executive Officer of First Interstate
62
Capital, Inc., the venture capital affiliate of First Interstate Bancorp. Mr.
Jones is a director of Earthanol, Inc. He is a graduate of Dartmouth College and
holds Masters of Business Administration and law degrees from the University of
Southern California.
JEROME VACCARO, M.D., DIRECTOR
Jerome Vaccaro, M.D., joined the Board of Directors of CNSR California
in 2006. Dr. Vaccaro is a Senior Vice President with United Health Group's
Specialized Care Services. He has served in a number of health care executive
roles, most recently as Chief Executive Officer of United Behavioral Health, and
before that as President and Chief Executive Officer of PacifiCare Behavioral
Health ("PBH"). Dr. Vaccaro has also served as Medical Director of PBH
(1996-2001), Chief Executive Officer of PacifiCare Dental and Vision
(2002-2004), and Senior Vice President for the PacifiCare Specialty Health
Division (2002-2004). Dr. Vaccaro has an extensive background in community
mental health and public sector work, including editing the textbook,
"Practicing Psychiatry in the Community," which is hailed as the definitive
community psychiatry text. Dr. Vaccaro completed medical school and a Psychiatry
Residency at the Albert Einstein College of Medicine in New York City. After his
training, Dr. Vaccaro served on the full-time faculty of the University of
Hawaii (1985-1989) and UCLA (1989-1996) Departments of Psychiatry.
BOARD COMPOSITION AND COMMITTEES
Our board of directors currently consists of three members: Leonard
Brandt, David Jones, and Jerome Vaccaro. Each director was elected either at a
meeting of shareholders or by written consent of the shareholders and serves
until our next annual meeting or until his or her successor is duly elected and
qualified. We do not have a separately designated audit, compensation or
nominating committee of our board of directors and the functions customarily
delegated to these committees are performed by our full board of directors. We
are not a "listed company" under SEC rules and are therefore not required to
have separate committees comprised of independent directors. We have, however,
determined that David Jones and Jerome Vaccaro are "independent" as that term is
defined in Section 4200 of the Marketplace Rules as required by the NASDAQ Stock
Market. We have also determined that our board of directors does not include an
"audit committee financial expert" within the meaning of the rules and
regulations of the SEC. However, the company's board of directors has determined
that each of its members is able to read and understand fundamental financial
statements and has substantial business experience that results in that member's
financial sophistication. Accordingly, our board of directors believes that each
of its members has sufficient knowledge and experience necessary to fulfill the
duties and obligations that an audit committee would have.
We intend to establish an audit, compensation and nominating committee
of our board of directors to the extent we expand our board to include at least
three directors who are independent directors under the applicable rules of the
SEC and NASDAQ.
In the past five years, none of our officers or directors has had any
bankruptcy petition filed by or against any business of which such officer or
director was a general partner or executive officer either at the time of the
bankruptcy or within two years prior to that time. None of our officers and
directors have been convicted in a criminal proceeding or are subject to a
pending criminal proceeding, excluding traffic violations or similar
misdemeanors, nor have they been a party to any judicial or administrative
proceeding during the past five years, except for matters that were dismissed
without sanction or settlement, that resulted in a judgment, decree or final
order enjoining the person from future violations of, or prohibiting activities
subject to, federal or state securities laws, or a finding of any violation of
federal or state securities laws. There are no family relationships among our
executive officers and directors.
63
KEY EMPLOYEES
MICHAEL TIPPIE has served as VP of Pharmaceutical Business Development for the
Company since January, 2006. Prior to CNSR, Mr. Tippie consulted for a number of
biotechnology therapeutic, diagnostic and medical device companies from January
2002 to January 2006. From 1996-2002 Mr. Tippie was VP, Business Development for
LifeSpan BioSciences, Inc., a genomic database and pathology services company,
where he was responsible for 14 transactions with large pharmaceutical
companies, as well as the management of their contract research business. Mr.
Tippie has additional senior management experience in biotechnology
(ZymoGenetics, Tacora, StressGen Biotechnologies), as well as venture capital
experience (Norwest Venture Capital under Mr. Brandt; Medical Innovation
Partners). Mr. Tippie started his career as a medicinal chemist at Syntex
Research (since acquired by Hoffman LaRoche). Mr. Tippie holds a Masters of
Business Administration from the Sloan School of Management at the Massachusetts
Institute of Technology, a Master of Science in Chemistry from the University of
Washington and a Bachelor of Science in Chemistry from Reed College.
BRIAN MACDONALD, a co-founder of the Company, has served as its Director of
Engineering since 2000. Prior to receiving his Master of Business Administration
from the Wharton School of Business, University of Pennsylvania, in 1990, Brian
was trained in operations and chemical engineering. He consulted for Deloitte &
Touche Management Consulting from July 1990 to April 1995 KPMG Strategic
Services from April 1995 through April1996 and in private practice from April
1996 until January 1999. Mr. MacDonald's focus throughout this time was in the
area of operations and information systems. Brian is co-founder of Mill City
Venture Development, an entity founded in January 1999 that consulted for the
predecessor company to CNSR. In addition to his Masters of Business
Administration, Mr. MacDonald holds a Bachelor of Science degree from the
University of Alabama.
SCIENTIFIC AND MEDIA ADVISORS
CNSR's Scientific Advisors and Media Advisors are experts in their field. During
their tenure, CNSR Board of Directors and management team utilize their
specialized expertise on an as-needed basis.
STEPHEN C. SUFFIN, MD, Advisor, is certified in anatomic and clinical pathology
and has published more than 50 scientific papers. Dr. Suffin is a former
Investigator at the Laboratory of Infectious Diseases at the National Institute
of Allergy and Infectious Diseases and consultant to the Armed Forces Institute
of Pathology before returning to the West Coast to become Medical Director at
Upjohn's Laboratory Procedures. Dr. Suffin has served as a medical director for
SmithKline Beecham and Quest Diagnostics for over 20 years. Additionally, Dr.
Suffin is a board certified psychiatrist who has served as the medical director
of two psychiatric hospitals and as the Chief Medical Officer of CNSR from its
founding in 2000 until 2002.
MAURIZIO FAVA, MD, Advisor, is currently Associate Chief of Psychiatry for
Clinical Research and Director of the Depression Clinical and Research Program
at the Massachusetts General Hospital and Professor of Psychiatry at Harvard
Medical School. Dr. Fava has authored or co-authored more than 200 original
articles, edited four books, published more than 50 chapters, 200 abstracts and
given more than 200 presentations at national or international meetings. He has
received several awards during his career and is on the editorial board of four
international medical journals. Dr. Fava's prominence in the field is reflected
by his role as the co-principal investigator of STAR*D, the largest study ever
conducted in the area of depression.
ALAN SCHATZBERG, MD, Advisor, is the Kenneth T. Norris, Jr., Professor and
Chairman of the Department of Psychiatry and Behavioral Sciences at Stanford
University. He has authored over 500 publications and abstracts, including the
MANUAL OF CLINICAL PSYCHOPHARMACOLOGY, (fifth edition published in 2005), co-
64
edited the TEXTBOOK OF PSYCHOPHARMACOLOGY (third edition 2003) and is
Co-Editor-in-Chief of the JOURNAL OF PSYCHIATRIC RESEARCH. He has received
numerous awards during his career, including most recently the Distinguished
Service in Psychiatry Award from the American College of Psychiatrists and is on
the editorial board of several international medical journals. In 2003, Dr.
Schatzberg was elected into the Institute of Medicine of the National Academy of
Sciences.
MAX A. SCHNEIDER, MD, Medical Advisor to CNSR, Director of Education, Positive
Action Center at Chapman Medical Center, Orange, California, is a Fellow and
Past President of the American Society of Addiction Medicine (ASAM), a Past
Chair of the Board of Directors of the National Council on Alcoholism and Drug
Dependence (NCADD), a former consultant to the Drug and Alcohol Advisory
Committee of the U.S. Food and Drug Administration and a Certified Medical
Review Officer. He currently serves as a Clinical Professor at the University of
California at Irvine where he teaches in their Addiction Medicine program which
he founded in 1969. Dr. Schneider has produced ten films and five booklets on
addiction. In 1956 he was a member of the research team that developed "mouth to
mouth" resuscitation that revolutionized the technique of artificial
resuscitation.
GREGORY VISTICA, Advisor to CNSR, is the president of Washington Media Group,
Inc., a communications firm that specializes in crisis management. He is also a
principal with SAIL Venture Partners, an energy/cleantech venture firm. He is an
author and former award-winning investigative journalist who has worked as a
correspondent for NEWSWEEK, a contributing writer for THE NEW YORK TIMES
MAGAZINE, a staff writer for THE WASHINGTON POST, a producer for 60 MINUTES II,
and a military affairs writer for THE SAN DIEGO UNION-TRIBUNE. He has been
nominated for an EMMY by CBS News and was a finalist for a PULITZER PRIZE
nominated by the New York Times. He won a PEABODY AWARD and THE GEORGE POLK
AWARD for his investigative reporting of the "Tailhook Scandal."
65
EXECUTIVE COMPENSATION
CNS RESPONSE, INC. (FORMERLY STRATIVATION, INC.)
We did not have a bonus, profit sharing, or deferred compensation plan
for the benefit of our employees, officers or directors in 2006 or 2005. We did
not pay any other salaries or other compensation above $100,000 to our officers,
directors or employees in 2006 or 2005. Further, we have not entered into an
employment agreement with any of our officers, directors or any other persons.
We have not accrued any officer compensation.
There were no option grants to any executive officers during our fiscal
year ended December 31, 2006, and no options were exercised by any executive
officer during the fiscal year ended December 31, 2006.
In 2006, none of our directors received compensation for their services
as directors on our board.
CNSR CALIFORNIA
The following table sets forth information concerning all compensation
paid to CNSR California's Executive Officers for services to CNSR California in
all capacities for each of the three fiscal years ended September 30, indicated
below.
CNS RESPONSE SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------ ------------
NUMBER OF
NAME AND FISCAL YEAR SECURITIES
PRINCIPAL ENDED OTHER ANNUAL UNDERLYING
POSITION SEPTEMBER 30, SALARY(1) BONUS COMPENSATION OPTIONS *(2)
- ------------------------- ------------ ------------ ------------ ------------ ------------
Leonard Brandt (1) ...... 2006 $ 175,000 $ 10,000 $ 59,700 2,124,740
Chief Executive 2005 175,000 8,000 48,900 --
Officer, Director 2004 165,000 8,000 40,400 --
* The Number of Securities Underlying Options represents the number of
shares of our Common Stock for which the CNSR California common stock
underlying the originally issued options was exchanged upon the closing
of the Merger.
(1) For the fiscal years ended 2004, 2005 and 2006 Mr. Brandt agreed to
forgo payment of his salary and allow CNSR California to accrue such
compensation. In August 2006, Mr. Brandt agreed to settle his claims
for compensation through September 30, 2006 in the aggregate amount of
$1,106,900 in exchange for the issuance of 298,437 shares of CNSR
California common stock, which were exchanged for 298,437 shares of our
Common Stock upon the closing of the Merger.
(2) The options are fully vested and exercisable at $0.132 per share.
66
EMPLOYMENT CONTRACTS
The Company is not currently party to any employment contracts with any
of its executive officers and we do not expect to have any employment agreements
with our new executive officers.
DIRECTOR COMPENSATION
Currently, our non-employee directors do not receive compensation for
their services on our board. However, we reimburse directors for their travel
expenses associated with attendance at meetings of our board of directors. There
were no reimbursements for travel expenses for the fiscal year ended September
30, 2006, or for the six months ended March 31, 2007.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
The Delaware General Corporation Law and certain provisions of our
certificate of incorporation an bylaws under certain circumstances provide for
indemnification of our officers, directors and controlling persons against
liabilities which they may incur in such capacities. A summary of the
circumstances in which such indemnification is provided for is contained herein,
but this description is qualified in its entirety by reference to our bylaws and
to the statutory provisions.
In general, any officer, director, employee or agent may be indemnified
against expenses, fines, settlements or judgments arising in connection with a
legal proceeding to which such person is a party, if that person's actions were
in good faith, were believed to be in our best interest, and were not unlawful.
Unless such person is successful upon the merits in such an action,
indemnification may be awarded only after a determination by independent
decision of the board of directors, by legal counsel, or by a vote of the
stockholders, that the applicable standard of conduct was met by the person to
be indemnified.
The circumstances under which indemnification is granted in connection
with an action brought on our behalf is generally the same as those set forth
above; however, with respect to such actions, indemnification is granted only
with respect to expenses actually incurred in connection with the defense or
settlement of the action. In such actions, the person to be indemnified must
have acted in good faith and in a manner believed to have been in our best
interest, and have not been adjudged liable for negligence or misconduct.
Indemnification may also be granted pursuant to the terms of agreements
which may be entered into in the future or pursuant to a vote of stockholders or
directors. The provision cited above also grants the power to us to purchase and
maintain insurance which protects our officers and directors against any
liabilities incurred in connection with their service in such a position, and
such a policy may be obtained by us.
A stockholder's investment may be adversely affected to the extent we
pay the costs of settlement and damage awards against directors and officers as
required by these indemnification provisions. At present, there is no pending
litigation or proceeding involving any of our directors, officers or employees
regarding which indemnification by us is sought, nor are we aware of any
threatened litigation that may result in claims for indemnification.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling us pursuant
to the foregoing provisions, we have been informed that, in the opinion of the
SEC, this indemnification is against public policy as expressed in the
Securities Act and is therefore unenforceable.
67
PRINCIPAL AND SELLING STOCKHOLDERS
The selling security holders may offer and sell, from time to time, any
or all of the shares of common stock held by them. Because the selling security
holders may offer all or only some portion of the 9,983,138 shares of common
stock to be registered, we cannot estimate how many shares of common stock the
selling security holders may hold upon termination of the offering, nor can we
express, as a percentage, how this number of shares will relate to the total
number of shares that we will have outstanding at that time.
The following table presents information regarding the beneficial
ownership of our common stock as of May 17, 2007, and the number of shares of
common stock covered by this prospectus. The number of shares in the table
represents an estimate of the number of shares of common stock to be offered by:
o each of the executive officers;
o each of our directors;
o all of our directors and executive officers as a group;
o each stockholder known by us to be the beneficial owner of
more than 5% of our common stock; and
o each of the selling stockholders.
Beneficial ownership is determined in accordance with the rules of the
SEC and generally includes voting or investment power with respect to
securities. Unless otherwise indicated below, to our knowledge, the persons and
entities named in the table have sole voting and sole investment power with
respect to all shares beneficially owned, subject to community property laws
where applicable. Shares of our common stock subject to options and warrants
from the company that are currently exercisable or exercisable within 60 days of
May 17, 2007 are deemed to be outstanding and to be beneficially owned by the
person holding the options for the purpose of computing the percentage ownership
of that person but are not treated as outstanding for the purpose of computing
the percentage ownership of any other person.
The information presented in this table is based on 25,303,302 shares
of our common stock outstanding on May 17, 2007. Unless otherwise indicated, the
address of each of the executive officers and directors and 5% or more
stockholders named below is c/o CNS Response, Inc., 2755 Bristol St., Suite 285
Costa Mesa, CA 92626
NUMBER OF SHARES NUMBER OF SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING AFTER OFFERING
- ------------------------------------------ --------------------------- NUMBER ---------------------------
PERCENTAGE OF SHARES PERCENTAGE
OF SHARES BEING OF SHARES
NAME OF BENEFICIAL OWNER NUMBER OUTSTANDING OFFERED NUMBER OUTSTANDING
- ------------------------------------------ ------------ ------------ ------------ ------------ ------------
EXECUTIVE OFFICERS AND DIRECTORS:
Leonard Brandt (1) ....................... 8,536,277 29.7% 0 8,536,277 29.7%
Director, President, Chief Executive
Officer and Secretary
David B. Jones(2) ........................ 4,338,521 16.4% 484,250 3,854,271 14.6%
Director
68
NUMBER OF SHARES NUMBER OF SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING AFTER OFFERING
- ------------------------------------------------ --------------------------- NUMBER ---------------------------
PERCENTAGE OF SHARES PERCENTAGE
OF SHARES BEING OF SHARES
NAME OF BENEFICIAL OWNER NUMBER OUTSTANDING OFFERED NUMBER OUTSTANDING
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Dr. Jerome Vaccaro ............................. 5,000 * 0 5,000 *
Director (3)
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Horace Hertz ................................... 0 0 0 0 0
Chief Financial Officer
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Directors and officers as a group (4 persons)
(4) ............................................ 12,879,798 43.0% 484,250 12,395,548 41.5%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
5% STOCKHOLDERS:
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Stephen C. Suffin (5) .......................... 1,260,316 5.0% 0 1,260,316 5.0%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Sail Venture Partners LP (2) ................... 4,338,521 16.4% 484,250 3,854,271 14.6%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Brian MacDonald(6) ............................. 1,985,039 7.6% 0 1,985,039 7.6%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
W. Hamlin Emory (7) ............................ 1,316,781 5.1% 0 1,316,781 5.1%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Heartland Value Fund (8) ....................... 2,340,000 9.1% 2,340,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
EAC Investment Limited Partnership (9) ......... 1,766,279 6.8% 0 1,766,279 6.8%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
LMA SPC for and on behalf of Map 2 Segregated
Portfolio; ..................................... 1,625,000 6.3% 1,625,000 -- --
Partner Healthcare Offshore Fund, Ltd.;
Partner Healthcare Fund, L.P. (10)
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
OTHER SELLING STOCKHOLDERS:
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Mark Abdou (11) ................................ 15,609 * 15,609 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Addison Adams (12) ............................. 15,610 * 15,610 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Corporate Capital Partners (13) ................ 17,839 * 17,839 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Kevin Friedmann (14) ........................... 13,380 * 13,380 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Victor Fu (15) ................................. 13,379 * 13,379 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Peter Hogan (16) ............................... 4,460 * 4,460 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Ryan Hong (17) ................................. 22,299 * 22,299 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Lisa Klein (18) ................................ 13,380 * 13,380 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Kevin Leung (19) ............................... 17,839 * 17,839 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Albert Liou (20) ............................... 22,300 * 22,300 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
A&E Capital Partners, LLC (21) ................. 22,299 * 22,299 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Nimish Patel (22) .............................. 66,899 * 66,899 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Luan Phan (23) ................................. 22,299 * 22,299 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Silas Phillips (24) ............................ 22,300 * 22,300 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Erick E. Richardson (25) ....................... 66,898 * 66,898 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Troy Rillo (26) ................................ 22,300 * 22,300 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
John Tishbi (27) ............................... 4,460 * 4,460 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
David J. Zwiebel (28) .......................... 54,169 * 54,169 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Craig B. Swanson (29) .......................... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Jaeger Family LLC (30) ......................... 16,249 * 16,249 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Henry Harbin, M.D. (31) ........................ 10,835 * 10,835 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Edward M. Giles (32) ........................... 110,500 * 110,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
69
NUMBER OF SHARES NUMBER OF SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING AFTER OFFERING
- ------------------------------------------------ --------------------------- NUMBER ---------------------------
PERCENTAGE OF SHARES PERCENTAGE
OF SHARES BEING OF SHARES
NAME OF BENEFICIAL OWNER NUMBER OUTSTANDING OFFERED NUMBER OUTSTANDING
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
David J. Galey (33) ............................ 10,970 * 10,970 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Bill and Kim Woodworth (34) .................... 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Edmund H. Melhado (35) ......................... 36,563 * 36,563 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Bradley N. Rotter Self Employed Pension Plan &
trust (36) ..................................... 146,250 * 146,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Bradley Rotter (37) ............................ 433,335 1.7% 433,335 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Paul E. von Kuster (38) ........................ 109,688 * 109,688 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Paul E. von Kuster, Trustee, Credit trust
under will of Thomas W. von Kuster (39) ........ 55,575 * 55,575 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Joseph E. Stocke (40) .......................... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Martha S. McCormick (41) ....................... 13,000 * 13,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
D. Dean McCormick III (42) ..................... 13,299 * 13,299 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
David R. Holbrooke (43) ........................ 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Max A Schneider, M.D. Trust (44) ............... 14,625 * 14,625 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Frederick E. Kahn, MD (45) ..................... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Dr. Jim Greenblatt (46) ........................ 129,028 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Lawrence M. Baill (47) ......................... 32,886 * 14,625 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Lionsgate Capital (48) ......................... 219,375 * 219,375 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Jospeh A. Bailey (49) .......................... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Dr. Samuel Klagsbrun (50) ...................... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Daniel E. Greenblatt (51) ...................... 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Fred Ehrman (52) ............................... 325,000 1.3% 325,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
William C. Brown (53) .......................... 36,563 * 36,563 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Michael T. Cullen, M.D. (54) ................... 48,182 * 26,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Crown Jewel Ventures, LLC (55) ................. 131,807 * 30,713 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Thomas W. von Kuster Jr. (56) .................. 14,625 * 14,625 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
George Karfunkel (57) .......................... 130,000 * 130,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Westfield Microcap Fund L.P. (58) .............. 216,668 * 216,668 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Itasca Capital Partners, LLC (59) .............. 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
P. Kent Pachl (60) ............................. 5,418 * 5,418 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Kerry Judd and Susan Stillman (61) ............. 10,970 * 10,970 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Mr. & Mrs. Shannon Sullivan (62) ............... 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
H. R. Swanson Revocable Trust (63) ............. 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Robert James Blinken Jr. (64) .................. 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Van Zandt Hawn (65) ............................ 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Thomas E. Brust and Susan Brust(66) ............ 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Brean Murray Carret & Co. (67) ................. 1,270,323 4.9% 1,244,978 25,345 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Pradeep Sinha (68) ............................. 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Dr. Daniel Hoffman (69) ........................ 54,168 * 54,168 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Rotter Family Trust (70) ....................... 130,000 * 130,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Hal F. Lewis (71) .............................. 32,500 * 32,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
G&A Consulting Retirement Trust (72) ........... 58,500 * 58,500 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Arthur J. Bauernfeind RLT dated 6/25/04 (73) ... 260,000 1.0% 260,000 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Frederick Winston Trustee, Frederick Winston
Revocable Trust u/a dated 11/02/01 (74) ........ 29,250 * 29,250 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Pacific Ridge Capital, LLC (75) ................ 40,954 * 40,954 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
70
NUMBER OF SHARES NUMBER OF SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING AFTER OFFERING
- ------------------------------------------------ --------------------------- NUMBER ---------------------------
PERCENTAGE OF SHARES PERCENTAGE
OF SHARES BEING OF SHARES
NAME OF BENEFICIAL OWNER NUMBER OUTSTANDING OFFERED NUMBER OUTSTANDING
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
SLWK Venture Fund, LLP (76) .................... 62,166 * 62,166 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Medlen & Carroll, LLP (77) ..................... 119,834 * 16,035 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Hooper, Lundy & Bookman, Inc. (78) ............. 27,085 * 27,085 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Scott Alderton (79) ............................ 50,894 * 29,726 21,168 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Murray Markiles (80) ........................... 50,894 * 29,726 21,168 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
V. Joseph Stubbs (81) .......................... 50,894 * 29,726 21,168 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Jonathan Hodes (82) ............................ 25,535 * 17,308 8,227 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
John McIlvery (83) ............................. 25,804 * 17,308 8,496 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Greg Akselrud (84) ............................. 21,272 * 15,411 5,861 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Scott Galer (85) ............................... 17,877 * 11,759 6,118 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Kevin DeBre (86) ............................... 22,558 * 15,756 6,802 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Ryan Azlein (87) ............................... 9,430 * 9,430 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
AJ Investors # 1 (88) .......................... 216,668 * 216,668 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Westminster Securities (89) .................... 2,633 * 2,633 -- --
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
John Pagnucco (90) ............................. 485,807 1.9% 64,125 421,682 1.7%
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
Doug Metz (91) ................................. 25,101 * 7,359 17,742 *
- ------------------------------------------------ ------------ ------------ ------------ ------------ ------------
* Less than 1%
(1) Consists of (a) 5,138,991 shares of common stock (including 540,000
shares owned by Mr. Brandt's children), and 3,397,286 shares of common
stock issuable upon the exercise of vested and exercisable options and
warrants held by Mr. Brandt.
(2) Consists of (a) 3,109,406 shares of Common Stock and (b) 1,229,115
shares of Common Stock issuable upon the exercise of vested and
exercisable warrants held by Sail Venture Partners, LP. Of these
holdings, 372,500 shares of common stock and 111,750 shares of common
stock reserved for issuance upon exercise of certain warrants to
purchase common stock are being registered for resale. Sail Venture
Partners, LLC is the general partner of Sail Venture Partners, L.P..
The unanimous vote of the managing members of Sail Venture Partners,
LLC (who are Walter Schindler, Alan Sellers, Thomas Cain, and David B.
Jones), is required to voting and make investment decisions over the
shares held by this selling stockholder. The address of Sail Venture
Partners, L.P. is 600 Anton Blvd., Suite 1750, Costa Mesa, CA 92626.
(3) Consists of options to acquire 5,000 shares of common stock exercisable
within 60 days of May 17, 2007.
(4) Consists of 8,248,397 shares of common stock and 4,631,401 shares of
common stock issuable upon the exercise of vested and exercisable
options and warrants.
(5) Consists of 965,422 shares of common stock and 294,894 shares of common
stock issuable upon the exercise of vested and exercisable options and
warrants held by Mr. Suffin.
(6) Consists of 1,242,375 shares of common stock and 742,664 shares of
common stock issuable upon the exercise of vested and exercisable
options to purchase common stock. The address of Brian MacDonald is
4007 Beard Ave. South, Minneapolis, MN 55410.
(7) Consists of 1,019,249 shares of common stock and 297,532 shares of
common stock issuable upon the exercise of vested and exercisable
options to purchase common stock. The address of Mr. Emory is 9663
Santa Monica Blvd., Suite 221, Beverly Hills, CA 90210.
(8) Consists of 1,800,000 shares of common stock and 540,000 shares
reserved for issuance upon exercise of warrants to purchase common
stock. Heartland Group Value Fund is affiliated with Hartland Investor
Services, LLC, a registered broker/dealer and member of NASD. Heartland
Group Value Fund purchased or otherwise acquired its shares in the
ordinary course of business and, at the time of such
purchase/acquisition, had no agreements or understandings, directly or
indirectly, with any person, to distribute the securities to be resold.
Mr. Paul T. Beste, Vice President & Secretary of Heartland Group Inc.,
exercises
71
voting and investment authority over the shares held by this selling
stockholder. The address of the selling stockholder is c/o Brown
Brothers Harriman, 140 Broadway St., New York, NY 10005.
(9) Consists of 1,249,846 shares of common stock and 516,433 shares of
common stock issuable upon the exercise of warrants to purchase common
stock. Anthony Morgentheau exercises voting and investment authority
over the shares held by this selling stockholder. The address of the
selling stockholder is 380 Leucadendra Drive, Cora Gables, FL 33156.
(10) Consists of 224,110 shares of common stock and 67,233 shares reserved
for issuance upon exercise of warrants to purchase common stock held by
LMA SPC for and on behalf of Map 2 Segregated Portfolio; 651,090 shares
of common stock and 195,327 shares reserved for issuance upon exercise
of certain warrants to purchase common stock held by Partner Healthcare
Fund, LP, and 374,800 shares of common stock and 112,440 shares
reserved for issuance upon exercise of warrants to purchase common
stock held by Partner Healthcare Offshore Fund, Ltd. Eric Moore, as the
Chief Financial Officer of Partner Healthcare Offshore Fund, Ltd.,
exercises voting and investment authority over the shares held by
Partner Healthcare Offshore Fund, Ltd. Eric Moore, as the Chief
Financial Officer of Partner Healthcare Fund, L.P., exercises voting
and investment authority over the shares held by Partner Healthcare
Fund, L.P.. Robert P. Swan, as director, exercises voting and
investment authority over the shares held by LMA SPC for and on behalf
of Map 2 Segregated Portfolio. The address of each of the selling
stockholders is One Market Plaza, Steuart Tower, 22nd Floor, San
Francisco, CA 94105.
(11) Consists of 15,609 shares of common stock.
(12) Consists of 15,610 shares of common stock.
(13) Consists of 17,839 shares of common stock.
(14) Consists of 13,380 shares of common stock.
(15) Consists of 13,379 shares of common stock.
(16) Consists of 4,460 shares of common stock.
(17) Consists of 22,299 shares of common stock.
(18) Consists of 13,380 shares of common stock.
(19) Consists of 17,839 shares of common stock.
(20) Consists of 22,300 shares of common stock.
(21) Consists of 22,299 shares of common stock. Edgar Park, as member,
exercises voting and investment authority over the shares held by this
selling stockholder.
(22) Consists of 66,899 shares of common stock.
(23) Consists of 22,299 shares of common stock.
(24) Consists of 22,300 shares of common stock.
(25) Consists of 66,898 shares of common stock.
(26) Consists of 22,300 shares of common stock. (
27) Consists of 4,460 shares of common stock.
(28) Consists of 41,668 shares of common stock and 12,501 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(29) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(30) Consists of 12,499 shares of common stock and 3,750 shares reserved for
issuance upon exercise of warrants to purchase common stock. Eric
Jaeger, President and General Manager of Jaeger Family LLC exercises
voting and investment authority over the shares held by this selling
stockholder.
(31) Consists of 8,334 shares of common stock and 2,501 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(32) Consists of 85,000 shares of common stock and 25,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
72
(33) Consists of 8,438 shares of common stock and 2532 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(34) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
Kimberly Craig-Woodworth and William N. Woodworth are affiliated with
Brean Murray, Carret & Co. a registered broker/dealer and member of
NASD. Kimberly Craig-Woodworth and William N. Woodworth purchased or
otherwise acquired these shares in the ordinary course of business and,
at the time of such purchase/acquisition, had no agreements or
understandings, directly or indirectly, with any person, to distribute
the securities to be resold.
(35) Consists of 28,125 shares of common stock and 8,438 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(36) Consists of 112,500 shares of common stock and 33,751 shares reserved
for issuance upon exercise of warrants to purchase common stock.
Bradley Rotter, Trustee of the Bradley N. Rotter Self Employed Pension
Plan & Trust, exercises voting and investment authority over the shares
held by this selling stockholder.
(37) Consists of 333,334 shares of common stock and 100,000 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(38) Consists of 84,375 shares of common stock and 25,313 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(39) Consists of 42,750 shares of common stock and 12,825 shares reserved
for issuance upon exercise of warrants to purchase common stock. Paul
E. von Kuster, Trustee, Credit trust under will of Thomas W. von
Kuster, exercises voting and investment authority over the shares held
by this selling stockholder.
(40) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(41) Consists of 10,000 shares of common stock and 3,000 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(42) Consists of 10,230 shares of common stock and 3,069 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(43) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(44) Consists of 11,250 shares of common stock and 3,375 shares reserved for
issuance upon exercise of warrants to purchase common stock. Max
Schneider, Trustee of the Max A Schneider, M.D. Trust, exercises voting
and investment authority over the shares held by this selling
stockholder.
(45) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(46) Consists of 115,528 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock. 45,000
shares of common stock and 13,500 shares reserved for issuance upon
exercise of warrants to purchase common stock are being registered for
re-sale by the selling shareholder on this prospectus. Dr. Greenblatt
is a contractor who acts as one of CNS Response, Inc.'s Regional
Medical Directors and in this capacity, among other things, trains
physicians in the use of rEEG.
(47) Consists of 29,511 shares of common stock and 3,375 shares reserved for
issuance upon exercise of warrants to purchase common stock. 11,250
shares of common stock and 3,375 shares reserved for issuance upon
exercise of warrants to purchase common stock are being registered for
re-sale by the selling shareholder on this prospectus.
(48) Consists of 168, 750 shares of common stock and 50,625 shares reserved
for issuance upon exercise of warrants to purchase common stock.
Kenneth Rickel, as President of Liongate Capital, exercises voting and
investment authority over the shares held by this selling stockholder.
(49) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock. Mr. Bailey
is affiliated with Brean Murray, Carret & Co., LLC, a registered
broker/dealer and member of NASD, as he is an employee of Brean Murray,
Carret & Co., LLC. Mr. Bailey purchased or otherwise acquired his
shares in the ordinary course of business and, at the time of such
purchase/acquisition, had no agreements or understandings, directly or
indirectly, with any person, to distribute the securities to be resold.
73
(50) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(51) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(52) Consists of 250,000 shares of common stock and 75,000 shares reserved
for issuance upon exercise of warrants to purchase common stock. Mr.
Ehrman is affiliated with Brean Murray, Carret & Co. a registered
broker/dealer and member of NASD. Mr. Ehrman purchased or otherwise
acquired his shares in the ordinary course of business and, at the time
of such purchase/acquisition, had no agreements or understandings,
directly or indirectly, with any person, to distribute the securities
to be resold.
(53) Consists of 28,125 shares of common stock and 8,438 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(54) Consists of 42,182 shares of common stock and 6,000 shares reserved for
issuance upon exercise of warrants to purchase common stock. 20,000
shares of common stock and 6,000 shares reserved for issuance upon
exercise of warrants to purchase common stock are being registered for
re-sale by the selling shareholder on this prospectus.
(55) Consists of 124,719 shares of common stock and 7,088 shares reserved
for issuance upon exercise of warrants to purchase common stock. Sharon
Keene exercises voting and investment authority over the shares held by
this selling stockholder. 23,625 shares of common stock and 7,088
shares reserved for issuance upon exercise of warrants to purchase
common stock are being registered for re-sale by the selling
shareholder on this prospectus.
(56) Consists of 11,250 shares of common stock and 3,375 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(57) Consists of 100,000 shares of common stock and 30,000 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(58) Consists of 166,667 shares of common stock and 50,001 shares reserved
for issuance upon exercise of warrants to purchase common stock.
William A. Muggia, the general partner of Westfield Microcap Fund L.P.,
exercises voting and investment authority over the shares held by this
selling stockholder.
(59) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
Michael S. Wallace, the Managing Member of Itasca Capital Partners,
LLC, exercises voting and investment authority over the shares held by
this selling stockholder.
(60) Consists of 4,167 shares of common stock and 1,251 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(61) Consists of 8,438 shares of common stock and 2,532 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(62) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(63) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock. H. R.
Swanson, Trustee of the H. R. Swanson Rev. Trust, exercises voting and
investment authority over the shares held by this selling stockholder.
(64) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(65) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(66) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock.
(67) Consists of 633,138 shares of common stock and 637,185 shares reserved
for issuance upon exercise of warrants to purchase common stock. Brean
Murray, Carret & Co., LLC is a NASD member firm. Brean Murray, Carret &
Co., LLC purchased or otherwise acquired its shares in the ordinary
course of business and, at the time of such purchase/acquisition, had
no agreements or understandings, directly or indirectly, with any
person, to distribute the securities to be resold. William McCluskey,
President and Chief Executive Officer of Brean Murray, Carret & Co.,
LLC, exercises voting and investment authority over the
74
shares held by this selling stockholder. 625,218 shares of common stock
and 619,760 shares reserved for issuance upon exercise of warrants to
purchase common stock are being registered for re-sale by the selling
shareholder on this prospectus.
(68) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(69) Consists of 41,667 shares of common stock and 12,501 shares reserved
for issuance upon exercise of warrants to purchase common stock. Dr.
Hoffman is a contractor who acts as CNS Response, Inc.'s National
Medical Director and in this capacity, among other things, trains
physicians in the use of rEEG.
(70) Consists of 100,000 shares of common stock and 30,000 shares reserved
for issuance upon exercise of warrants to purchase common stock. John
Rotter, Trustee of the Rotter Family Trust, exercises voting and
investment authority over the shares held by this selling stockholder.
(71) Consists of 25,000 shares of common stock and 7,500 shares reserved for
issuance upon exercise of warrants to purchase common stock. Mr. Lewis
is affiliated with a registered broker/dealer and member of NASD. Mr.
Lewis purchased or otherwise acquired his shares in the ordinary course
of business and, at the time of such purchase/acquisition, had no
agreements or understandings, directly or indirectly, with any person,
to distribute the securities to be resold.
(72) Consists of 45,000 shares of common stock and 13,500 shares reserved
for issuance upon exercise of warrants to purchase common stock. Gary
Gossard, as Trustee of the G&A Consulting Retirement Trust, exercises
voting and investment authority over the shares held by this selling
stockholder.
(73) Consists of 200,000 shares of common stock and 60,000 shares reserved
for issuance upon exercise of warrants to purchase common stock. Arthur
J. Bauernfeind, as Trustee of the Arthur J. Bauernfeind RLT dated
6/25/04, exercises voting and investment authority over the shares held
by this selling stockholder.
(74) Consists of 22,500 shares of common stock and 6,750 shares reserved for
issuance upon exercise of warrants to purchase common stock. Frederick
Winston, as Trustee of the Frederick Winston Revocable Trust u/a dated
11/2/01, exercises voting and investment authority over the shares held
by this selling stockholder.
(75) Consists of 8,334 shares of common stock and 32,620 shares reserved for
issuance upon exercise of warrants to purchase common stock.. Mark
Mansfield of Pacific Ridge Capital, LLC, exercises voting and
investment authority over the shares held by this selling stockholder.
(76) Consists of 47,820 shares of common stock and 14,346 shares reserved
for issuance upon exercise of warrants to purchase common stock. Steve
Lundberg of SLWK Venutre Fund, LLP, exercises voting and investment
authority over the shares held by this selling stockholder.
(77) Consists of 116,133 shares of common stock and 3,701 shares reserved
for issuance upon exercise of warrants to purchase common stock. Peter
Carroll of Medlen & Carroll, LLP, exercises voting and investment
authority over the shares held by this selling stockholder. 12,334
shares of common stock and 3,701 shares reserved for issuance upon
exercise of warrants to purchase common stock are being registered for
re-sale by the selling shareholder on this prospectus.
(78) Consists of 20,834 shares of common stock and 6,251 shares reserved for
issuance upon exercise of warrants to purchase common stock. Stephen K.
Phillips of Hooper, Lundy & Bookman, Inc. exercises voting and
investment authority over the shares held by this selling stockholder.
(79) Consists of 36,096 shares of common stock and 14,798 shares reserved
for issuance upon exercise of warrants to purchase common stock. 22,866
shares of common stock and 6,860 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(80) Consists of 36,096 shares of common stock and 14,798 shares reserved
for issuance upon exercise of warrants to purchase common stock. 22,866
shares of common stock and 6,860 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(81) Consists of 36,096 shares of common stock and 14,798 shares reserved
for issuance upon exercise of warrants to purchase common stock. 22,866
shares of common stock and 6,860 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
75
(82) Consists of 18,456 shares of common stock and 7,079 shares reserved for
issuance upon exercise of warrants to purchase common stock. 13,314
shares of common stock and 3,994 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(83) Consists of 18,624 shares of common stock and 7,180 shares reserved for
issuance upon exercise of warrants to purchase common stock. 13,314
shares of common stock and 3,994 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(84) Consists of 15,518 shares of common stock and 5,754 shares reserved for
issuance upon exercise of warrants to purchase common stock. 11,855
shares of common stock and 3,556 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(85) Consists of 12,869 shares of common stock and 5,008 shares reserved for
issuance upon exercise of warrants to purchase common stock. 9,045
shares of common stock and 2,714 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(86) Consists of 16,371 shares of common stock and 6,187 shares reserved for
issuance upon exercise of warrants to purchase common stock. 12,120
shares of common stock and 3,636 shares of common stock reserved for
issuance upon exercise of warrants to purchase common stock are being
registed for re-sale on this prospectus by the selling shareholder.
(87) Consists of 7,254 shares of common stock and 2,176 shares reserved for
issuance upon exercise of warrants to purchase common stock.
(88) Consists of 166,667 shares of common stock and 50,001 shares reserved
for issuance upon exercise of warrants to purchase common stock. Adam
Katz, as Partner of AJ Investors #1, exercises voting and investment
authority over the shares held by this selling stockholder.
(89) Consists of 2,633 shares reserved for issuance upon exercise of
warrants to purchase common stock.
(90) Consists of 225,856 shares of common stock and 259,951 shares reserved
for issuance upon exercise of warrants to purchase common stock. Of
these holdings, 64,125 shares of common stock reserved for issuance
upon exercise of common stock are being registered for resale sale on
this prospectus by the selling shareholder.
(91) Consists of 9,566 shares of common stock and 15,535 shares reserved for
issuance upon exercise of warrants to purchase common stock. Of these
holdings, 7,539 shares of common stock reserved for issuance upon
exercise of common stock are being registered for resale on this
prospectus by the selling shareholder.
76
RELATED PARTY TRANSACTIONS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CNSR CALIFORNIA
Except as follows, and as contemplated by the Merger Agreement, since
September 30, 2003, there has not been, nor is there currently proposed, any
transaction or series of similar transactions to which CNSR California is or
will be a party:
o in which the amount involved exceeds $60,000; AND
o in which any director, executive officer, other stockholders
of more than 5% of our common stock or any member of their
immediate family had or will have a direct or indirect
material interest.
From August 2000 through February 2003, Leonard J. Brandt, together
with Meyerlen, LLC, a company in which Mr. Brandt owned a controlling interest,
loaned CNSR a total of approximately $718,900 and purchased warrants to purchase
approximately 945,750 shares of CNSR California common stock, pursuant to the
terms of certain Note and Warrant Purchase Agreements. In October 2006 Mr.
Brandt agreed to cancel the promissory notes and convert the loans, including
all outstanding principal and accrued interest thereon, into 1,218,741 shares of
CNSR California's Series A-1 Preferred Stock and 255,306 shares of CNSR
California's Series A-2 Preferred Stock. At the closing of the Merger, the
1,218,741 shares of CNSR California's Series A-1 Preferred Stock and 255,306
shares of CNSR California's Series A-2 Preferred Stock converted into an
aggregate of 1,474,047 shares of our Common Stock. Subsequent to the closing of
the Merger, Meyerlen, LLC was dissolved, and ownership of all of the shares of
our Common Stock formerly held by Meyerlen, LLC were distributed to Mr. Brandt.
In connection with the consummation of an asset purchase transaction in
January 2000, by and between Mill City/CNS, LLC and NuPharm, Mill City issued to
NuPharm Database, LLC a certain Promissory Note dated January 11, 2000 (the
"Original NuPharm Note") pursuant to which Mill City was obligated to pay
NuPharm an aggregate principal amount of $299,923.00 together with interest
pursuant to the payment schedule set forth in the Original NuPharm Note. In
January 2000, Mill City contributed substantially all of its assets, including
those securing the Original Note, to CNSR California, and CNSR California
assumed certain debts and obligations of Mill City, including Mill City's
obligations under the Original NuPharm Note. In October 2006, CNSR California
entered into an agreement with NuPharm to cancel the Original NuPharm Note in
consideration for the extension of the expiration date of a Warrant to purchase
CNSR California Common Stock held by NuPharm and a new promissory note in the
principal amount of $287,423 (the "New NuPharm Note"). Upon the closing of the
Private Placement, the principal and accrued interest through December 31, 2006
on the New NuPharm Note automatically converted into 215,567 shares of our
Common Stock.
In May 2005, April 2006 and July 2006, Odyssey Venture Partners II,
L.P. (now called Sail Venture Partners LP) of which David Jones is a partner,
loaned CNSR California an aggregate of approximately $999,400 and purchased
warrants to purchase approximately 523,305 shares of CNSR California common
stock, pursuant to the terms of certain Note and Warrant Purchase Agreements. In
October 2006 Odyssey Venture Partners II, L.P. agreed to cancel the promissory
notes and convert the loans, including all outstanding principal and accrued
interest thereon, into 1,693,899 shares of CNSR California's Series A-1
Preferred
77
Stock and 52,907 shares of CNSR California's Series A-2 Preferred Stock. At the
closing of the Merger, the 1,693,899 shares of CNSR California's Series A-1
Preferred Stock and 255,306 shares of CNSR California's Series A-2 Preferred
Stock converted into an aggregate of 1,949,205 shares of our Common Stock.
On August 11, 2006, Mr. Brandt was granted an option to purchase
2,124,740 shares of CNSR California's common stock for an exercise price of
$0.132 per share pursuant to CNSR California's 2006 Stock Incentive Plan. At the
closing of the Merger, the option to purchase 2,124,740 shares of CNSR
California's common stock was converted into the right to purchase an aggregate
of 2,124,740 shares of our Common Stock at an exercise price of $0.132 per
share.
In September 2006, CNSR California entered into multiple settlement
agreements with its employees and consultants with respect to compensation
accrued for services provided to CNSR California. Pursuant to CNSR California's
settlement agreement with Mr. Brandt, CNSR California issued to Mr. Brandt
1,519,366 shares of its common stock in settlement of accrued compensation due
in the amount of $1,258,705.00. In connection with this settlement, CNSR
California loaned Mr. Brandt approximately $91,700 to pay the withholding tax on
the value of such shares, which loan was evidenced by a promissory note.
Immediately following the closing of the Merger, the loan to Mr. Brandt was
repaid by Mr. Brandt returning to us 78,219 shares of our common stock having a
value equal to the loan amount plus accrued interest thereon. Under a separate
Settlement Agreement, Mr. Brandt was issued 1,827,827 shares of CNSR
California's common stock in settlement of amounts owed for reimbursement for
business expenses paid by Mr. Brandt through July 2006. At the closing of the
Merger, the 1,519,366 shares of CNSR California's common stock issued pursuant
to the first of the aforementioned settlement agreements, and the 1,827,827
shares of CNSR California's common stock issued pursuant to the second of the
aforementioned settlement agreements converted into an aggregate of 3,347,193
shares of our Common Stock.
In October 2006, Odyssey Venture Partner II, L.P. (now called Sail
Venture Partners LP) invested $800,000 in CNSR California's mezzanine financing
and received 792,080 shares of CNSR California's Series B Preferred Stock and
warrants to purchase 475,248 shares of CNSR California's common stock. David B.
Jones is one of the two board members that were designated by the holders of
CNSR California's Series B Preferred Stock pursuant to a Voting Agreement
entered into in connection with the mezzanine financing and note conversion
transaction. At the closing of the Merger, David B. Jones was appointed as a
director of the company.
CNS RESPONSE, INC. (A DELAWARE CORPORATION)
Other than the transactions described below, since January 1, 2005,
there has not been, nor is there currently proposed, any transaction or series
of similar transactions to which we were or will be a party:
o in which the amount involved exceeds the lessor of $120,000 or
1% of the average of our total assets at year-end for the last
three completed fiscal years; and
o in which any director, executive officer, shareholder who
beneficially owns 5% or more of our common stock or any member
of their immediate family had or will have a direct or
indirect material interest.
NEOTACTIX, INC. CONSULTING AGREEMENT
Prior to the Merger, on June 22, 2004, the Company and NeoTactix (NTX)
entered into a Business Consulting Agreement ("NeoTactix Agreement") pursuant to
which NeoTactix agreed to provide certain business consulting services, in
exchange for 4,500,000 shares of the Company's common
78
stock (on a pre-reverse stock split basis). On August 24, 2004, our board
elected both managing partners of NTX, Scott Absher and George LeFevre, to our
board of directors, and also elected Mr. Absher as CEO and Mr. LeFevre as CFO
and Secretary. The Company and NTX agreed that the compensation shares issued by
the Company to affiliates of NTX would be cancelled and returned to the Company
if, prior to October 31, 2005, the Company had not achieved certain benchmarks
pursuant to the NeoTactix Agreement. On October 5, 2005, the NeoTactix Agreement
was extended to October 31, 2006. On May 31, 2006, the Board of the Company
approved the waiver of the forfeiture clause contained in the NeoTactix
Agreement and it was deemed fully performed, and then terminated.
STOCK PURCHASE AGREEMENT
Prior to the Merger, on July 18, 2006, the Company entered into a Stock
Purchase Agreement with seventeen accredited investors pursuant to which the
Company agreed to issue 3,800,000 shares of the Company's common stock (76,000
shares of our common stock after taking into account our 1-for-50 reverse stock
split which became effective on January 10, 2007) to the purchasers. The Company
received an aggregate of $237,669 as consideration for the share issuance. In
addition, these investors acquired shares in private transactions with certain
of our stockholders, and acquired a majority stake in our issued and outstanding
shares. In connection with these transactions, effective July 18, 2006, Mr.
Scott Absher and Mr. George LeFevre resigned as officers and members of the
board of directors, and Mr. Silas Philips was appointed our Chief Executive
Officer, Chief Financial Officer, Secretary, and sole director. Mr. Phillips was
an investor in this private placement.
DEBT CANCELLATION AGREEMENTS
Prior to the Merger, on July 28, 2006, Scott Absher, our former CEO,
was paid a sum of $33,943 in full satisfaction of outstanding debt payable to
him by the Company pursuant to a Debt Cancellation Agreement. The remaining
balance of $47,612 including accrued interest was forgiven. Our former CFO,
George LeFevre, also agreed to forgive all of his outstanding debt, including
accrued interest, of $12,353 payable to the Company pursuant to a separate Debt
Cancellation Agreement.
NOTES PAYABLE
Prior to the Merger, on July 28, 2006, the principal balance of the
notes payable to related parties of $28,800 were satisfied. All related interest
was forgiven by related parties.
PRIVATE PLACEMENT
On March 7, 2007, Odyssey Venture Partners II, L.P. (now called Sail
Venture Partners LP), invested an aggregate of $447,000 in our Private Placement
and in exchange were issued 372,500 shares of our Common Stock and a warrant to
purchase 111,750 shares of our common stock at an exercise price of $1.80 per
share. Mr. Jones, a director of the company, is a partner of Sail Venture
Partners, L.P.
TRANSACTIONS WITH PROMOTERS AND CONTROL PERSONS
Prior to the Merger, which closed on March 7, 2007, Strativation, Inc.
(now called CNS Response, Inc.) existed as a "shell company" with nominal assets
whose sole busines was to identify, evalutate and investigate various companies
to acquire or with which to merge.
79
SHARES FOR DEBT AGREEMENT
Prior to the Merger, on January 11, 2007, we entered into a Shares For
Debt Agreement with Richardson & Patel LLP ("R&P"), our former legal counsel,
pursuant to which we agreed to issue and R&P agreed to accept 645,846 restricted
shares of our common stock (the "Shares") as full and complete settlement of a
portion of the total outstanding debt in the amount of $261,201.84 that we owed
to R&P for legal services (the "Partial Debt"). On January 15, 2007, the company
and R&P agreed to amend and restate the Shares for Debt Agreement to increase
the number of Shares to be issued in settlement of such Partial Debt to 656,103
restricted shares of our common stock, which then represented 75.5% of our
issued and outstanding common stock.
REGISTRATION RIGHTS AGREEMENT
On January 11, 2007, we entered into a Registration Rights Agreement in
connection with the above referenced Shares For Debt Agreement with R&P and
various other stockholders of the Corporation signatory thereto ("Majority
Stockholders") in connection with the shares of the company acquired pursuant to
the Shares For Debt Agreement and certain other previously disclosed or
privately negotiated transactions that took place on or around July 18, 2006. On
January 15, 2007, the company and the Majority Stockholders agreed to amend and
restate the Registration Rights Agreement to provide registration rights to the
Majority Stockholders for up to 767,101 shares of our common stock held or to be
acquired by them.
MERGER AGREEMENT
On January 16, 2007, we entered into an Agreement and Plan of Merger
with CNS Response, Inc., a California corporation (or CNSR California), and CNS
Merger Corporation, a California corporation and our wholly-owned subsidiary
that was formed to facilitate the acquisition of CNSR California. On March 7,
2007, the merger with CNSR California closed, CNSR California became our
wholly-owned subsidiary, and we changed our name from Strativation, Inc. to CNS
Response, Inc..
At the Effective Time of the Merger (as defined in the Merger
Agreement, as amended on February 23, 2007), MergerCo was merged with and into
CNSR California, the separate existence of MergerCo ceased, and CNSR California
continued as the surviving corporation at the subsidiary level. We issued an
aggregate of 17,744,625 shares of our common stock to the stockholders of CNSR
California in exchange for 100% ownership of CNSR California. Additionally, we
assumed an aggregate of 8,407,517 options to purchase shares of common stock and
warrants to purchase shares of common stock on the same terms and conditions as
previously issued by CNSR California. Pursuant to the merger agreement, our
former sole director and executive officer, Silas Phillips, resigned as a
director and executive officer of our company effective as of the closing of the
Merger, and the directors and officers of CNSR California were appointed to
serve as directors and officer of our company. Except for the Merger Agreement,
as amended, and the transactions contemplated by that agreement, neither CNSR
California, nor the directors and officers of CNSR California serving prior to
the consummation of the Merger, nor any of their associates, had any material
relationship with us, or any of our directors and officers, or any of our
associates prior to the merger. Following the Merger, the business conducted by
the company is the business conducted by CNSR California.
Immediately prior to the closing of the Merger, we had outstanding
868,823 shares of common stock. Immediately after the closing of the Merger, and
without taking into consideration the Private Placement offering described
below, we had 18,613,448 outstanding shares of common stock, and options and
warrants to purchase 8,407,517 shares of common stock.
80
DESCRIPTION OF CAPITAL STOCK
The information set forth below is a general summary of our capital
stock structure. As a summary, this Section is qualified by, and not a
substitute for, the provisions of our Certificate of Incorporation, as amended,
and Bylaws.
AUTHORIZED CAPITAL STOCK
Our authorized capital stock consists of 750,000,000 shares of Common
Stock, par value $0.001 per share.
COMMON STOCK
As of May 17, 2007, we had 25,303,302 shares of Common Stock issued and
outstanding. In addition, we have reserved 4,136,103 shares of Common Stock for
issuance in respect of options to purchase common stock and 6,899,352 shares of
Common Stock were reserved for issuance pursuant to issued and outstanding
warrants to purchase our Common Stock.
DIVIDEND RIGHTS
The holders of outstanding shares of Common Stock are entitled to
receive dividends out of funds legally available at the times and in the amounts
that our Board may determine.
VOTING RIGHTS
Each holder of Common Stock is entitled to one vote for each share of
Common Stock held on all matters submitted to a vote of stockholders.
NO PREEMPTIVE OR SIMILAR RIGHTS
Holders of Common Stock do not have preemptive rights, and Common Stock
is not convertible or redeemable.
RIGHT TO RECEIVE LIQUIDATION DISTRIBUTIONS
Upon our dissolution, liquidation or winding-up, the assets legally
available for distribution to our stockholders are distributable ratably among
the holders of Common Stock.
WARRANTS
At May 17, 2007, the following warrants were outstanding:
o warrants that will expire at various times through 2012 to
purchase an aggregate of 1,688,132 shares of our common stock
at an exercise price per share of $0.01, which were granted in
connection with the issuance of convertible promissory notes;
o warrants that will expire at various times through 2015 to
purchase an aggregate of 1,427,022 shares of our common stock
at an exercise price per share of $0.59 which were granted in
connection with the issuance of convertible promissory notes;
o warrants that will expire at various times through 2011 to
purchase an aggregate of 1,143,587 shares of our common stock
at an exercise price per share of $1.51 which were issued to
investors in connection with the private placement completed
in November 2006;
81
o warrants that will expire in 2011 to purchase 7,921 shares of
our common stock at an exercise price per share of $1.01 which
were granted to the placement agent in connection with the
private placement completed in November 2006;
o warrants that will expire in 2011 to purchase an aggregate of
4,752 shares of our common stock at an exercise price per
share of $1.812 which were granted to the placement agent in
connection with the private placement completed in November
2006;
o warrants that will expire in 2012 to purchase 1,951,444 shares
of our common stock at an exercise price per share of $1.80
which were issued to investors in connection with the private
placement which was completed concurrently with the Merger on
March 7, 2007;
o warrants that will expire in 2012 to purchase 520,381 shares
of our common stock at an exercise price per share of $1.44
which were issued to the placement agent in connection with
the private placement which was completed concurrently with
the Merger on March 7, 2007;
o warrants that will expire in 2012 to purchase 156,114 shares
of our common stock at an exercise price per share of $1.80
which were issued to the placement agent in connection with
the private placement which was completed concurrently with
the Merger on March 7, 2007.
OPTIONS
At May 17, 2007, options to purchase 4,136,103 shares of our common
stock were outstanding. These options were granted to former holders of options
of CNSR California, were assumed by us, and converted into options to purchase
shares of our common stock. The options granted to former holders of options of
CNSR California are exercisable at a weighted average exercise price of
approximately $0.14 per share, and will expire at various times on the tenth
anniversary of the date on which they were granted.
ANTI-TAKEOVER PROVISIONS
Delaware has enacted the following legislation that may deter or
frustrate takeovers of Delaware corporations, such as CNS Response:
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW. Section 203
provides, with some exceptions, that a Delaware corporation may not engage in
any of a broad range of business combinations with a person or affiliate, or
associate of the person, who is an "interested stockholder" for a period of
three years from the date that the person became an interested stockholder
unless: (i) the transaction resulting in a person becoming an interested
stockholder, or the business combination, is approved by the board of directors
of the corporation before the person becomes an interested stockholder; (ii) the
interested stockholder acquires 85% or more of the outstanding voting stock of
the corporation in the same transaction that makes it an interested stockholder,
excluding shares owned by persons who are both officers and directors of the
corporation, and shares held by some employee stock ownership plans; or (iii) on
or after the date the person becomes an interested stockholder, the business
combination is approved by the corporation's board of directors and by the
holders of at least 66 2/3% of the corporation's outstanding voting stock at an
annual or special meeting, excluding shares owned by the interested stockholder.
An "interested stockholder" is defined as any person that is (a) the owner of
15% or more of the outstanding voting stock of the corporation or (b) an
affiliate or associate of the corporation and was the owner of 15% or more of
the outstanding voting stock of the corporation at any time within the
three-year period immediately prior to the date on which it is sought to be
determined whether the person is an interested stockholder.
82
AUTHORIZED BUT UNISSUED STOCK. The authorized but unissued shares of
our common stock are available for future issuance without shareholder approval.
These additional shares may be used for a variety of corporate purposes,
including future public offering to raise additional capital, corporate
acquisitions and employee benefit plans. The existence of authorized but
unissued shares of common stock may enable our Board to issue shares of stock to
persons friendly to existing management, which may deter or frustrate a takeover
of the company.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is American Stock
Transfer & Trust Company. The address of American Stock Transfer & Trust Company
is 59 Maiden Lane, New York, New York, and the phone number is (718) 921-8201.
LISTING
Our common stock is currently quoted on the Over-The-Counter Bulletin
Board under the trading symbol "CNSO.OB".
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Our common stock is currently listed for trading on the
Over-the-Counter Bulletin Board under the symbol CNSO.OB.
We have never paid dividends on our common stock. CNSR California has
never paid dividends on its common stock. We intend to retain any future
earnings for use in our business.
83
PLAN OF DISTRIBUTION
We are registering the shares of common stock on behalf of the selling
security holders. Sales of shares may be made by selling security holders,
including their respective donees, transferees, pledgees or other
successors-in-interest directly to purchasers or to or through underwriters,
broker-dealers or through agents. Sales may be made from time to time on the
Over-the-Counter Bulletin Board or any exchange upon which our shares may trade
in the future, in the over-the-counter market or otherwise, at market prices
prevailing at the time of sale, at prices related to market prices, or at
negotiated or fixed prices. The shares may be sold by one or more of, or a
combination of, the following:
o a block trade in which the broker-dealer so engaged will
attempt to sell the shares as agent but may position and
resell a portion of the block as principal to facilitate the
transaction (including crosses in which the same broker acts
as agent for both sides of the transaction);
o purchases by a broker-dealer as principal and resale by such
broker-dealer, including resales for its account, pursuant to
this prospectus;
o ordinary brokerage transactions and transactions in which the
broker solicits purchases;
o through options, swaps or derivatives;
o in privately negotiated transactions;
o in making short sales or in transactions to cover short sales;
o put or call option transactions relating to the shares; and
o any other method permitted under applicable law.
The selling security holders may effect these transactions by selling
shares directly to purchasers or to or through broker-dealers, which may act as
agents or principals. These broker-dealers may receive compensation in the form
of discounts, concessions or commissions from the selling security holders
and/or the purchasers of shares for whom such broker-dealers may act as agents
or to whom they sell as principals, or both (which compensation as to a
particular broker-dealer might be in excess of customary commissions). The
selling security holders have advised us that they have not entered into any
agreements, understandings or arrangements with any underwriters or
broker-dealers regarding the sale of their securities.
The selling security holders may enter into hedging transactions with
broker-dealers or other financial institutions. In connection with those
transactions, the broker-dealers or other financial institutions may engage in
short sales of the shares or of securities convertible into or exchangeable for
the shares in the course of hedging positions they assume with the selling
security holders. The selling security holders may also enter into options or
other transactions with broker-dealers or other financial institutions which
require the delivery of shares offered by this prospectus to those
broker-dealers or other financial institutions. The broker-dealer or other
financial institution may then resell the shares pursuant to this prospectus (as
amended or supplemented, if required by applicable law, to reflect those
transactions).
The selling security holders and any broker-dealers that act in
connection with the sale of shares may be deemed to be "underwriters" within the
meaning of Section 2(11) of the Securities Act of 1933, and any commissions
received by broker-dealers or any profit on the resale of the shares sold by
them while acting as principals may be deemed to be underwriting discounts or
commissions under the Securities Act. The selling security holders may agree to
indemnify any agent, dealer or broker-dealer that participates in transactions
involving sales of the shares against liabilities, including liabilities arising
84
under the Securities Act. We have agreed to indemnify certain selling security
holders and certain selling security holders have agreed, severally and not
jointly, to indemnify us against some liabilities in connection with the
offering of the shares, including liabilities arising under the Securities Act.
The selling security holders will be subject to the prospectus delivery
requirements of the Securities Act. We have informed the selling security
holders that the anti-manipulative provisions of Regulation M promulgated under
the Securities Exchange Act of 1934 may apply to their sales in the market.
Selling security holders also may resell all or a portion of the shares
in open market transactions in reliance upon Rule 144 under the Securities Act,
provided they meet the criteria and conform to the requirements of Rule 144.
Upon being notified by a selling security holder that a material
arrangement has been entered into with a broker-dealer for the sale of shares
through a block trade, special offering, exchange distribution or secondary
distribution or a purchase by a broker or dealer, we will file a supplement to
this prospectus, if required pursuant to Rule 424(b) under the Securities Act,
disclosing:
o the name of each such selling security holder and of the
participating broker-dealer(s);
o the number of shares involved;
o the initial price at which the shares were sold;
o the commissions paid or discounts or concessions allowed to
the broker-dealer(s), where applicable;
o that such broker-dealer(s) did not conduct any investigation
to verify the information set out or incorporated by reference
in this prospectus; and
o other facts material to the transactions.
In addition, if required under applicable law or the rules or
regulations of the Commission, we will file a supplement to this prospectus when
a selling security holder notifies us that a donee or pledgee intends to sell
more than 500 shares of common stock.
We are paying all expenses and fees in connection with the registration
of the shares. The selling security holders will bear all brokerage or
underwriting discounts or commissions paid to broker-dealers in connection with
the sale of the shares.
85
LEGAL MATTERS
Stubbs Alderton & Markiles, LLP ("SAM LLP"), has provided legal
services to us in connection with its preparation of the registration statement
covering the securities offered by this prospectus. In addition, SAM LLP has
rendered a legal opinion, attached hereto as Exhibit 5.1, as to the validity of
the shares of the our common stock to be registered hereby. SAM LLP was the
holder of 61,880 shares of common stock and warrants to purchase 37,128 shares
of common stock at an exercise price of $1.51 of CNS Response, Inc., a
California corporation, which converted into 61,880 shares of our common stock
and warrants to purchase 37,128 shares of our common stock at an exercise price
of $1.51 upon the closing of the merger on March 7, 2007. In addition, SAM
Venture Partners Invested $162,600 in the Private Placement that closed on March
7, 2007, and in exchange received 135,500 shares of our common stock, and
warrants to purchase 40,650 shares of our common stock at an exercise price of
$1.81 per share. Subsequent to the Private Placement, SAM Venture Partners
distributed the aforementioned shares and warrants to its partners, each of whom
is a partner in SAM LLP.
EXPERTS
The consolidated financial statements included in this prospectus have
been audited by Cacciamatta Accountancy Corporation, independent certified
public accountants, to the extent and for the periods set forth in their reports
appearing elsewhere herein, and are included in reliance on such reports given
upon the authority of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and
other information with the SEC. We have also filed with the SEC under the
Securities Act a registration statement on Form SB-2 with respect to the common
stock offered by this prospectus. This prospectus, which constitutes part of the
registration statement, does not contain all the information set forth in the
registration statement or the exhibits and schedules which are part of the
registration statement, portions of which are omitted as permitted by the rules
and regulations of the SEC. Statements made in this prospectus regarding the
contents of any contract or other document are summaries of the material terms
of the contract or document. With respect to each contract or document filed as
an exhibit to the registration statement, reference is made to the corresponding
exhibit. For further information pertaining to us and the common stock offered
by this prospectus, reference is made to the registration statement, including
the exhibits and schedules thereto, copies of which may be inspected without
charge at the public reference facilities of the SEC at 100 F Street, N.E.,
Washington, D.C. 20549. Copies of all or any portion of the registration
statement may be obtained from the SEC at prescribed rates. Information on the
public reference facilities may be obtained by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains a web site that contains reports,
proxy and information statements and other information that is filed through the
SEC's EDGAR System. The web site can be accessed at http://www.sec.gov.
86
INDEX TO FINANCIAL STATEMENT
Page
Report of Independent Registered Public Accounting Firm .................. F-2
Consolidated Balance Sheets .............................................. F-3
Consolidated Statements of Operations .................................... F-4
Consolidated Statement of Changes in Stockholders' Equity (Deficit) ...... F-5
Consolidated Statements of Cash Flows .................................... F-6
Notes to Consolidated Financial Statements ............................... F-8
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
CNS Response, Inc.
We have audited the accompanying balance sheet of CNS Response, Inc. (the
"Company") as of September 30, 2006, and the related statements of operations
and comprehensive loss, changes in stockholders' equity and cash flows for each
of the years in the two-year period ended September 30, 2006. These financial
statements are the responsibility of the Company's management. 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. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
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 CNS Response, Inc. at September
30, 2006, and the results of its operations and it cash flows for each of the
years in the two-year period ended September 30, 2006 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 1 to the
financial statements, the Company's continued operating losses, limited capital
and stockholders' deficit raise substantial doubt about its ability to continue
as a going concern. Management's plans in regard to this matter are also
described in Note 1. The accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Cacciamatta Accountancy Corporation
- ---------------------------------------
Irvine, California
November 15, 2006
F-2
CNS RESPONSE, INC.
CONSOLIDATED BALANCE SHEETS AT MARCH 31, 2007 (UNAUDITED)
AND SEPTEMBER 30, 2006
MARCH 31,
2007 SEPTEMBER 30,
(unaudited) 2006
------------ ------------
ASSETS
CURRENT ASSETS:
Cash ............................................. $ 6,383,000 $ 204,900
Accounts receivable (net
of allowance for doubtful accounts of $17,200 in
2007 and $4,800 in 2006) ....................... 47,000 25,400
Prepaids and other ............................... 228,700 67,000
------------ ------------
Total current assets ........................... 6,658,700 297,300
OTHER ASSETS:
Intangible assets (net of accumulated amortization
of $558,100 in 2007 and $538,200 in 2006) ...... -- 19,900
Loans to related parties ......................... -- 96,600
Other assets ..................................... 8,700 80,400
------------ ------------
TOTAL ASSETS ....................................... $ 6,667,400 $ 494,200
============ ============
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable including ($8,000 in 2007
and $8,000 in 2006 to related parties) ......... 361,900 $ 666,100
Accrued liabilities .............................. 250,000 248,700
Deferred compensation (including $56,700
in 2007 and $58,000 in 2006 to related
parties) ....................................... 79,100 75,200
Accrued consulting fees .......................... 103,000 136,700
Accrued interest (including $0 in 2007 and
$414,700 in 2006 to related parties) ........... 32,500 1,156,500
Note payable to NuPharm Database, LLC ............ -- 287,400
Convertible promissory notes (including
$0 in 2007 and $1,768,300 in 2006 to
related parties) ............................... 50,000 3,116,700
Derivative instrument liability .................. 2,041,500 --
------------ ------------
Total current liabilities ...................... 2,918,000 5,687,300
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $0.001 par value; authorized
750,000,000 shares; 24,638,912 outstanding
in 2007 and 7,902,940 outstanding in 2006 ...... 24,600 7,900
Additional paid-in capital ....................... 13,217,500 2,822,100
Accumulated deficit .............................. (9,492,700) (8,023,100)
------------ ------------
Total stockholders' equity (deficit) ........... 3,749,400 (5,193,100)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY ........................................... $ 6,667,400 $ 494,200
============ ============
(See accompanying Notes to Consolidated Financial Statements)
F-3
CNS RESPONSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED MARCH 31, 2007
(UNAUDITED) AND 2006 (UNAUDITED) AND FOR THE YEARS
ENDED SEPTEMBER 30, 2006 AND 2005.
SIX MONTHS ENDED MARCH 31, YEAR ENDED
(Unaudited) SEPTEMBER 30,
---------------------------- ----------------------------
2007 2006 2006 2005
------------ ------------ ------------ ------------
REVENUES ........................................... $ 112,700 $ 85,800 $ 175,900 $ 127,400
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Cost of revenues (including amortization expense
of $19,900 for the six months ended March 31,
2007, $39,800 for the six months ended March 31,
2006, and $79,800 for each of the years ended
September 30, 2006 and 2005) ................... 76,600 75,700 175,900 165,100
Research and development ......................... 451,200 204,200 76,700 58,500
Sales and marketing .............................. 47,500 71,300 36,000 52,900
General and administrative ....................... 874,700 265,900 1,671,100 811,800
------------ ------------ ------------ ------------
Total operating expenses ....................... 1,450,000 617,100 1,959,700 1,088,300
------------ ------------ ------------ ------------
OPERATING LOSS ..................................... (1,337,300) (531,300) (1,784,200) (960,900)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense, net ............................ (193,200) (163,000) (390,600) (330,700)
Gain (loss on derivative instruments ............. -- -- 1,178,500 (212,500)
Gain on troubled debt restructuring .............. -- -- 1,079,700
Other ............................................ 61,700 -- -- --
------------ ------------ ------------ ------------
Total other income (expense) ..................... (131,500) (163,000) 1,867,600 (543,200)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES .... (1,468,800) (694,300) 83,400 (1,504,100)
PROVISION FOR INCOME TAXES ......................... 800 -- 800 800
------------ ------------ ------------ ------------
NET INCOME (LOSS) .................................. $ (1,469,600) $ (694,300) $ 82,600 $ (1,504,900)
============ ============ ============ ============
BASIC NET INCOME (LOSS) PER SHARE .................. $ (0.12) $ (0.34) $ 0.03 $ (0.73)
============ ============ ============ ============
DILUTED NET INCOME (LOSS) PER SHARE ................ $ (0.12) $ (0.34) -- $ (0.73)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ............................................ 12,425,285 2,068,823 2,836,049 2,068,823
============ ============ ============ ============
Diluted .......................................... 12,425,285 2,068,823 33,369,578 2,068,823
============ ============ ============ ============
(See accompanying Notes to Consolidated Financial Statements)
F-4
CNS RESPONSE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE SIX MONTHS ENDED MARCH 31, 2007
(UNAUDITED) AND THE YEARS ENDED SEPTEMBER 30, 2006 AND 2005
Common Stock Additional
---------------------------- Paid-in Accumulated
For the six months ended March 31, 2007 Shares Amount Capital Deficit
------------ ------------ ------------ ------------
BALANCE - October 1, 2004 ........................................... 2,068,823 $ 2,100 $ 26,100 $ (6,600,800)
Net loss for the year ended September 30, 2005 ...................... -- -- -- (1,504,900)
------------ ------------ ------------ ------------
BALANCE - September 30,2005 ......................................... 2,068,823 2,100 26,100 (8,105,700)
Reclassification of derivative instrument ........................... -- -- 343,100 --
Issuance of stock for settlement of debt ............................ 5,834,117 5,800 695,000 --
Troubled debt restructuring with related parties .................... -- -- 1,388,000 --
Fair value of options issued to employees and consultants ........... -- -- 369,900 --
Net income for the year ended September 30, 2006 .................... -- -- -- 82,600
------------ ------------ ------------ ------------
BALANCE - September 30,2006 ......................................... 7,902,940 $ 7,900 $ 2,822,100 $ (8,023,100)
Forgiveness of accrued interest from NuPharm and issuance and
exercise of warrants by NuPharm (unaudited) ................... 2,800,000 2,800 334,800 --
Conversion of convertible promissory notes and
accrued interest (unaudited) ................................... 5,993,515 6,000 4,061,100 --
Issuance of stock in connection with mezzanine
financing, net of offering costs of $47,600 (unaudited) ........ 1,905,978 1,900 1,875,500 --
Issuance of stock for settlement of debt (unaudited) ................ 11,015 -- 1,300 --
Issuance of options in settlement of accrued consulting fees
(unaudited) ..................................................... -- -- 27,000 --
Issuance of stock in connection with private
placement, net of offering costs of $991,600 (unaudited) ...... 5,840,375 5,800 6,011,100 --
Issuance of stock as payment of placement agent fee (unaudited) ..... 83,333 100 (100) --
Issuance of stock to repay note to NuPharm and
related accrued interest (unaudited) ........................... 244,509 200 293,200 --
Collection of loans receivable through the receipt of stock
(unaudited) ..................................................... (142,753) (100) (171,200) --
Stock- based compensation (unaudited) .............................. -- -- 4,200 --
Derivative instrument liability (unaudited) ......................... -- -- (2,041,500) --
Net loss for the six months ended March 31, 2007 (unaudited) ........ -- -- -- (1,469,600)
------------ ------------ ------------ ------------
Balance at March 31, 2007 (unaudited) ............................... 24,638,912 $ 24,600 $ 13,217,500 $ (9,492,700)
============ ============ ============ ============
For the six months ended March 31, 2007 Total
------------
BALANCE - October 1, 2004 ........................................... $ (6,572,600)
Net loss for the year ended September 30, 2005 ...................... (1,504,900)
------------
BALANCE - September 30,2005 ......................................... (8,077,500)
Reclassification of derivative instrument ........................... 343,100
Issuance of stock for settlement of debt ............................ 700,800
Troubled debt restructuring with related parties .................... 1,388,000
Fair value of options issued to employees and consultants ........... 369,900
Net income for the year ended September 30, 2006 .................... 82,600
------------
BALANCE - September 30,2006 ......................................... $ (5,193,100)
Forgiveness of accrued interest from NuPharm and issuance and
exercise of warrants by NuPharm (unaudited) .................... 337,600
Conversion of convertible promissory notes and
accrued interest (unaudited) ................................... 4,067,100
Issuance of stock in connection with mezzanine
financing, net of offering costs of $47,600 (unaudited) ........ 1,877,400
Issuance of stock for settlement of debt (unaudited) ............... 1,300
Issuance of options in settlement of accrued consulting fees
(unaudited) ..................................................... 27,000
Issuance of stock in connection with private
placement, net of offering costs of $991,600 (unaudited) ...... 6,016,900
Issuance of stock as payment of placement agent fee (unaudited) ..... --
Issuance of stock to repay note to NuPharm and
related accrued interest (unaudited) ........................... 293,400
Collection of loans receivable through the receipt of stock
(unaudited) ..................................................... (171,300)
Stock- based compensation (unaudited) .............................. 4,200
Derivative instrument liability (unaudited) ......................... (2,041,500)
Net loss for the six months ended March 31, 2007 (unaudited) ........ (1,469,600)
------------
Balance at March 31, 2007 (unaudited) ............................... $ 3,749,400
============
(See accompanying Notes to Consolidated Financial Statements)
F-5
CNS RESPONSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED MARCH 31, 2007
(UNAUDITED) AND 2006 (UNAUDITED) AND FOR YEARS ENDED SEPTEMBER 30, 2006 AND 2005
SIX MONTHS ENDED MARCH 31,
(unaudited) YEAR ENDED SEPTEMBER 30,
-------------------------- --------------------------
2007 2006 2006 2005
----------- ----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................................ $(1,469,600) $ (694,300) 82,600 (1,504,900)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Amortization of intangibles ................................ 19,900 39,900 79,800 79,800
Allowance for doubtful accounts ............................ -- -- 4,800 --
Gain (loss) on derivative instruments ...................... -- -- (1,178,500) 212,500
Gain on troubled debt restructuring ........................ -- -- (1,079,700) --
Other ...................................................... (51,800) -- -- --
Stock based compensation ................................... 4,200 -- 369,900 --
Non-cash interest expense .................................. 189,800 -- -- --
Warrants issued for marketing activities ................... -- -- -- 18,000
Changes in operating assets and liabilities:
Accounts receivable ...................................... (21,600) (8,500) (1,700) (10,100)
Prepaids and other ....................................... (157,700) -- (67,000) (800)
Accounts payable ......................................... (170,300) (41,200) 202,700 82,200
Accrued liabilities ...................................... 1,200 27,800 5,900 3,700
Deferred compensation .................................... 7,900 120,400 298,800 297,300
Accrued consulting ....................................... 6,400 152,100 301,300 265,800
Accrued interest ......................................... 7,300 160,600 383,500 323,500
----------- ----------- ----------- -----------
Net cash used in operating activities .................... (1,634,300) (243,200) (597,600) (233,000)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES-
Increase in deposits ......................................... (3,000) -- -- --
Loans to employees ........................................... (4,100) -- (175,900) --
----------- ----------- ----------- -----------
Net cash used in investing activities .................... (7,100) -- (175,900) --
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt ............................................ (5,000) -- -- --
Proceeds from issuance of convertible promissory notes, net of
offering costs ............................................. -- -- 500,000 499,500
Proceeds from the sale of preferred stock, net of offering
costs ...................................................... 1,717,300
F-6
Proceeds from the sale of common stock, net of offering costs 6,079,300 -- -- --
Proceeds from exercise of warrants ........................... 28,000 -- -- --
----------- ----------- ----------- -----------
Net cash provided by financing activities ................ 7,819,600 -- 500,000 499,500
----------- ----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH ................................ 6,178,200 (243,200) (273,500) 266,500
CASH- BEGINNING OF PERIOD ...................................... 204,800 478,400 478,400 211,900
----------- ----------- ----------- -----------
CASH- END OF PERIOD ............................................ $ 6,383,000 $ 235,200 $ 204,900 $ 478,400
=========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for:
Interest ................................................... 2,300 -- -- --
=========== =========== =========== ===========
Income taxes ............................................... $ 800 -- $ 800 --
=========== =========== =========== ===========
Common stock issued for settlement of troubled debt .......... -- -- 700,800 --
=========== =========== =========== ===========
Conversion of preferred stock into common stock .............. $ 5,958,200 -- -- --
=========== =========== =========== ===========
Common stock received as collection of loans receivable ...... $ 171,300 -- -- --
=========== =========== =========== ===========
Derivative instrument liability .............................. $ 2,041,500 -- -- --
=========== =========== =========== ===========
(See accompanying Notes to Consolidated Financial Statements)
F-7
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE SIX
MONTHS ENDED MARCH 31, 2007 (UNAUDITED) AND MARCH
31, 2006 (UNAUDITED) AND THE YEARS ENDED SEPTEMBER
30, 2006 AND 2005
1. NATURE OF OPERATIONS
ORGANIZATION AND NATURE OF OPERATIONS - CNS Response, Inc. (the "Company") was
incorporated in Delaware on July 10, 1984. The Company utilizes a patented
system that guides psychiatrists and other physicians to determine a proper
treatment for patients with mental, behavioral and/or addictive disorders. The
Company also intends to identify, develop and commercialize new indications of
approved drugs and drug candidates for this patient population.
GOING CONCERN UNCERTAINTY - The Company has a limited operating history and its
operations are subject to certain risks and uncertainties frequently encountered
by rapidly evolving markets. These risks include the failure to develop or
supply technology or services, the ability to obtain adequate financing,
competition within the industry and technology trends.
To date, the Company has financed its cash requirements primarily from debt
financings. It will be necessary for the Company to raise additional funds. The
Company's liquidity and capital requirements depend on several factors,
including the rate of market acceptance of its services, the ability to expand
and retain its customer base, its ability to execute its current business plan
and other factors.
The Company sold 6,504,765 Units at $1.20 per unit. Each Unit is comprised of
(i) one share of Common Stock and one five year non-callable warrant to purchase
three-tenths (3/10) of one share of Common Stock at an exercise price of $1.80
per share.
2. REVERSE MERGER AND FINANCING
COMPLETION OF MERGER (UNAUDITED)
On January 16, 2007, CNS Response, Inc. (formerly Strativation, Inc), a
Delaware corporation (the "Company"), along with CNS Merger Corporation, a
California corporation and the Company's wholly-owned subsidiary ("Merger Sub")
entered into an Agreement and Plan of Merger (the "Merger Agreement") with CNS
Response, Inc, a privately held California corporation ("CNSR California"),
pursuant to which CNSR California would be acquired by the Company in a merger
transaction wherein Merger Sub would merge with and into CNSR California, with
CNSR California being the surviving corporation (the "Merger"). On March 7,
2007, the Merger closed and CNSR California became a wholly-owned subsidiary of
the Company. At the closing, the Company changed its name to CNS Response, Inc.
Accordingly, from a historical perspective, CNSR California was deemed
to have been the acquirer in the reverse merger and CNSR California is deemed
the survivor of the reorganization. As a result, the consolidated financial
statements of the Company presented reflect the historical results of CNSR
California prior to the Merger, and of the combined entities following the
merger, and do not include the historical financial results of the entity
formerly known as Strativation, Inc. Common stock has been retroactively
restated to reflect the number of shares received by CNSR California equity
holders in the Merger after giving effect to the difference in par value, with
the offset to additional paid-in capital. The equity of the Company survives the
reorganization. Upon the closing of the reorganization, the Company changed its
fiscal year to September 30. All costs associated with the Merger were expensed
as incurred.
F-8
PRINCIPAL TERMS OF THE MERGER (UNAUDITED)
On March 7, 2007, Merger Sub was merged with and into CNSR California,
the separate existence of Merger Sub ceased, and CNSR California continued as
the surviving corporation at the subsidiary level. The Company issued 17,827,958
shares of its common stock pursuant to certain exchange ratios set forth in the
Merger Agreement to the stockholders of CNSR California in exchange for 100% of
the issued and outstanding shares of common stock of CNSR California.
Additionally, the Company assumed options to purchase shares of common stock and
warrants to purchase shares of common stock on the same terms and conditions as
previously issued by CNSR California.
Pursuant to the terms of the Merger Agreement, CNS Response, Inc.
(formerly Strativation, Inc.) paid an advisory fee of $475,000 to Richardson &
Pattel, LLP, the Company's former legal counsel and a principal shareholder,
immediately upon the closing of the Merger. The fee has been expensed as a cost
of the merger.
Immediately after the closing of the Merger, and without taking into
consideration the Private Placement Offering, the issuance of shares of common
stock to repay the note to NuPharm Database, LLC and the tendering to the
Company of shares of common stock by an officer and certain employees to repay
their loans to CNSR California described below, the Company had outstanding
18,696,781 shares of common stock, options to purchase 4,136,103 shares of
common stock and warrants to purchase 4,271,414 shares of common stock.
THE PRIVATE PLACEMENT (UNAUDITED)
Immediately following the closing of the Merger, the Company received
gross proceeds of approximately $7.0 million in a private placement transaction
(the "Private Placement") with institutional investors and other high net worth
individuals ("Investors"). Pursuant to Subscription Agreements entered into with
these Investors, the Company sold 5,840,375 Investment Units, at $1.20 per
Investment Unit. Each Investment Unit consists of one share of Company common
stock, and a five year non-callable warrant to purchase three-tenths of one
share of the Company common stock at an exercise price of $1.80 per share. The
value of the warrants was determined to be $1,503,600 using the Black-Scholes
option pricing model with the following assumptions: a volatility rate of 100%,
risk free interest rate of 5%, an expected life of five years and zero
dividends. The value of the warrants has been recorded as a liability in
accordance with SFAS No. 133 and EITF 00-19. As of March 31, 2007, the value of
the warrants had not changed.
In May 2007, the Company completed a second closing of the Private
Placement for an additional 664,390 Investment Units. The additional gross
proceeds to the Company amounted to $797,300.
As consideration for services rendered further to the Private
Placement, the Company's placement agent was issued 83,333 shares of common
stock, warrants to purchase 520,381 shares of Company common stock at an
exercise price of $1.44 per share and warrants to purchase 156,114 shares of
Company's common stock at exercise price of $1.80 per share . The value of the
warrants was determined to be $537,900 using the Black-Scholes option pricing
model with the following assumptions: a volatility rate of 100%, risk free
interest rate of 5%, an expected life of five years and zero dividends. The
value of the warrants has been recorded as a liability in accordance with SFAS
No. 133 and EITF 00-19. As of March 31, 2007, the value of the warrants had not
changed.
REPAYMENT OF NOTE PAYABLE TO NUPHARM DATABASE, LLC
In connection with the January 2000 Asset Purchase Agreement between
the Company and NuPharm Database, LLC (NuPharm) providing for the purchase of a
database and the assumption of certain NuPharm liabilities, the Company issued a
subordinated note payable to NuPharm in the amount of $299,900 bearing interest
at 8% per year and due on March 15, 2004 and a warrant to purchase
F-9
2,800,000 shares of the Company's common stock at $0.01 per share. The warrant
was not exercised before expiring in 2005.
In October 2006, the Company and NuPharm Database, LLC (NuPharm) agreed
to exchange the note and the related accrued interest for a 5% note in the
principal amount of $287,400, representing the outstanding principal at
September 30, 2006, and warrants to purchase 2,800,000 shares of the Company's
common stock at $0.01 per share. The note is due and payable on demand five
years from the date of issuance, can be prepaid by the Company at any time
without penalties and is convertible into shares of common stock of the Company
upon the completion of a financing (as defined) at a price per share of the
common stock in the financing. Such warrant was exercised in October 2006
(unaudited).
The Company valued the warrant at $309,550 using the Black-Scholes
model and recorded the excess of the value of the warrant over the forgiven
accrued interest of $119,700 as a prepaid asset. The excess is being amortized
as interest expense over the expected term of the new note of one year
(unaudited).
Pursuant to the abovementioned terms, the note payable to NuPharm was
converted into 244,509 shares of the Company's Common Stock upon the completion
of the merger and private placement described above. Upon conversion, the entire
balance of the unamortized prepaid interest was charged to interest expense
(unaudited).
LOANS TO OFFICER AND EMPLOYEES
In September 2006, the Company loaned certain officer and employees
$167,200 under notes bearing interest at 5.26% per annum, compounded annually,
and requiring payment on or after the earlier of (i) the date that is two years
following the date of the note, and (ii) a demand by the Company following the
date on which the Company has received an aggregate of $5,000,000 from the
sale(s) of its capital stock provided the assigned value (as defined) of the
stock at the time of the demand is more than $1. The repayment of the notes may
be made in one of the following ways, or in combination of both:
(a) in cash, or
(b) by tendering Common Stock of the Company owned by the
borrower, with an aggregate Assigned Value (as defined) equal
to the principal and accrued interest on the notes.
Pursuant to the abovementioned terms, the Company demanded payment of
all such notes upon the completion of the merger and private placement for
$7,005,000 described above. The officer who owed the Company $93,900, including
interest, repaid the loan by tendering 78,219 shares of the Company's Common
Stock. The remaining employees repaid their loans by tendering an aggregate of
64,534 shares of the Company's Common Stock. (unaudited)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of CNS Response, Inc., an inactive parent company, and its wholly owned
subsidiary CNSR California. All significant intercompany transactions have been
eliminated in consolidation.
USE OF ESTIMATES - The preparation of the consolidated financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenue and expense, and related disclosure of
contingent assets and liabilities. On an ongoing basis, the Company evaluates
its estimates, including those related to revenue recognition, doubtful
accounts, intangible assets, income taxes, valuation of equity instruments,
contingencies and litigation. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of
F-10
assets and liabilities that are not readily apparent from other sources. Actual
results may differ materially from these estimates.
UNAUDITED INTERIM RESULTS - The accompanying consolidated balance sheet as of
March 31, 2006, the consolidated statements of operations and the consolidated
statements of cash flows for the six months ended March 31, 2007 and 2006, and
the consolidated statement of changes in stockholders' equity for the six months
ended March 31, 2007, are unaudited. The unaudited consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles in the United States for interim financial information and with the
instructions to Item 310 of Regulation S-B. Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting
principles in the United States for complete financial presentation. The
accompanying unaudited consolidated financial statements reflect all adjustments
that, in the opinion of management, are considered necessary for a fair
presentation of the financial position, results of operations, and cash flows
for the periods presented. The results of operations for such periods are not
necessarily indicative of the results expected for the full fiscal year or for
any future period.
CASH - The Company deposits its cash with major financial institutions and may
at times exceed federally insured limits. The Company believes that the risk of
loss is minimal. To date, the Company has not experienced any losses related to
cash deposits with financial institutions.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The Company's short-term financial
instruments, including cash, accounts receivable and accounts payable are
carried at cost. The cost of the short-term financial instruments approximates
fair value due to their relatively short maturities. The carrying value of
long-term financial instruments, including notes payable, approximates fair
value as the interest rates approximate current market rates of similar debt
obligations.
ACCOUNTS RECEIVABLE - The Company estimates the collectibility of customer
receivables on an ongoing basis by reviewing past-due invoices and assessing the
current creditworthiness of each customer. Allowances are provided for specific
receivables deemed to be at risk for collection.
INTANGIBLE ASSETS - Intangible assets consisted of a purchased database recorded
at cost and were amortized over an estimated useful life of seven years.
LONG-LIVED ASSETS - As required by Statement of Financial Accounting Standards
("SFAS") No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS, the Company reviews the carrying value of its long-lived assets whenever
events or changes in circumstances indicate that the historical cost-carrying
value of an asset may no longer be appropriate. The Company assesses
recoverability of the carrying value of the asset by estimating the future net
cash flows expected to result from the asset, including eventual disposition. If
the future net cash flows are less than the carrying value of the asset, an
impairment loss is recorded equal to the difference between the asset's carrying
value and fair value. No impairment loss was recorded for the years ended
September 30, 2006 and 2005, or for the six month period ended March 31, 2007.
REVENUES - The Company recognizes revenue as the related services are delivered.
RESEARCH AND DEVELOPMENT EXPENSES--The Company charges all research and
development expenses to operations as incurred.
ADVERTISING EXPENSES - The Company charges all advertising expenses to
operations as incurred.
STOCK-BASED COMPENSATION - The Company has adopted SFAS No. 123R, SHARE-BASED
PAYMENT (revised 2004) and related interpretations which establish the
accounting for equity instruments exchanged for employee services. Under SFAS
No. 123R, share-based compensation cost is measured at
F-11
the grant date based on the calculated fair value of the award. The expense is
recognized over the employees' requisite service period, generally the vesting
period of the award.
INCOME TAXES - The Company accounts for income taxes to conform to the
requirements of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Under the provisions
of SFAS 109, an entity recognizes deferred tax assets and liabilities for future
tax consequences of events that have already been recognized in the Company's
financial statements or tax returns. The measurement of deferred tax assets and
liabilities is based on provisions of the enacted tax law. The effects of future
changes in tax laws or rates are not anticipated. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized.
COMPREHENSIVE INCOME (LOSS) - SFAS No. 130, REPORTING COMPREHENSIVE INCOME,
requires disclosure of all components of comprehensive income (loss) on an
annual and interim basis. Comprehensive income (loss) is defined as the change
in equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. The Company's comprehensive
income (loss) is the same as its reported net income (loss) for the years ended
September 30, 2006 and 2005.
The Company's comprehensive income (loss) is the same as its reported net income
(loss) for the six months ended March 31, 2007 and 2006 (unaudited).
INCOME (LOSS) PER SHARE - Basic and diluted net income (loss) per share has been
computed using the weighted average number of shares of common stock outstanding
during the period.
SEGMENT INFORMATION - The Company uses the management approach for determining
which, if any, of its products and services, locations, customers or management
structures constitute a reportable business segment. The management approach
designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of any reportable
segments. Management uses one measurement of profitability and does not
disaggregate its business for internal reporting and therefore operates in a
single business segment.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140."
SFAS No. 155 eliminates the exemption from applying SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," to interests in securitized
financial assets so that similar instruments are accounted for similarly
regardless of the form of the instruments. SFAS No. 155 also allows issuers of
financial statements to elect fair value measurement at acquisition, at
issuance, or when a previously recognized financial instrument is subject to a
remeasurement (new basis) event, on an instrument-by-instrument basis, in cases
in which a derivative would otherwise have to be bifurcated. SFAS No. 155 is
effective for all financial instruments acquired or issued after the first
fiscal year beginning after September 15, 2006. The adoption of SFAS No. 155 did
not have a material impact on our consolidated financial statements.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets--an amendment of FASB Statement No. 140." SFAS No. 156
requires that all separately recognized servicing assets and servicing
liabilities be initially measured at fair value, if practicable. It also
permits, but does not require, the subsequent measurement of servicing assets
and servicing liabilities at fair value. An entity that uses derivative
instruments to mitigate the risks inherent in servicing assets and servicing
liabilities is required to account for those derivative instruments at fair
value. Under SFAS No. 156, an entity can elect subsequent fair value measurement
of its servicing assets and servicing liabilities by class, thus simplifying its
accounting and providing for income statement recognition of the potential
offsetting changes in fair value of the servicing assets, servicing liabilities,
and related derivative instruments. An entity that elects to subsequently
measure servicing assets and servicing liabilities at fair value is expected to
recognize declines in fair value of the servicing assets and servicing
liabilities more consistently than
F-12
by reporting other-than-temporary impairments. SFAS No. 156 is effective for
fiscal years beginning after September 15, 2006. The adoption of SFAS No. 156
did not have a material impact on our consolidated financial statements.
In June 2006, Emerging Issues Task Force Issue No. 06-3, "How Sales
Taxes Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross Versus Net Presentation),"
or EITF 06-3, was issued. EITF 06-3 requires disclosure of the presentation of
taxes on either a gross (included in revenues and costs) or a net (excluded from
revenues) basis as an accounting policy decision. The provisions of this
standard are effective for interim and annual reporting periods beginning after
December 15, 2006. We do not expect the adoption of EITF 06-3 to have a material
impact on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, or FIN 48,
"Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement
No. 109, Accounting for Income Taxes," which clarifies the accounting for
uncertainty in income taxes. FIN 48 prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return. The Interpretation
requires that the Company recognize in the financial statements, the impact of a
tax position, if that position is more likely than not of being sustained on
audit, based on the technical merits of the position. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods and disclosure. The provisions of FIN 48 are effective beginning
January 1, 2007 with the cumulative effect of the change in accounting principle
recorded as an adjustment to opening retained earnings. We are continuing to
evaluate the possible impact of FIN 48, on our consolidated financial
statements.
In September 2006, the SEC released Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in Current Year Financial Statements" (SAB 108). SAB 108 provides
guidance on how the effects of the carryover or reversal of prior year financial
statement misstatements should be considered in quantifying a current year
misstatement. Prior practice allowed the evaluation of materiality on the basis
of the error quantified as the amount by which the current year income statement
was misstated (rollover method) or the cumulative error quantified as the
cumulative amount by which the current year balance sheet was misstated (iron
curtain method). The guidance provided in SAB 108 requires both methods to be
used in evaluating materiality. Immaterial prior year errors may be corrected
with the first filing of prior year financial statements after adoption. The
cumulative effect of the correction would be reflected in the opening balance
sheet with appropriate disclosure of the nature and amount of each individual
error corrected in the cumulative adjustment, as well as a disclosure of the
cause of the error and that the error had been deemed to be immaterial in the
past. The adoption of SAB 108 did not have a material impact on our consolidated
financial statements.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, "Fair Value Measurements," or SFAS No. 157. This Statement
defines fair value as used in numerous accounting pronouncements, establishes a
framework for measuring fair value in generally accepted accounting principles,
or GAAP, and expands disclosure related to the use of fair value measures in
financial statements. SFAS No. 157 does not expand the use of fair value
measures in financial statements, but standardizes its definition and guidance
in GAAP. The Standard emphasizes that fair value is a market-based measurement
and not an entity-specific measurement based on an exchange transaction in which
the entity sells an asset or transfers a liability (exit price). SFAS No. 157
establishes a fair value hierarchy from observable market data as the highest
level to fair value based on an entity's own fair value assumptions as the
lowest level. The Statement is to be effective for our financial statements
issued in 2008; however, earlier application is encouraged. We believe that SFAS
No. 157 will not have a material impact on our consolidated financial
statements.
F-13
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB
Statements No. 87, 88, 106, and 132(R)," which requires the recognition of the
over-funded or under-funded status of a defined benefit postretirement plan in a
company's balance sheet. This portion of the new guidance is effective on
December 31, 2006. Additionally, the pronouncement eliminates the option for
companies to use a measurement date prior to their fiscal year-end effective
December 31, 2008. SFAS No. 158 provides two approaches to transition to a
fiscal year-end measurement date, both of which are to be applied prospectively.
Under the first approach, plan assets are measured on September 30, 2007 and
then remeasured on January 1, 2008. Under the alternative approach, a 15-month
measurement will be determined on September 30, 2007 that will cover the period
until the fiscal year-end measurement is required on December 31, 2008. We do
not have any defined benefit pension or postretirement plans that are subject to
SFAS No. 158. As such, we do not expect the pronouncement to have a material
impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities Including an Amendment of FASB
Statement No. 115," which permits companies to measure many financial
instruments and certain other assets and liabilities at fair value on an
instrument-by-instrument basis (the fair value option). Adoption of the standard
is optional and may be adopted beginning in the first quarter of 2007. We are
currently evaluating the possible impact of adopting SFAS No. 159 on our
consolidated financial statements.
4. TROUBLED DEBT RESTRUCTURING--DEFERRED COMPENSATION AND ACCRUED
CONSULTING FEES
At September 30, 2005, the Company owed certain employees and
consultants deferred compensation, accrued consulting fees, other
compensation-related liabilities and accrued interest thereon aggregating
$2,480,900. Due to financial difficulties experienced by the Company, in August
and September 2006, certain employees and consultants to whom the Company owed
an aggregate of $3,199,400 forgave approximately 80% of the debt and accepted
5,834,117 shares of the Company's common stock (of which 182,952 were
restricted), and warrants and options to purchase an aggregate of 270,638 shares
of the Company's common stock at an exercise price of $0.59 per share in full
settlement of the Company's remaining obligations. On the date of transfer, the
amounts due to employees and consultants exceeded the aggregate estimated fair
value (based on an estimate of $0.12 per share) of the shares, warrants and
options transferred by $2,467,700. The gain attributable to employees considered
related parties of $1,388,000 has been treated as a capital transaction and
included in additional paid-in capital in the accompanying financial statements.
The remaining gain of $1,079,700 has been recorded as a gain on troubled debt
restructuring in the accompanying financial statements.
5. CONVERTIBLE PROMISSORY NOTES
The Company has issued convertible promissory notes with detachable
warrants from time to time to fund its operations. The notes bear interest at 8%
per year, compounded annually, and are payable on demand. The terms of the notes
provide for the (i) conversion of principal and accrued interest into the same
type of securities issued by the Company upon a qualified institutional
financing, the amount of which financing varies between notes and ranges from $1
to $4 million, and (ii) conversion price to be equal to the same price as the
shares sold in the financing. The notes provide for an aggregate of $2,196,000
in principal to convert automatically and $920,700 to convert at the note
holders' options based upon certain financing requirements (as defined).
Due to the variable conversion price, the notes were potentially
convertible into an unlimited number of common shares. Accordingly, the Company
has accounted for the notes under SFAS 133 and EITF 00-19 which require the
beneficial conversion feature to be treated as an embedded derivative, recording
a liability equal to the estimated fair value of the conversion option. In
addition, all non-employee warrants that are exercisable during the period the
notes were potentially convertible into an
F-14
unlimited number of common shares are required to be recorded as liabilities at
their fair value. The fair value of the beneficial conversion feature and the
warrants were estimated using the Black-Scholes option pricing model. The fair
value of the beneficial conversion feature and the warrants and options was
recomputed each reporting period with the change in fair value recorded as a
gain or loss on derivative instruments.
In August 2006, CNSR California amended its Articles of Incorporation
whereby the number of authorized shares was increased to 100,000,000, of which
80,000,000 were designated as common shares and 20,000,000 were designated as
preferred shares.
In October 2006, the Company and the note holders agreed to modify the
terms of the original agreements such that all convertible notes and related
accrued interest were converted into 5,993,515 shares of the Company's preferred
shares and to change the exercise price for warrants to purchase 1,087,514
shares of the Company's common stock to $0.59 per share. The preferred shares
were converted into 5,993,515 shares of the Company's common stock upon the
completion of the Merger described in Note 2.(unaudited)
Since at September 30, 2006, the number of authorized shares was
sufficient to accommodate the conversion of all notes, related accrued interest
and outstanding warrants, the Company has reclassified the derivative instrument
liability with an estimated fair value of $343,100 to equity in the accompanying
financial statements.
6. STOCKHOLDERS' EQUITY
COMMON AND PREFERRED STOCK
As of March 31, 2007, the Company was authorized to issue 750,000,000
shares of common stock. (unaudited)
As of September 30, 2006, CNSR California was authorized to issue
100,000,000 shares of two classes of stock, 80,000,000 of which was designated
as common shares and 20,000,000 of which was designated as preferred shares.
During August and September 2006, CNSR California issued 5,834,117
shares of its common stock with a fair value of $700,800 in connection with the
restructuring of certain debt. (See Note 4).
There were no shares of Preferred Stock outstanding as of September 30,
2006. In October 2006, CNSR California issued 5,993,515 shares of its preferred
stock in connection with the conversion of notes payable. (See Note 5). All
shares of preferred stock were converted into 5,993,515 shares of common stock
concurrently with the completion of the Merger. (unaudited)
STOCK-OPTION PLAN
On September 27, 2004, the Company adopted the 2004 Stock Option Plan
pursuant to which there were 15,000,000 shares of common stock reserved for
issuance and under which the Company may issue incentive stock options,
nonqualified stock options, stock awards and stock bonuses to officers,
directors and employees. The option price for each share of stock subject to an
option was to be (i) no less than the fair market value of a share of stock on
the date the option is granted, if the option is an ISO, or (ii) no less than
85% of the fair market value of the stock on the date the option is granted, if
the option is a NSO ; provided, however, if the option was an ISO granted to an
eligible employee who is a 10% shareholder, the option price for each share of
stock subject to such ISO was to be no less than 110% of the fair market value
of a share of stock on the date such ISO is granted. Stock options were to have
a maximum term of ten years from the date of grant, except for ISOs granted to
an eligible employee who is a 10% shareholder, in which case the maximum term
was to be five years from the date of grant. ISOs
F-15
could be granted only to eligible employees. At March 31, 2007, there were no
options outstanding under this plan (unaudited).
In connection with the Merger described in Note 2, the Company assumed
the CNSR California stock option plan described below and all of the options
granted thereunder at the same price and terms.
On August 3, 2006, CNSR California adopted the CNSR California 2006
Stock Incentive Plan (the "2006 Plan"). The 2006 Plan provides for the issuance
of awards in the form of restricted shares, stock options (which may constitute
incentive stock options(ISO) or nonstatutory stock options (NSO)), stock
appreciation rights and stock unit grants to eligible employees, directors and
consultants and is administered by the board of directors. A total of 10 million
shares of stock are reserved for issuance under the 2006 Plan. As of March 31,
2007, there were 4,136,103 options and 183,937 restricted shares outstanding
under the 2006 Plan and 5,679,960 shares available for issuance of awards
(unaudited).
The 2006 Plan provides that in any calendar year, no eligible employee
or director shall be granted an award to purchase more than 3 million shares of
stock. The option price for each share of stock subject to an option shall be
(i) no less than the fair market value of a share of stock on the date the
option is granted, if the option is an ISO, or (ii) no less than 85% of the fair
market value of the stock on the date the option is granted, if the option is a
NSO ; provided, however, if the option is an ISO granted to an eligible employee
who is a 10% shareholder, the option price for each share of stock subject to
such ISO shall be no less than 110% of the fair market value of a share of stock
on the date such ISO is granted. Stock options have a maximum term of ten years
from the date of grant, except for ISOs granted to an eligible employee who is a
10% shareholder, in which case the maximum term is five years from the date of
grant. ISOs may be granted only to eligible employees.
The Company has adopted SFAS No. 123R (revised 2004), "Share-Based
Payment", and related interpretations. Under SFAS No. 123R, share-based
compensation cost is measured at the grant date based on the calculated fair
value of the award. The Company estimates the fair value of each option on the
grant date using the Black-Scholes model. The following assumptions were made in
estimating the fair value:
Dividend yield .......................... 0%
Risk-free interest rate ................. 5.46%
Expected volatility ..................... 100%
Expected life ........................... 5 years
The expense is recognized over the employees' requisite service period,
generally the vesting period of the award. Compensation costs charged to
operations for the six months ended March 31, 2007 amounted to $4,200
(unaudited),and for fiscal 2006 amounted to $369,900. There were no options
issued or outstanding prior to September 2006..
A summary of stock option activity is as follows:
Weighted
Number Average
of Shares Exercise Price
-------------- --------------
Outstanding at October 1, 2005
Granted ............................................... 4,000,403 $ 0.13
Exercised ............................................. -- --
Forfeited ............................................. -- --
Outstanding at September 30, 2006 .......................... 4,000,403 $ 0.13
Activity for the six months ended March 31, 2007 (unaudited)
Granted ............................................... 135,700 $ 0.30
F-16
Exercised ............................................. -- --
Forfeited ............................................. -- --
Outstanding at end of year ................................. 4,136,103 $ 0.14
Weighted average fair value of options granted during:
Year ended September 30, 2006 ......................... -- $ 0.09
Six months ended March 31, 2007 (unaudited) ........... -- $ 0.27
Following is a summary of the status of options outstanding at
September 30, 2006:
Weighted Average Weighted Average
Exercise Price Number of Shares Average Contractual Life Exercise Price
- ---------------- ----------------- ------------------------ -----------------
$0.12 859,270 10 years $0.12
- ---------------- ----------------- ------------------------ -----------------
$0.132 3,112,545 10 years $0.132
- ---------------- ----------------- ------------------------ -----------------
$0.59 28,588 10 years $0.59
- ---------------- ----------------- ------------------------ -----------------
At September 30, 2006, all of the above options are fully vested,
except for 20,000 options at an exercise price of $0.12. Such options vest over
12 months.
Following is a summary of the status of options outstanding at March 31,
2007 (unaudited):
Weighted Average Weighted Average
Exercise Price Number of Shares Average Contractual Life Exercise Price
- ---------------- ------------------ ------------------------ ----------------
$0.12 859,270 10 years $0.12
- ---------------- ------------------ ------------------------ ----------------
$0.132 3,112,545 10 years $0.132
- ---------------- ------------------ ------------------------ ----------------
$0.30 135,700 10 years $0.30
- ---------------- ------------------ ------------------------ ----------------
$0.59 28,588 10 years $0.59
- ---------------- ------------------ ------------------------ ----------------
At March 31, 2007, options to purchase 4,043,603 shares are fully
vested; options to purchase 10,000 shares at an exercise price of $0.12 vest
over 6 months; and options to purchase 82,500 shares at an exercise price of
$0.30 vest over 20 months. (unaudited)
WARRANTS TO PURCHASE COMMON STOCK
At September 30, 2006, there were warrants outstanding to purchase
3,115,154 shares of the Company's common stock at exercise prices ranging from
$0.01 to $0.59 with a weighted average exercise price of $0.28. The warrants
expire at various times through 2016.
As described in Note 6, these warrants were initially recorded as a
liability at their fair value. Fair value was computed using the Black-Scholes
pricing model at each reporting period with the change in fair value recorded as
a gain or loss on derivative instruments. For the year ended September 30, 2006,
the Company recorded a gain on derivative instruments amounting to $1,178,500.
For the year ended September 30, 2005, the Company recorded a loss on derivative
instruments of $212,500. As of September 30, 2006, the warrants were
reclassified to equity since the number of authorized shares was increased to
accommodate the exercise of all warrants and settlement of warrants was within
the control of the Company.
During the six months ended March 31, 2007, the following additional
3,515,772 warrants were granted and are outstanding as of such date (unaudited):
F-17
Exercise
Warrants to Purchase Price Issued in Connection With:
- -------------------- -------- --------------------------------------------
1,143,587 shares $ 1.51 Private placement described in Note 12 below
7,921 shares $ 1.01 To placement agent for private placement
described in Note 12 below
4,752 shares $ 1.812 To placement agent for private placement
described in Note 12 below
1,752,113 shares $ 1.80 Private placement completed immediately
after the merger and described in Note 2
467,230 shares $ 1.44 To placement agent for private placement
completed immediately after the merger and
described in Note 2
140,169 shares $ 1.80 To placement agent for private placement
completed immediately after the merger and
described in Note 2
As described in Note 2, the warrants to purchase 1,892,282 shares of
common stock at $1.80 per share and the warrants to purchase 467,230 shares at
$1.44 per share were initially recorded as a liability at their fair value. Fair
value was computed using the Black-Scholes pricing model. No gain or loss was
reported for the six months ended March 31, 2007 as there was no change in fair
value recorded. (unaudited)
7. INCOME TAXES
The Company accounts for income taxes under the liability method.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities, and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse. We provide a valuation allowance to reduce our deferred
tax assets to their estimated realizable value.
Reconciliations of the provision (benefit) for income taxes to the
amount compiled by applying the statutory federal income tax rate to profit
(loss) before income taxes is as follows for each of the years ended September
30:
2006 2005
---- ----
Federal income tax (benefit) at statutory rates .............. 34% (34%)
Non-recognizable (gains) losses from derivative instruments .. (483%) 5%
Gain from troubled debt restructured with related parties .... 566% 0%
Change in valuation allowance ................................ (117%) 29%
State income taxes ........................................... 1% 0%
Income tax provision ......................................... 1% 0%
Temporary differences between the financial statement carrying amounts
and tax bases of assets and liabilities that give rise to significant portions
of deferred taxes relate to the following at September 30, 2006 and 2005:
2006 2005
----------- -----------
Deferred income tax assets:
Net operating loss carryforward ............ $ 1,851,000 $ 1,054,300
Deferred interest, consulting and
compensation liabilities ................. 462,500 1,410,100
Amortization ............................... 215,400 183,400
----------- -----------
2,528,900 2,647,800
F-18
Deferred income tax liabilities - other ...... (34,600) (81,300)
----------- -----------
Deferred income tax asset - net before
valuation allowance ........................ 2,494,300 2,566,500
Valuation allowance .......................... (2,494,300) (2,566,500)
----------- -----------
Deferred income tax asset - net .............. $ -- $ --
----------- -----------
Current and non-current deferred taxes have been recorded on a net
basis in the accompanying balance sheet. As of September 30, 2006 we have net
operating loss carryforwards of approximately $4,627,600. The net operating loss
carryforwards expire by 2026. Utilization of net operating losses and capital
loss carryforwards may be subject to the limitations imposed by Section 382 of
the Internal Revenue Code. The Company has placed a valuation allowance against
the deferred tax assets in excess of deferred tax liabilities due to the
uncertainty surrounding the realization of such excess tax assets. Management
periodically evaluates the recoverability of the deferred tax assets and the
level of the valuation allowance. At such time as it is determined that it is
more likely than not that the deferred tax assets are realizable, the valuation
allowance will be reduced accordingly.
8. EARNINGS PER SHARE
In accordance with SFAS 128, "Computation of Earnings Per Share," basic
net income (loss) per share is computed by dividing the net income (loss) to
common stockholders for the period by the weighted average number of common
shares outstanding during the period. Diluted net income (loss) per share is
computed by dividing the net income (loss) for the period by the weighted
average number of common and dilutive common equivalent shares outstanding
during the period. The number of dilutive common equivalent shares for the year
ended September 30, 2006 has been determined in accordance with the
treasury-stock method. For the year ended September 30, 2005, the Company has
excluded all common equivalent shares from the calculation of diluted net loss
per share as such securities are anti-dilutive.
A summary of the net income (loss) and shares used to compute net
income (loss) per share for the years ended September 30, 2006 and 2005,
respectively, is as follows:
2006 2005
------------- -------------
Net income (loss) for computation of basic net
income (loss) per share ...................... $ 82,600 $ (1,504,900)
Add interest expense relating to convertible
debt ......................................... 297,800 --
------------- -------------
Net income (loss) for computation of dilutive
net income (loss) per share .................. $ 380,400 $ (1,504,900)
Basic net income (loss) per share .............. $ 0.03 $ (0.73)
============= =============
Diluted net income (loss) per share ............ $ 0.01 $ (0.73)
============= =============
Basic weighted average shares outstanding ...... 2,836,049 2,068,823
Dilutive common equivalent shares .............. 30,533,528 --
------------- -------------
Diluted weighted average common shares ......... 33,369,578 2,068,823
============= =============
Anti-dilutive common equivalent shares not
included in the computation of dilutive net
loss per share:
Convertible debt ........................... -- 323,086,919
Warrants ................................... 1,162,705 2,496,063
A summary of the net income (loss) and shares used to compute net
income (loss) per share for the six months ended March 31, 2007 and 2006,
respectively, is as follows (unaudited):
F-19
March 31,
----------------------------
2007 2006
------------ ------------
Net (loss) for computation of basic net
(loss) per share ............................. $ (1,469,600) $ (694,200)
Basic weighted average shares outstanding ...... 12,425,285 2,068,823
Diluted weighted average shares outstanding .... 12,425,285 2,068,823
Anti-dilutive common equivalent shares not
included in the computation of dilutive
net loss per share:
Convertible debt ........................... -- 29,583,285
Warrants ................................... 4,584,277 2,771,060
Options .................................... 4,136,103 --
9. COMMITMENTS AND CONTINGENT LIABILITIES
LITIGATION--The Company is subject to legal proceedings and claims, which arise
in the ordinary course of its business. The Company believes that although there
can be no assurances as to the disposition of the proceedings, based upon
information available to the Company at this time, the expected outcome of these
matters would not have a material impact on the Company's results of operations
or financial condition (unaudited).
RENT EXPENSE--The Company leases its headquarters under an operating lease
expiring in November 2007 and requiring monthly rentals of $3,000. Total rental
expense for the year ended September 30, 2006 and 2005 was $8,300 and $7,600,
respectively.
In March 2007, the Company entered into a new lease for its headquarters at the
same location expiring in November 2007 and requiring monthly rentals of $3,500.
Total rent expense for the six months ended March 31, 2007 and 2006 was $18,000
and $3,600, respectively (unaudited).
10. SIGNIFICANT CUSTOMERS
For the year ended September 30, 2006, five customers accounted for 75%
of the Company's revenue and 29% of accounts receivable at September 30, 2006.
For the six months ended March 31, 2007,, six customers accounted for
70% of the Company's revenue and 71% of accounts receivable at March 31, 2007
(unaudited).
11. RELATED PARTY TRANSACTIONS
Convertible promissory notes to related parties amounted to $1,768,300
and $1,257,000 at September 30, 2006 and 2005, respectively. Accrued interest to
related parties amounted to $414,300 and $301,800 at September 30, 2006 and
2005, respectively. Interest expense to related parties amounted to $112,900 and
$76,300 for the years ended September 30, 2006 and 2005, respectively.
Consulting expenses to a director amounted to $10,000 and $40,000 for
the years ended September 30, 2006 and 2005, respectively.
As described in Note 4, in August 2006 the Company and two of its
employees, who are significant shareholders, entered into an agreement whereby
the two employees received 4,362,652 shares of the Company's common stock,
warrants to purchase 242,050 shares of the Company's common stock at $0.59 per
share and options to purchase 28,588 shares of the Company's common stock at
$0.59 per share in full settlement of debt aggregating $1,943,100. On the date
of transfer, the amounts due to employees exceeded the aggregate fair value
(based on an estimate of $0.12 per share) of the shares, warrants and options
transferred by $1,388,000. The gain has been treated as a capital transaction
and included in additional paid-in capital in the accompanying financial
statements.
F-20
12. SUBSEQUENT EVENTS
In October 2006, NuPharm (see Note 5) exercised the warrant to purchase
2,800,000 shares of the Company's common stock at a price of $0.01 per share.
In October, 2006, the Company sold 1,905,978 Units in a private
financing resulting in net proceeds of $1877,400. Each Unit consists of one
share of Series B Preferred Stock and 5-year warrants to purchase .6 shares of
the Company's common stock at $1.51 per share. Holders of the Series B Preferred
Stock will be entitled to receive non-cumulative dividends at an annual rate of
4% when, as and if declared by the Board. Each share of the Series B Preferred
Stock initially converts into one share of the Company's Common Stock at any
time at the option of the holder. However, each share of Series B Preferred
Stock will automatically convert into Common Stock at the then applicable
conversion rate in the event of (i) the sale of $5,000,000 or more of Common
Stock or units consisting of Common Stock and warrants in one or more related
transactions; (ii) the closing of an underwritten public offering with a price
equal or greater than $1.21 per share and net proceeds to the Company of not
less than $5,000,000, or (iii) upon the written consent of the holders of the
majority of the Series A Preferred (see below) in the case of conversion of the
Series A Preferred or the Series B Preferred in the case of conversion of the
Series B Preferred.
In October 2006, the Company and the note holders of certain of the
convertible promissory notes described in Note 6 converted promissory notes with
an aggregate outstanding balance of $3,061,700 and related accrued and unpaid
interest of $1,005,300 at September 30, 2006 into 5,993,515 shares of the
Company's Series A Preferred Stock. In addition, the exercise price of warrants
to purchase 1,062,116 shares of the Company's common stock was changed to $0.59
per share. The preferred shares are convertible into 5,993,515 shares of the
Company's common stock.
F-21
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Delaware General Corporation Law and certain provisions of our
certificate of incorporation an bylaws under certain circumstances provide for
indemnification of our officers, directors and controlling persons against
liabilities which they may incur in such capacities. A summary of the
circumstances in which such indemnification is provided for is contained herein,
but this description is qualified in its entirety by reference to our bylaws and
to the statutory provisions.
In general, any officer, director, employee or agent may be indemnified
against expenses, fines, settlements or judgments arising in connection with a
legal proceeding to which such person is a party, if that person's actions were
in good faith, were believed to be in our best interest, and were not unlawful.
Unless such person is successful upon the merits in such an action,
indemnification may be awarded only after a determination by independent
decision of the board of directors, by legal counsel, or by a vote of the
stockholders, that the applicable standard of conduct was met by the person to
be indemnified.
The circumstances under which indemnification is granted in connection
with an action brought on our behalf is generally the same as those set forth
above; however, with respect to such actions, indemnification is granted only
with respect to expenses actually incurred in connection with the defense or
settlement of the action. In such actions, the person to be indemnified must
have acted in good faith and in a manner believed to have been in our best
interest, and have not been adjudged liable for negligence or misconduct.
Indemnification may also be granted pursuant to the terms of agreements
which may be entered into in the future or pursuant to a vote of stockholders or
directors. The provision cited above also grants the power to us to purchase and
maintain insurance which protects our officers and directors against any
liabilities incurred in connection with their service in such a position, and
such a policy may be obtained by us. We do not currently have any
indemnification agreements with any of our directors or executive officers.
A stockholder's investment may be adversely affected to the extent we
pay the costs of settlement and damage awards against directors and officers as
required by these indemnification provisions. At present, there is no pending
litigation or proceeding involving any of our directors, officers or employees
regarding which indemnification by us is sought, nor are we aware of any
threatened litigation that may result in claims for indemnification.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling us pursuant
to the foregoing provisions, we have been informed that, in the opinion of the
SEC, this indemnification is against public policy as expressed in the
Securities Act and is therefore unenforceable.
Reference is made to the following documents filed as exhibits to this
Registration Statement regarding relevant indemnification provisions described
above and elsewhere herein:
EXHIBIT NUMBER
Certificate of Incorporation of Registrant, as amended 3.1.1
Bylaws of Registrant 3.2
II-1
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The Registrant will bear all expenses of registration incurred in
connection with this offering. The selling shareholders whose shares are being
registered will bear all selling and other expenses. The following table
itemizes the expenses incurred by the Registrant in connection with the
offering. All the amounts shown are estimates except the Securities and Exchange
Commission registration fee.
AMOUNT
----------
Registration fee - Securities and Exchange Commission ............. $ 506
Legal fees and expenses ........................................... $ 50,000
Accounting fees and expenses ...................................... $ 10,000
Miscellaneous expenses ............................................ $ 5,000
----------
Total ........................................................ $ 65,506
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
RECENT SALES OF UNREGISTERED SECURITIES BY CNSR DELAWARE
Reference is made to the Stock Purchase Agreement entered into on July
18, 2006, and the Shares for Debt Agreement entered into on January 11, 2007
described above in the section entitled Certain Relationships and Related
Transaction, which is hereby incorporated by reference.
MERGER WITH CNSR CALIFORNIA
On January 16, 2007, we entered into an Agreement and Plan of Merger
with CNS Response, Inc., a California corporation (or CNSR California), and CNS
Merger Corporation, a California corporation and our wholly-owned subsidiary
that was formed to facilitate the acquisition of CNSR California. On March 7,
2007, the merger with CNSR California closed, CNSR California became our
wholly-owned subsidiary, and we changed our name from strativation, Inc. to CNS
Response, Inc.. At the Effective Time of the Merger (as defined in the Merger
Agreement, as amended on February 23, 2007), MergerCo was merged with and into
CNSR California, the separate existence of MergerCo ceased, and CNSR California
continued as the surviving corporation at the subsidiary level. We issued an
aggregate of 17,744,625 shares of our common stock to the stockholders of CNSR
California in exchange for 100% ownership of CNSR California. Additionally, we
assumed an aggregate of 8,407,517 options to purchase shares of common stock and
warrants to purchase shares of common stock on the same terms and conditions as
previously issued by CNSR California.
SECURITIES ISSUED IN PRIVATE PLACEMENT
On March 7, 2007, simultaneous with the closing of the Merger, we
received gross proceeds of approximately $7,008,450 in the first closing of a
private placement transaction (the "Private Placement") with institutional
investors and other high net worth individuals ("Investors"). Pursuant to
Subscription Agreements entered into with these Investors, we sold 5,840,374
Investment Units, at $1.20 per Investment Unit. Each "Investment Unit" consists
of one share of our common stock, and a five year non-callable warrant to
purchase three-tenths of one share of our common Stock, at an exercise price of
$1.80 per share (the "Investor Warrant"). On May 16, 2007, we completed a second
closing of the Private Placement for an additional 664,390 Investment Units. The
additional gross proceeds to us amounted to $797,300.
Brean Murray Carret & Co. ("Brean Murray") acted as placement agent and
corporate finance advisor in connection with the Private Placement. For their
services as placement agent and financial advisor, pursuant to the terms of an
Engagement Agreement between CNSR California and Brean Murray, Brean Murray
II-2
received a retainer in the form of 83,333 shares of our common stock (having a
deemed value of $100,000) upon the closing of the Private Placement. We also
paid Brean Murray a fee equal to 8% of the funds raised in the Private
Placement, or approximately $624,500 of the gross proceeds from the financing.
In addition, Brean Murray received warrants (the "Placement Agent Warrants") to
purchase shares of our common stock in amounts equal to (i) 8% of the shares of
common stock sold by Brean Murray in the Private Placement (520,381 warrants at
an exercise price of $1.44 per share), and (ii) 8% of the shares underlying the
Investor Warrants sold by Brean Murray in the Private Placement (156,114
warrants at an exercise price of $1.80 per share). The Placement Agent Warrants
are fully vested and have a term of 5 years. We also paid $87,700 in costs, fees
and expenses incurred by Brean Murray in connection with the Private Placement.
We expressly assumed CNSR California's agreement with Brean Murray upon the
closing of the Merger. Pursuant to this agreement, Brean Murray has a right of
first refusal to represent us in certain corporate finance transactions for a
period of one year following the closing of the Private Placement. After payment
of commissions and expenses associated with the offering, we received net
proceeds of approximately $6.9 million in the private placement financing.
In connection with the above stock issuances, except as otherwise
disclosed we did not pay any underwriting discounts or commissions. None of the
sales of securities described or referred to above was registered under the
Securities Act of 1933, as amended (the "Securities Act"). Each of the
purchasers fell into one or more of the categories that follow: one of our
existing shareholders, one of our creditors, one of our current or former
officers or directors, one of our employees, one of our service providers, or an
accredited investor with whom we or one of our affiliates had a prior business
relationship. As a result, no general solicitation or advertising was used in
connection with the sales. In making the sales without registration under the
Securities Act, the company relied upon one or more of the exemptions from
registration contained in Sections 4(2) of the Securities Act, and in Regulation
D promulgated under the Securities Act..
RECENT SALES OF UNREGISTERED SECURITIES BY CNSR CALIFORNIA
PREFERRED STOCK TRANSACTIONS
NOTE CONVERSION TRANSACTION
In October 2006, CNSR California and the holders of certain promissory
notes agreed to convert such notes with an aggregate outstanding balance of
$3,061,700 and related accrued and unpaid interest of $1,005,300 at September
30, 2006, into 5,189,294 shares of CNSR California's Series A-1 Preferred Stock,
and 804,221 shares of CNSR California's Series A-2 Preferred Stock. At the
closing of the Merger, the aforementioned shares converted into an aggregate of
5,993,515 shares of our common stock.
MEZZANINE FINANCING
In October 2006, CNSR California sold 1,905,978 units (each, a
"Mezzanine Unit") in a private financing resulting in net proceeds of
$1,925,000. Each Mezzanine Unit consisted of one share of CNSR California's
Series B Preferred Stock and a 5-year warrant to purchase 0.6 shares of CNSR
California's common stock at $1.51 per share. At the closing of the Merger, the
aforementioned shares and warrants were converted into 1,905,978 shares of our
common stock and a warrant to purchase an aggregate of 1,138,835 shares of our
common stock at $1.51 per share on or before October 6, 2011.
COMMON STOCK TRANSACTIONS
SETTLEMENT AGREEMENT FINANCING
In August and September 2006, certain employees and consultants to whom
CNSR California owed an aggregate of $3,199,400 forgave approximately 80% of the
debt and accepted 5,834,117 shares of CNSR California's common stock, and
warrants and options to purchase an aggregate of 270,638 shares of CNSR
California's common stock at $0.59 per share in full settlement of CNSR
II-3
California's remaining obligations. At the closing of the Merger, the
aforementioned shares and warrants were converted into 5,834,117 shares of our
common stock and warrants and options to purchase an aggregate of 270,638 shares
of our common stock at $0.59 per share.
CONVERSION OF NUPHARM DATABASE, LLC PROMISSORY NOTE
In connection with the consummation of an asset purchase transaction in
January 2000, by and between Mill City/CNS, LLC and NuPharm, Mill City issued to
NuPharm Database, LLC a certain Promissory Note dated January 11, 2000 (the
"Original NuPharm Note") pursuant to which Mill City was obligated to pay
NuPharm an aggregate principal amount of $299,923.00 together with interest
pursuant to the payment schedule set forth in the Original NuPharm Note. In
January 2000, Mill City contributed substantially all of its assets, including
those securing the Original Note, to CNSR California, and CNSR California
assumed certain debts and obligations of Mill City, including Mill City's
obligations under the Original NuPharm Note.
In October 2006, CNSR California entered into an agreement with NuPharm
to cancel the Original NuPharm Note in consideration for the extension of the
expiration date of a Warrant to purchase CNSR California Common Stock held by
NuPharm and a new promissory note in the principal amount of $287,423 (the "New
NuPharm Note"). Upon the closing of the Private Placement and Merger, the
principal and accrued interest through December 31, 2006 on the New NuPharm Note
automatically converted into 244,509 shares of our Common Stock.
Immediately upon extension of the of the NuPharm Warrant, NuPharm
exercised the NuPharm Warrant to purchase 2,800,000 shares of CNSR California
common stock for total proceeds of $147,700. At the closing of the Merger, the
aforementioned shares converted into an aggregate of 2,800,000 shares of our
common stock. Please also see the disclosure set forth above in relation to the
shares of common stock that were issued in the Merger and Private Placement.
STOCK OPTIONS
OPTION GRANT TO LEONARD BRANDT
On August 11, 2006, Mr. Brandt was granted an option to purchase
2,124,740 shares of CNSR California's common stock for an exercise price of
$0.132 per share pursuant to CNSR California's 2006 Stock Incentive Plan. At the
closing of the Merger, the option to purchase 2,124,740 shares of CNSR
California's common stock was converted into the right to purchase an aggregate
of 2,142,740 shares of our Common Stock at an exercise price of $0.132 per
share.
In connection with the above stock issuances and option grants, CNSR
California did not pay any underwriting discounts or commissions. None of the
sales of securities described or referred to above was registered under the
Securities Act of 1933, as amended (the "Securities Act"). Each of the
purchasers fell into one or more of the categories that follow: one of the
Company's existing stockholders, one of the company's creditors, one of the
company's current or former officers or directors, one of the company's service
providers, or an accredited investor with whom the company or one of its
affiliates had a prior business relationship. As a result, no general
solicitation or advertising was used in connection with the sales. In making the
sales without registration under the Securities Act, the company relied upon one
or more of the exemptions from registration contained in Sections 4(2) of the
Securities Act, and in Regulation D promulgated under the Securities Act.
ITEM 27. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) The following exhibits are filed herewith:
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- ------------------------------------------------------------------
2.1 Agreement and Plan of Merger between Strativation, Inc., CNS
Merger Corporation and CNS Response, Inc. dated as of January 16,
2007. Incorporated by reference to Exhibit No. 10.1 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on January 22, 2007.
2.2 Amendment No. 1 to Agreement and Plan of Merger by and among
Strativation, Inc., CNS Merger Corporation, and CNS Response, Inc.
dated as of February 28, 2007. Incorporated by reference to
Exhibit No. 10.1 to the Registrant's Current Report on Form 8-K
(File No. 000-26285) filed with the Commission on March 1, 2007.
3.1.1 Certificate of Incorporation, dated March 17, 1987. Incorporated
by reference to Exhibit No. 3(i) to the Registrant's Form 10-SB
(File No. 000-26285) filed with the Commission on June 7, 1999.
3.1.2 Certificate of Amendment of Certificate of Incorporation, dated
June 1, 2004. Incorporated by reference to Exhibit 16 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on June 8, 2004.
3.1.3 Certificate of Amendment of Certificate of Incorporation, dated
August 2, 2004. Incorporated by reference to Exhibit 16 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on August 5, 2004.
3.1.4 Certificate of Ownership and Merger Merging CNS Response, Inc., a
Delaware corporation, with and into Strativation, Inc., a Delaware
corporation, dated March 7, 2007. Incorporated by reference to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on March 13, 2007.
3.2 Bylaws. Incorporated by reference to Exhibit No. 3(ii) to the
Registrant's Form 10-SB (File No. 000-26285) filed with the
Commission on June 7, 1999.
4.1 2006 CNS Response, Inc. Option Plan. Incorporated by reference to
Exhibit 4.1 to the Registrant's Current Report on Form 10-QSB
(File No. 000-26285) filed with the Commission on May 15, 2007. *
4.2 Form of Warrant issued to Investors in Private Placement.
Incorporated by reference to Exhibit 4.1 to the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on March 13, 2007.
5.1 Opinion of Stubbs Alderton & Markiles LLP
10.1 Stock Purchase Agreement by and among the Registrant and George
LeFevre, Scott Absher, and the purchasers signatory thereto dated
July 18, 2006. Incorporated by reference from the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on July 24, 2006.
10.2 Amended and Restated Shares for Debt Agreement, dated January 16,
2007 by and between the Registrant and Richardson & Patel LLP
2007. Incorporated by reference to Exhibit No. 10.1 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on January 16, 2007.
II-4
10.3 Amended and Restated Registration Rights Agreement, dated January
16, 2007 by and among the Registrant and the stockholders
signatory thereto. Incorporated by reference to Exhibit No. 10.2
to the Registrant's Current Report on Form 8-K (File No.
000-26285) filed with the Commission on January 16, 2007.
10.4 Form of Subscription Agreement between the Registrant and certain
investors, dated March 7, 2007. Incorporated by reference to
Exhibit 10.4 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on March 13, 2007.
10.5 Form of Indemnification Agreement by and among the Registrant, CNS
Response, Inc., a California corporation, and certain individuals,
dated March 7, 2007. Incorporated by reference to Exhibit 10.5 to
the Registrant's Current Report on Form 8-K (File No. 000-26285)
filed with the Commission on March 13, 2007.
10.6 Form of Registration Rights Agreement by and among the Registrant
and certain Investors signatory thereto dated March 7, 2007.
Incorporated by reference to Exhibit 10.6 to the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on March 13, 2007.
10.7 Form of Registration Rights Agreement by and among the Registrant
and certain stockholders of the Company signatory thereto dated
March 7, 2007. Incorporated by reference to Exhibit 10.7 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on March 13, 2007.
21.1 Subsidiaries of the Registrant. Incorporated by reference to
Exhibit 21 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on March 13, 2007.
23.1 Consent of Stubbs, Alderton & Markiles LLP (included in Exhibit
5.1)
23.2 Consent of Cacciamatta Accountancy Corporation
24.1 Power of Attorney (included on signature page)
* Indicates a management contract or compensatory plan.
(b) Financial Statement Schedules
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
consolidated financial statements or notes thereto.
II-5
ITEM 28. UNDERTAKINGS.
(a) RULE 415 OFFERING. The undersigned registrant hereby
undertakes to:
(1) File, during any period in which it offers or sells
securities, a post-effective amendment to this registration statement
to:
(i) Include any prospectus required by Section
10(a)(3) of the Securities Act;
(ii) Reflect in the prospectus any facts or events
which, individually or together, represent a fundamental
change in the information in the registration statement; and
notwithstanding the forgoing, any increase or decrease in
volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered)
and any deviation from the low or high-end of the estimated
maximum offering range may be reflected in the form of
prospects filed with the Commission pursuant to Rule 424(b)
if, in the aggregate, the changes in the volume and price
represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration
Fee" table in the effective registration statement.
(iii) Include any additional or changed material
information on the plan of distribution.
(2) For determining liability under the Securities Act, treat
each post-effective amendment as a new registration statement of the
securities offered, and the offering of the securities at that time as
the initial bona fide offering.
(3) File a post-effective amendment to remove from
registration any of the securities that remain unsold at the end of the
offering.
(e) REQUEST FOR ACCELERATION OF EFFECTIVE DATE. Insofar as
indemnification for liabilities arising under the Securities Act may be
permitted to directors, officers and controlling persons of the small business
issuer pursuant to the foregoing provisions, or otherwise, the small business
issuer has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the small business issuer of expenses incurred or
paid by a director, officer or controlling person of the small business issuer
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the small business issuer will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
(g) RELIANCE ON 430C. For the purpose of determining liability under
the Securities Act to any purchaser, each prospectus filed pursuant to Rule
424(b) as part of a registration statement relating to an offering, other than
registration statements relying on Rule 430B or other than prospectuses filed in
reliance on Rule 430A, shall be deemed to be part of and included in the
registration statement as of the date it is first used after effectiveness.
Provided, however, that no statement made in a registration statement or
prospectus that is part of the registration statement or made in a document
incorporated or deemed incorporated by reference into the registration statement
or prospectus that is part of the registration statement will, as to a purchaser
with a time of contract of sale prior to such first use, supersede or modify any
statement that was made in the registration statement or prospectus that was
part of the registration statement or made in any such document immediately
prior to such date of first use.
II-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, in the City of Irvine,
California, on May 21, 2007.
CNS RESPONSE, INC.
(Registrant)
By: /s/ Leonard J. Brandt
------------------------------------------------
Leonard J. Brandt
Chief Executive Officer, President and Secretary
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS that each individual whose signature
appears below constitutes and appoints Leonard J. Brandt and Horace Hertz, and
each of them, his or her true and lawful attorneys-in-fact and agents with full
power of substitution, for him or her and in his or her name, place and stead,
in any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Registration Statement, and to sign any
registration statement for the same offering covered by the Registration
Statement that is to be effective upon filing pursuant to Rule 462(b)
promulgated under the Securities Act, and all post-effective amendments thereto,
and to file the same, with all exhibits thereto and all documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or his, her or their substitute or
substitutes, may lawfully do or cause to be done or by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates stated.
Signature Title Date
--------- ----- ----
/s/ Leonard J. Brandt President, Chief Executive May 21, 2007
- ------------------------------ Officer and Secretary, and
Leonard J. Brandt Chairman of the Board
(Principal Executive Officer)
/s/ Horace Hertz Chief Financial Officer May 21, 2007
- ------------------------------ (Principal Financial and
Horace Hertz Accounting Officer)
/s/ David B. Jones Director May 21, 2007
- ------------------------------
David B. Jones
Director
- ------------------------------
Jerome Vaccaro, M.D.
Ma
II-7
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- ------------------------------------------------------------------
2.1 Agreement and Plan of Merger between Strativation, Inc., CNS
Merger Corporation and CNS Response, Inc. dated as of January 16,
2007. Incorporated by reference to Exhibit No. 10.1 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on January 22, 2007.
2.2 Amendment No. 1 to Agreement and Plan of Merger by and among
Strativation, Inc., CNS Merger Corporation, and CNS Response, Inc.
dated as of February 28, 2007. Incorporated by reference to
Exhibit No. 10.1 to the Registrant's Current Report on Form 8-K
(File No. 000-26285) filed with the Commission on March 1, 2007.
3.1.1 Certificate of Incorporation, dated March 17, 1987. Incorporated
by reference to Exhibit No. 3(i) to the Registrant's Form 10-SB
(File No. 000-26285) filed with the Commission on June 7, 1999.
3.1.2 Certificate of Amendment of Certificate of Incorporation, dated
June 1, 2004. Incorporated by reference to Exhibit 16 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on June 8, 2004.
3.1.3 Certificate of Amendment of Certificate of Incorporation, dated
August 2, 2004. Incorporated by reference to Exhibit 16 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on August 5, 2004.
3.1.4 Certificate of Ownership and Merger Merging CNS Response, Inc., a
Delaware corporation, with and into Strativation, Inc., a Delaware
corporation, dated March 7, 2007. Incorporated by reference to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on March 13, 2007.
3.2 Bylaws. Incorporated by reference to Exhibit No. 3(ii) to the
Registrant's Form 10-SB (File No. 000-26285) filed with the
Commission on June 7, 1999.
4.1 2006 CNS Response, Inc. Option Plan. Incorporated by reference to
Exhibit 4.1 to the Registrant's Current Report on Form 10-QSB
(File No. 000-26285) filed with the Commission on May 15, 2007. *
4.2 Form of Warrant issued to Investors in Private Placement.
Incorporated by reference to Exhibit 4.1 to the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on March 13, 2007.
5.1 Opinion of Stubbs Alderton & Markiles LLP
10.1 Stock Purchase Agreement by and among the Registrant and George
LeFevre, Scott Absher, and the purchasers signatory thereto dated
July 18, 2006. Incorporated by reference from the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on July 24, 2006.
10.2 Amended and Restated Shares for Debt Agreement, dated January 16,
2007 by and between the Registrant and Richardson & Patel LLP
2007. Incorporated by reference to Exhibit No. 10.1 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on January 16, 2007.
EX-1
10.3 Amended and Restated Registration Rights Agreement, dated January
16, 2007 by and among the Registrant and the stockholders
signatory thereto. Incorporated by reference to Exhibit No. 10.2
to the Registrant's Current Report on Form 8-K (File No.
000-26285) filed with the Commission on January 16, 2007.
10.4 Form of Subscription Agreement between the Registrant and certain
investors, dated March 7, 2007. Incorporated by reference to
Exhibit 10.4 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on March 13, 2007.
10.5 Form of Indemnification Agreement by and among the Registrant, CNS
Response, Inc., a California corporation, and certain individuals,
dated March 7, 2007. Incorporated by reference to Exhibit 10.5 to
the Registrant's Current Report on Form 8-K (File No. 000-26285)
filed with the Commission on March 13, 2007.
10.6 Form of Registration Rights Agreement by and among the Registrant
and certain Investors signatory thereto dated March 7, 2007.
Incorporated by reference to Exhibit 10.6 to the Registrant's
Current Report on Form 8-K (File No. 000-26285) filed with the
Commission on March 13, 2007.
10.7 Form of Registration Rights Agreement by and among the Registrant
and certain stockholders of the Company signatory thereto dated
March 7, 2007. Incorporated by reference to Exhibit 10.7 to the
Registrant's Current Report on Form 8-K (File No. 000-26285) filed
with the Commission on March 13, 2007.
21.1 Subsidiaries of the Registrant. Incorporated by reference to
Exhibit 21 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on March 13, 2007.
23.1 Consent of Stubbs, Alderton & Markiles LLP (included in Exhibit
5.1)
23.2 Consent of Cacciamatta Accountancy Corporation
24.1 Power of Attorney (included on signature page)
* Indicates a management contract or compensatory plan.
EX-2