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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] Annual Report Pursuant To Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2008
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______________ to _______________
Commission file number 000-26285
CNS RESPONSE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 87-0419387
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2755 Bristol St., Suite 285
Costa Mesa, CA 92626
(Address of Principal Executive Offices)(Zip Code)
(714) 545-3288
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [_] No[X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [_] No[X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceeding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No[_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [_] Accelerated filer [_]
Non-accelerated filer [_] Smaller reporting company [X]
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act.) Yes [_] No[X]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on March 31, 2008, the last business day of the
registrant's most recently completed second fiscal quarter was $17,114,221
(based on the closing sales price of the registrant's common stock on that
date).
At January 13, 2009, the registrant had 25,299,547 shares of Common Stock,
$0.001 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed with the Securities and
Exchange Commission are incorporated by reference into Part III, Items 10, 11,
12, 13 and 14 of this Form 10-K.
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CNS RESPONSE, INC.
2008 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS .........................................................4
ITEM 1A. RISK FACTORS ....................................................29
ITEM 1B. UNRESOLVED STAFF COMMENTS .......................................44
ITEM 2. PROPERTIES ......................................................44
ITEM 3. LEGAL PROCEEDINGS ...............................................44
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............44
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ...............45
ITEM 6. SELECTED FINANCIAL DATA .........................................46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS .......................................46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .....................58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ........................................82
ITEM 9A(T). CONTROLS AND PROCEDURES .........................................82
ITEM 9B. OTHER INFORMATION ...............................................84
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ..........85
ITEM 11. EXECUTIVE COMPENSATION ..........................................85
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS .................................85
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE ....................................................85
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES ..........................85
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES .........................86
2
PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This 2008 Annual Report on Form 10-K, 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.
3
ITEM 1. 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 SUBSIDIARIES CNS RESPONSE, INC., A CALIFORNIA CORPORATION ("CNS
CALIFORNIA"), COLORADO CNS RESPONSE, INC., A COLORADO CORPORATION ("CNS
COLORADO") AND NEURO-THERAPY CLINIC, P.C., A COLORADO PROFESSIONAL MEDICAL
CORPORATION AND A WHOLLY-OWNED SUBSIDIARY OF CNS COLORADO ("NTC").
GENERAL
CNS Response, Inc. was incorporated on July 10, 1984, under the name
Mammon Oil & Gas, Inc., in the state of Utah. Prior to January 16, 2007, CNS
Response, Inc. (then called Strativation, Inc.) 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 January 16,
2007, we entered into an Agreement and Plan of Merger (the "Merger Agreement")
with CNS Response, Inc., a California corporation ("CNS California"), and CNS
Merger Corporation, a California corporation and our wholly-owned subsidiary
("MergerCo") pursuant to which we agreed to acquire CNS California in a merger
transaction wherein MergerCo would merge with and into CNS California, with CNS
California being the surviving corporation (the "Merger"). On March 7, 2007, the
Merger closed, CNS California became our wholly-owned subsidiary, and on the
same date we changed our corporate name from Strativation, Inc. to CNS Response,
Inc.
CNS CALIFORNIA
Founded in 2000, and located in Costa Mesa, CNS California's business
is focused on the commercialization of a patented system that guides physicians
in selecting 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"(R) or "rEEG"(R)
represents an innovative approach to identifying effective medications for
patients suffering from debilitating behavioral disorders. In this report, we
refer to the business conducted by CNS California, which we view as our core
operation, as our Laboratory Information Services business. Our Laboratory
Information Services business is conducted by eight full time employees.
NEURO-THERAPY CLINIC
In January 2008, through Colorado CNS Response, we acquired all of the
outstanding common stock of our largest customer, the Neuro-Therapy Clinic,
P.C., a Colorado professional medical corporation ("NTC"). Upon the completion
of the transaction, NTC became a wholly-owned subsidiary of ours. NTC operates
one of the largest psychiatric medication management practices in the state of
Colorado, with nine full time and four part time employees including
psychiatrists and clinical nurse specialists with prescribing privileges. Daniel
A. Hoffman, M.D. is the medical director at NTC, and, after the acquisition,
became our Chief Medical Officer.
NTC, having used rEEG technology extensively in its operations, serves
as an important resource in our product development, the expansion of our
proprietary database (further described below), our production system
development and implementation, along with the integration of our rEEG
methodology and services into a medical practice. Through NTC, we also expect to
successfully develop marketing and patient acquisition strategies for our
Laboratory Information Services business. Specifically, NTC is learning how to
4
best communicate the advantages of rEEG to patients and referring physicians in
the local market. We will share this knowledge and developed communication
programs learned through NTC with other physicians using our services, which we
believe will help drive market acceptance of our services. In addition, we plan
to use NTC to train practitioners across the country in the uses of rEEG
technology.
We view our Clinical Services business as secondary to our Laboratory
Information Services business, and we have no current plans to expand this
business. For this reason, this report focuses on our Laboratory Information
Services business.
OUR LABORATORY INFORMATION SERVICES BUSINESS
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, not just the manifestation of symptoms.
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 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:
- ----------
(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
"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, we estimate that approximately 10% of patients represent 35-40% of
MBHOs' patient costs, with the overwhelming majority deemed treatment-resistant
cases. MBHOs are estimated to manage over 210 million lives in the U.S. alone.
Magellan, Value Options, United Behavioral Health and CIGNA Behavioral Health
are some of the larger managers.(7)
A report from Analysis Group, a national economics consulting firm,
prepared for us and available at our website (see http://www.cnsresponse.com/
uploads/assets/0000/0080/Analysis_Group_Economic_Impact_of_rEEG.pdf) shows the
potential savings that our technology can bring to payers. The Analysis Group
study focused on treatment-resistant (TR) patients, who add significantly to
treatment costs--more than $8,000 annually, according to a 2004 study by
investigators Howard Birnbaum and Paul Greenberg of Analysis Group. "This
patient group is so costly because they have almost double the office visits,
more than three times the outpatient claims and nearly four times the inpatient
claims of patients who are not treatment-resistant," noted Dr. Birnbaum.
The authors of the study found that a sample health plan with 20
million members utilizing rEEG for its 80,000 patients with treatment-resistant
mental disorders would save potentially up to 40 percent in behavioral care
costs, and approximately $212 million annually in direct health care costs. An
even greater savings potential in reduced absence and productivity losses brings
the total to over $550 million, illustrating that the impacts of treatment
failure are not limited to behavioral health costs, but are in fact even greater
for health plans, disability plans, and employers.
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
- ----------
(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).
6
establishing etiology and finding effective therapy for only a relatively small
group of mental 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 empirical outcomes-based information treatment guidance tool
personalized to the functional neuro-physiological 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, physicians in sixteen 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 probability data for
individuals that have brain abnormalities (abnormalities of electrical power
distribution in the brain) similar to that of their patient. The clinical
results and economics demonstrated in multiple studies completed by either CNS
California 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 "CLINICAL
VALIDATION-SUMMARY" for a review of existing clinical data.
Over the course of the last twenty years, CNS California and its
scientific founders have collected treatment outcomes for patients using various
medications where the patients' brain function was first measured with an EEG
and 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" or alternatively as our "CNS Database". The
rEEG Outcomes Database containes outcomes for over 2000 patients and more than
13,000 treatment trials of medications on these patients.
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(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%
20Retail%20Drug%20Monitor%20April2006.pdf.
7
Using the rEEG analysis method and the information contained in the
rEEG Outcomes Database, we can provide a report (an "rEEG 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-norepinephrine reuptake inhibitors, an
example of which is Cymbalta). Further, and most importantly, our 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 "CLINICAL VALIDATION-SUMMARY." 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 Report. The vast
majority of subject patients for whom we have created rEEG 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
The rEEG method consists of the following four integrated components:
Quantitative Quantitative
Digital EEG + Normative + rEEG Outcomes + EEG/ Medication
Analysis Analysis Correlations
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.
8
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 more than seventy-five 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 over sixty medications now marketed
in the United States for the treatment of Alzheimer's, Parkinson's
Disease, migraines and Epilepsy.(14)
- ----------
(14) Drug Reference for FDA Approved Psychiatric Drugs,
http://neurotransmitter.net/drug_reference.html.
9
TREATMENT DECISIONS MADE BY LICENSED PROFESSIONALS
With the exception of our subsidiary, the Neuro-Therapy Clinic based in
Denver, CO, 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 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 Reports are responsible for exercising their independent medical
judgment in determining the specific application of the information contained in
the rEEG 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 Report
delivery. Previously, upon receipt of the EEG, a rEEG Report was generally
delivered to the referring physician in 3-4 days. In December, 2008 we
introduced a new process system that is delivering most reports with one day
turnaround. We think this is a major advantage to patients and of increased
convenience to the physician.
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 in our Type I rEEG Report.
10
OUR TECHNOLOGY AND INTELLECTUAL PROPERTY
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.
CNS California was incorporated 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 CNS
California'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.
rEEG PATENTS
We have two issued U.S. Patents which together provide us with the
right to exclude others from using our rEEG technology. In addition, these
patents cover the analytical methodology we use 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, and have issued patents in Australia and Israel.
rEEG TRADEMARKS
"Referenced-EEG" and "rEEG" are registered trademarks of CNS California
in the United States. We will continue to expand our brand names and our
proprietary trademarks worldwide as our operations expand.
rEEG OUTCOMES DATABASE
The rEEG Outcomes Database consists of over 13,000 clinical outcomes
across 2,000 patients who had psychiatric or addictive problems. The 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.
11
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, we 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.
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.
We currently offer rEEG 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.
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, all of the
rEEG 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.
12
OUR CURRENT MARKETS
CURRENT APPLIED DISORDERS
In the last 12 months, physicians in sixteen 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-SUMMARY." 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).
PRIVATE PAYERS
Currently, a large majority of our rEEG Reports ordered by
client-physicians they report as being 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).
13
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
plans 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. We estimate that
these psychiatrists treat a large proportion of the treatment resistant
patients, which comprises 2 million people in any given year or a potential
annual market of greater than $1 billion with present pricing.
CORPORATE/ MANAGED BEHAVIORAL HEALTH ORGANIZATIONS/MANAGED CARE PAYERS
Currently, only a small portion of our rEEG 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.
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 greater than $500 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
14
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 $2.0 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, we contract with a
neurophysiologist to supply a conventional review of and commentary on a
patient's EEG test. We also contract 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 are evaluating bringing both of these
functions in-house during 2009, thereby reducing our costs per test, and
improving our margins.
15
CLINICAL VALIDATION- SUMMARY
rEEG CONTROL
CONTROLLED TRIALS POPULATION GROUP EFF. GROUP
- ----------------- ---------- ---------- -----
ADD & Depression Blinded Trial (1,3) 100 68% 22%
VA Blinded Study (3,5) 13 85% 17%
Dr. Greenblatt Scientific Pres APA 2008 (7) 13 92% 0
Treatment Resistant Depression Study - Pilot 18 58% 27%
CASE SERIES POPULATION EFFICACY
- ----------- ---------- --------
CIGNA-Atlanta Pilot (3) 56 70%
Dr. Davis Case Series (3) 15 100%
Monte Nido Case Series (2,3) 104 83%
Dr. Hamilton Case Series (3) 34 78%
Dr. Hoffman Case Series (3) 74 76%
Rancho L'Abri Case Series (3,4) 58 93%
Dr. Schiller Case Series (7) 19 89%
TOTAL (ALL STUDIES) 504 78%
1. Clinical EEG and Neurosciences, 1995
2. NCDEU Poster at Annual Meeting 2004
3. APA Poster at Annual Meeting 2005
4. APA Poster at Annual Meeting 2005
5. Amer. College Phys. & Surg. 2007
6. CPDD Poster at Annual Meeting 2008
7. 2008 US Psychiatric & Mental Health Congress 2008
The table above identifies all of the studies that have been reported involving
use of rEEG in medication guidance. In total, four comparative control studies
and seven uncontrolled case series have evaluated rEEG's ability to predict
medication response in 473 patients (excludes non-rEEG controls). These studies
document rEEG's clinical utility to guide treating psychiatrists in their
pharmacotherapy selection process with difficult to treat patients. Summarizing
across these studies, rEEG guided pharmacotherapy:
o Resulted in positive treatment responses in 78% of patients
(371 of 473).
o Was consistent with effectiveness rates exceeding 69% across
numerous psychiatrists practicing in diverse settings and
exceeded 58% on studies restricted to treatment-resistant
patients.
o Often involved medications, and medication combinations, that
were non-intuitive.
o Resulted in sustainable treatment gains with all effectiveness
ratings conducted 3 to 24 months following treatment
initiation compared to STAR*D's 64.6% and 71.1% relapse rates
within several months following an initial step 3 or step 4
remission.
o Enhanced treatment compliance and decreased dropout rates. In
the five studies that reported such rates, 15% (27 of 180) of
rEEG patients were not medication compliant and dropped out of
treatment compared to STAR*D's 44.8% and 60.1% dropout rates
during steps 3 and 4 despite receiving exemplary free, acute
and continuing care.
o Evidenced real-world clinical efficacy with all studies done
in naturalistic practice settings.
CLINICAL VALIDATION - 2008
Two new studies were published in scientific posters on October 30, 2008.
1. TREATMENT REFRACTORY EATING DISORDER PATIENTS WITH COMORBID
DEPRESSION
16
Patient-Controlled Long Term Cohort Study
This study reports on a cohort of 13 patients with severe eating
disorders (6 anorexia nervosa, 4 bulimia nervosa, 3 eating disorder - not
otherwise specified) who had been under care of the principle investigator for
two years prior to receiving rEEG-guided pharmacotherapy and then followed for a
minimum of six months to two years. All patients had been hospitalized at least
once and the group totaled 53 hospitalizations over 999 inpatient or partial
residential days at a cost estimate of $1.75MM in the previous 24 months. At
baseline Clinical Global Severity (CGS) was rated between severely ill and
markedly ill and averaged 5.54 +/- . At 8 weeks CGS scores had decreased to an
average of 2.85 +/- 1.14, and at 6 months an average of 2.23 +/- .83, a rating
between mildly ill and borderline mentally ill (see figure 1 in Exhibit 99.1,
which is incorporated herein by reference). These changes were significant with
ANOVA of p<.001. Clinical Global Improvement (CGI) at 8 weeks was rated an
average of 1.77 +/- .72 and at six months of 1.23 +/.44 representing an average
CGI between much improved (rating of 2) and very much improved (rating of 1)
(see figure 2 in Exhibit 99.1, which is incorporated herein by reference).
FIGURES 1 & 2 (see Exhibit 99.1)
These patients all had a co-occurring diagnosis of major depression
disorder. At baseline the 21-item Hamilton Depression Rating Scale (HDRS)
averaged 39.8 +/- 5.7. By week 8 scores decreased to an average of 13.2 +/- 6.9
and to 8.5 +/- 5.2 each statistically significant at p<,001 by ANOVA.
Significant improvement was recorded in virtually every patient (see figure 3 in
Exhibit 99.1, which is incorporated herein by reference).
17
FIGURE 3 (See Exhibit 99.1)
The principle investigator utilized 14 different medications from six
different classes in this study. His concluding comments noted that, "the
diversity of medications successfully utilized in treatment of this dually
diagnosed cohort extended beyond the available literature and our own clinical
experience. It is one of the key findings of the study. Without objective
physiologic guidance, implementing such a broad based strategy would be
extremely difficult."
ANTIDEPRESSANTS(n*) ANTICONVULSANTS (n) STIMULANTS (n) MAOI's (n)
Bupropion (4) Lamotragine (3) Amphetamine (2) Selegiline (1)
Duloxetine (2) Oxcarbazepine (3) D-Amphetamine (2) ANTIPSYCHOTICS
Nortriptyline (1) Gabapentin (5) Methlpheridate (2) Arpiprazole (1)
Fluoxetine (1) Divalproex (1) BETA BLOCKERS
Metoprolol (1)
This study is an unusual effort to allow patients to serve as their own
control in a comparison of treatment results from the same treating physician
and same treatment facilities with the only difference being pharmacotherapy as
guided by rEEG. It suffers from a lack of blind, but benefits from greater
control of confounding factors generally uncontrolled in two arm studies by
virtue of the long term two year documented treatment history and the minimum of
six month and up to two year follow up. It is the second study to report on
benefits of rEEG in this difficult population.
2. MULTI-SITE RANDOMIZED BLINDED CONTROLLED STUDY OF TREATMENT
RESISTANT DEPRESSIVE PATIENTS
This study reports on eighteen adult patients who had failed to
adequately respond to three or more previous medication treatment regimens.
Patients were treated with pharmacotherapy guided by rEEG or the Texas
Medication Algorithm Project ("TMAP") depression guidelines. Results compared 13
patients where these two guides differed in therapeutic guidance. With five
other patients, the guided therapies were equivalent.
Where rEEG and TMAP guidance differed, the 7 rEEG guided patients
showed a mean improvement in QIDS (Quick Inventory of Depressive Symptomalogy)
of 39.5%, over twice as much as patients guided by TMAP who showed a mean
improvement of 14.5% (see figure 4 in Exhibit 99.1, which is incorporated herein
by reference). Using all measurement over a 12 week period this showed a
Generalized Estimating Equation (GEE) of p<.11. Mean improvement in the Q-LES-Q
(Quality of Life Enjoyment and Satisfaction Questionnaire) was 37%, or an
absolute improvement score of 14.9, for rEEG guided patients, over twice as
great as the 16%, or an absolute improvement score of 6.8, for TMAP guided
patients showing a GEE significance of p<.038 (see figure 5 in Exhibit 99.1,
which is incorporated herein by reference).
18
FIGURES 4 & 5 (See Exhibit 99.1)
The two measures combined (see figure 6 in Exhibit 99.1, which is
incorporated herein by reference) show 7 of 12 (58%) rEEG-guided patients (three
that TMAP treatment was equivalent) demonstrating greater than 50% improvement
in QIDS or an absolute improvement score of 25 for Q-LES-Q and no patients
guided by TMAP except when rEEG treatment was equivalent having exceeded these
standards (total TMAP is 3 of 11 or 27%).
FIGURE 6 (See Exhibit 99.1)
This study is a pilot that guided the design of a larger multi-site
treatment-resistant depression study that is now underway.
OTHER NOTABLE STUDIES IN 2008
This past year, the Center for Health Economics, Epidemiology, and
Science Policy at United BioSource Corporation, a global pharmacoeconomic
research firm and a firm experienced in providing evidence-based review of
innovative healthcare technologies, conducted a study, entitled COMPARING LEVELS
OF EVIDENCE FOR TREATMENT OF TREATMENT-RESISTANT DEPRESSION WITH
REFERENCED-EEG(R) TO CURRENT PRACTICE. This study analyzed published studies on
treatment resistant depression (TRD), and modeled the evidence for
Referenced-EEG (rEEG) against evidence for currently reimbursed therapies. The
study is available on the CNS Response website, www.cnsresponse.com.
19
The study concluded, "Evidence supporting rEEG appears superior to that
supporting APA (American Psychiatric Association) or TMAP (Texas Medication
Algorithm Project) treatment guidelines. The findings of this project provide a
compelling basis for the consideration of rEEG as a beneficial modality of
medication selection for the treatment of TRD. These findings may warrant the
consideration of rEEG for inclusion in treatment guidelines and perhaps a basis
for re-imbursement."
CLINICAL VALIDATION - PRE-2008
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 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 68% of the time. This study was published in
Clinical Electroencephalography.(16)
- ----------
(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.
20
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 (85%). 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.
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, 70%
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.
21
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 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 (78%) of
the cases.
HOFFMAN-DENVER CASE SERIES
-----------------------------------------------------------------------
Conducted by Daniel Hoffman, M.D., now our Chief Medical Officer, with
a practice in Denver, CO. This study was conducted prior to Dr. Hoffman
becoming the Chief Medical Officer of the Company. In this study, rEEG
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 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.
22
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 2010. We envision this introduction will have elements of pushing
demand for rEEG via physician education and pulling demand for rEEG through
consumer education. Certain initiatives which are being considered for 2009
include:
1. EXPAND OUR GROUP OF CLIENT-PHYSICIANS TO INCLUDE MOST MAJOR US
CITIES. We expect this goal to be accomplished some time in
2009.
2. CONDUCT PILOT PROGRAMS WITH CORPORATE AND MANAGED CARE PAYERS.
Payer's reimbursement is encouraged when new technology
crosses a threshold of being "evidence-based" and economically
compelling. As discussed earlier, third party consulting firms
have determined that rEEG technology has crossed these
threshholds. The Center for Health Economics, Epidemiology,
and Science Policy at United BioSource Corporation has opined
that evidence supporting rEEG use in treatment resistant
depression was superior to the guidelines of the American
Psychiatric Association which serves as a reimbursement basis
for many payers. The Analysis Group's study concluded the use
of rEEG in multiple diagnosis with patients considered
treatment resistant would result in very significant savings
to payers in both the total health care cost and behavioral
health cost of these patients. Since announcing these results
payers have expressed significant interest in piloting the use
of rEEG. Multiple discussions on organizing such pilots are
underway.
3. COMPLETE CURRENT MULTI-SITE AND CONDUCT ADDITIONAL ACADEMIC
TRIALS. We are conducting a 120 patient, controlled, blinded,
and randomized clinical study of patients suffering from
treatment resistant depression. The study is being conducted
at Stanford, Cambridge Hospital-Harvard, McLean
Hospital-Harvard, University of California - Irvine, Rush
University, Cornell University and a number of commercial
trial sites. This study follows a pilot study reported on in
October 2008, the results of which appear in the section
"Clinical Validation - 2008. This study will conclude in 2009
and if this trial demonstrates similar results to that of the
pilot, we believe this study will have a significant impact on
the acceptance of rEEG as enhancing guidance of hard to treat
depression patients.
4. PROVIDE FOUNDATION FOR MARKET ADOPTION. Completion of our
academic studies along with the already completed third party
economic analysis and evidence-based analytical review will
provide the foundation for developing market adoption of our
reports. Many of the principal investigators in our
treatment-resistant depression study now underway are
recognized thought leaders in psychiatry. In the area of
marketing we have chosen to delay expansion of our staff,
until completion of this trial.
MARKET INTRODUCTION
After accomplishing our immediate goals of completing the multisite
depression study, expanding our rEEG experienced physicians to most of the major
US cities and reaching agreement for pilot trials with payers, we will begin
aggressive national introduction of rEEG. We plan to accomplish this
introduction by using the following marketing techniques:
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.
23
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 Reports, we can offer free trials to physicians to encourage them to begin
to experience the benefits of rEEG. Our current program offers Physicians three
(3) 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 us 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. We also believe the
internet will allow major news and testimonials to replay and advance awareness
quickly. We also expect to be able to encourage word of mouth through this
medium.
Patient 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 us.
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, 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 October 2008,
Daniel Hoffman, our Chief Medical Officer, and Len Brandt, our Chief Executive
Officer, collaborated to produce a scientific poster at the 2008 US Psychiatric
and Mental Health Congress that analyzed a subset of child depression cases and
suggested that 3 out of 4 children with depression are not likely to respond to
standard first line antidepressant treatment, thus demonstrating the value of
rEEG with children and adolescents.
24
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. To advance that goal, we acquired the Neuro-Therapy
Clinic of Denver, CO this past fiscal year. We expect to export to other Centers
of Excellence in the United States the strategies used at the Neuro-Therapy
Clinic for marketing their capability in the Denver community and optimizing
implementation of rEEG in the process flow of the clinic.
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.
RESEARCH AND DEVELOPMENT
We will continue to enhance, refine and improve the accuracy of our CNS
Database and rEEG through expansion of the number of medications covered by our
rEEG Reports, expansion of our biomarkers, refinement of our biomarker system,
and by reducing the time to turnaround a report to the physician.
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.
- ----------
(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).
25
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.
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 have 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.
- ----------
(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).
26
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 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.
COMPARABLE COMPANIES, COMPETITION AND INDUSTRY DEVELOPMENTS RELATING TO OUR
LABORATORY INFORMATION SERVICES BUSINESS
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 BIOBEHAVIORAL DIAGNOSTICS COMPANY (www.biodx.com) - quantifies
motion 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
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
provided by us, 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. 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.
27
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), an 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.
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. This device has received pre-marketing
approval from the Food and Drug Agency for application in
depression.
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
We do not believe that sales of our Laboratory Information Services,
including our rEEG Reports, are subject to regulatory pre-market approval.
However, we received a "warning letter" from the FDA on April 10, 2008 in which
the FDA indicated it believed, based in part on the combination of certain
marketing statements it read on our website, together with the delivery of our
rEEG Reports, that we were selling a software product to aid in diagnosis, which
constituted a "medical device" requiring pre-market approval and clearance by
the FDA pursuant to the Federal Food, Drug and Cosmetic Act (the "Act"). We
responded to the FDA on April 24, 2008 indicating that we believed it had
incorrectly understood our product offering, and clarified that the Laboratory
Information Services were not diagnostic and thus did not constitute a medical
device. On December 14, 2008, the FDA again contacted us and indicated that
based upon its review of our description of our intended use of the rEEG Reports
on our website, it continued to maintain that the rEEG Reports were medical
devices. In response to the FDA communications, we have made a number of changes
to our website and other marketing documents to reflect that rEEG is a service
to aid in medication selection and is not a diagnosis aid. Based upon our
regulatory counsel's guidance, and our most recent response to the FDA, we
believe we will resolve this matter without further regulatory compliance.
28
Even if the sale of our Laboratory Information Services are not subject
to regulatory approval, 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 we
do not resolve the status of our Laboratory Information Services with the FDA,
or 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.
ITEM 1A. RISK FACTORS
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION
CONTAINED IN THIS REPORT 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 THE MONEY YOU PAID TO
PURCHASE OUR COMMON STOCK.
RISKS RELATED TO OUR COMPANY
OUR CORE LABORATORY INFORMATION SERVICES BUSINESS HAS A LIMITED OPERATING
HISTORY, MAKING IT DIFFICULT TO EVALUATE OUR FUTURE PERFORMANCE.
Our operating subsidiary which conducts our core Laboratory Information
Services business, CNS California, was incorporated in 2000 and therefore has a
limited operating history. Investors therefore have limited substantive
financial information relating to our core business to evaluate an investment in
our company. 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.
IF OUR rEEG 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
29
been developed over the last twenty years. We began selling reports, referred to
as rEEG Reports, based on our methodology in 2000. To date, we have not received
widespread market acceptance of the usefulness of our rEEG Reports in helping
psychiatrists and physicians inform their treatment strategies for patients
suffering from behavioral and/or addictive disorders. If we fail to achieve
widespread market acceptance for our rEEG Reports, we will not be able to grow
our revenues, which could negatively impact our stock price.
OUR CLINICAL SERVICES BUSINESS GENERATES THE MAJORITY OF OUR REVENUE, AND
ADVERSE DEVELOPMENTS IN THIS BUSINESS COULD NEGATIVELY IMPACT OUR OPERATING
RESULTS.
Our Clinical Services business, which we view as ancillary to our core
Laboratory Information Services business, currently generates the majority of
our revenue. In the event that NTC is unable to sustain the current demand for
its services because, for instance, the company is unable to maintain favorable
and continuing relations with its clients and referring psychiatrists and
physicians or Daniel Hoffman is no longer associated with NTC, our revenues
could significantly decline, which could adversely impact our operating results
and our ability to implement our growth strategy.
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 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 in our direct sales force;
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; and
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 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.
WE MAY 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, our cash on hand and the net proceeds of our private placement that we
concluded in May of 2007. As of September 30, 2008, we had approximately $2.0
million in cash and cash equivalents at hand which we believe are sufficient
funds to finance the cost of our operations, our operating and management
infrastructure, and planned expansion for 6 months. We currently have
30
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. 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 relating to our rEEG technology, individuals seeking
treatment for behavioral health disorders may seek alternative treatment
methods, which could negatively impact our sales and profitability.
OUR rEEG REPORTS MAY NOT BE AS EFFECTIVE AS WE BELIEVE THEM 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 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 Reports, may not increase as we anticipate, which would harm our
operating results and stock price.
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, WE MAY BE UNABLE TO INCREASE OUR SALES, AND IN SUCH
INSTANCES OUR PROFITABILITY WOULD BE HARMED.
Our relationships with psychiatrists and physicians are critical to the
growth of our Laboratory Information Services business. We believe that these
relationships are based on the quality and ease of use of our rEEG 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 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 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 Reports, psychiatric professionals must recommend and
endorse them. We may not obtain the necessary recommendations or endorsements
from this community. Acceptance of our rEEG Reports depends on educating
psychiatrists and physicians as to the benefits, clinical efficacy, ease of use,
revenue opportunity, and cost-effectiveness of our rEEG Reports and on training
the medical community to properly understand and utilize our rEEG Reports. If we
are not successful in obtaining the recommendations or endorsements of
psychiatrists and other physicians for our rEEG Reports, we may be unable to
increase our sales and profitability.
31
NEGATIVE PUBLICITY OR UNFAVORABLE MEDIA COVERAGE COULD DAMAGE OUR REPUTATION AND
HARM OUR OPERATIONS.
In the event that the marketplace perceives our rEEG 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 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.
Our primary business is the sale of rEEG 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.
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.
32
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 and volunteers into clinical
trials;
o lower than anticipated retention rates of patients and
volunteers 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 a limited number of employees to market and
promote our rEEG Reports. 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 Reports by psychiatrists and physicians and higher
additional employees for this purpose. 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.
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 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.
33
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, as well as
issued patents in Australia and Israel, 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 may
design around aspects of our technology, or alternatively may independently
develop similar or more advanced technologies that fall outside the scope of our
claimed subject matter but that can be used in the treatment of behavioral
health disorders.
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 our
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.
34
ALTHOUGH WE BELIEVE WE ARE NOT CURRENTLY SUBJECT TO REGULATORY APPROVAL FOR THE
SALE OF OUR rEEG REPORTS, REGULATIONS ARE CONSTANTLY CHANGING, AND IN THE FUTURE
OUR BUSINESS MAY BE SUBJECT TO REGULATION.
As discussed in Item 1 of this report under the heading "Government
Regulation", we do not believe that sales of our Laboratory Information
Services, including our rEEG Reports, are subject to regulatory approval.
However, federal, state and foreign laws and regulations relating to the sale of
our rEEG 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 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
business would be significantly harmed.
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.
35
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 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 Chief Executive Officer and Secretary, 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 intend to carry key man life insurance on Leonard Brandt in an
amount of $2.0 million, payable to the company. We do not carry key man life
insurance on any of our other key employees. We do not have employment
agreements in place with most of our executives and key employees, and each may
terminate their employment upon notice and without cause or good reason. 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, 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 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 Reports, involve the risk of
serious injury or death. While we do not treat patients or determine whether
treatment that is guided by rEEG 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 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
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.
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
36
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 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 REPORTS, OUR REVENUE
AND PROSPECTS FOR PROFITABILITY WILL 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 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 Reports, which will discourage
psychiatrists and physicians from utilizing the information services we provide.
We may need to conduct studies in addition to those we have already accounced 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.
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 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.
37
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 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.
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.
38
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 through our ownership of the Neuro-Therapy Clinic or by
providing administrative and ancillary services in connection with our rEEG
Reports. These parties may also assert that selling our rEEG Reports for a
portion of the patient fees constitutes improper fee-splitting. If asserted,
such claims could subject us to civil and criminal penalties, could result in
our contracts being found legally invalid and unenforceable, in whole or in
part, or could result in us being required to restructure our contractual
arrangements, all with potentially adverse consequences to our business and our
stockholders.
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 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.
39
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 Reports, as well as
in our Clinical Services business, 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.
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.
40
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 the
Over-the-Counter Bulletin Board under the symbol CNSO.OB. There is currently no
broadly followed, established trading market for our Common Stock and 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. Also, as a result of
this lack of trading activity, the quoted price for our Common Stock on the
Over-the-Counter 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 LARGER 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:
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;
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 our post-effective amendment to our
Registration Statement on Form S-1, 9,978,676 shares of Common Stock became
eligible for resale, including 2,627,939 shares of our Common Stock issuable
upon the exercise of certain warrants. 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.
41
Other holders of our Common Stock 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. Such shares may also
be eligible for resale pursuant to Rule 144 of the Securities Act of 1933, as
amended.
Moreover, as additional shares of Common Stock become available for
resale in the open market (including shares issuable upon the exercise of our
outstanding options and warrants), the supply of our publicly traded shares will
increase. This could decrease their price.
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.
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 therefor.
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 if current price
and volume information with respect to transactions in such securities is
provided by the exchange). 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.
42
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 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.
Our officers, directors and principal stockholders (greater than 5%
stockholders) collectively control approximately 60% 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.
Our officers, directors and principal stockholders (greater than 5%
stockholders) collectively control approximately 60% 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.
43
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, which could cause our stock price to decline. In addition,
these provisions could limit the price investors would be willing to pay in the
future for shares of our Common Stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
We currently lease space for our headquarters and Laboratory
Information Services business under a lease agreement which expires in May 2009.
The facility is approximately 1900 sq. ft, and is located in Costa Mesa,
California.
We also lease space for our Clinical Services operations under a lease
which expires in February 2010. The facility is approximately 3,500 square feet,
and is located in Denver, Colorado. In addition, we sublease approximately 1,000
square feet of space at a site adjacent to the primary suite on a month-to-month
basis for our Clinical Services business.
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.
ITEM 3. 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, would have a material
adverse effect on our results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders in the quarter
ended September 30, 2008.
44
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
COMMON STOCK
Our common stock is currently listed for trading on the OTC Bulletin
Board 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*
----- -----
YEAR ENDED SEPTEMBER 30, 2007
First Quarter ............................... $8.50 $0.55
Second Quarter .............................. $4.50 $0.55
Third Quarter ............................... $2.50 $1.05
Fourth Quarter .............................. $1.40 $0.70
YEAR ENDED SEPTEMBER 30, 2008
First Quarter ............................... $0.90 $0.75
Second Quarter .............................. $2.25 $0.75
Third Quarter ............................... $3.00 $0.55
Fourth Quarter .............................. $0.75 $0.51
* Adjusted price reflecting the 1:50 reverse stock split that became
effective January 10, 2007
On January 6, 2008, the closing sales price of our common stock as
reported on the OTC Bulletin Board was $0.90 per share. As of January 6, 2008,
there were 354 record holders of our common stock. The number of holders of
record is based on the actual number of holders registered on the books of our
transfer agent and does not reflect holders of shares in "street name" or
persons, partnerships, associations, corporations or other entities identified
in security position listings maintained by depository trust companies.
DIVIDEND RIGHTS
We have not paid or declared cash distributions or dividends on our
common stock and 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.
45
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND ACCOMPANYING NOTES PROVIDED UNDER PART II,
ITEM 8 OF THIS ANNUAL REPORT ON FORM 10-K. THIS DISCUSSION SUMMARIZES THE
SIGNIFICANT FACTORS AFFECTING THE CONDENSED CONSOLIDATED OPERATING RESULTS,
FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS OF CNS RESPONSE, INC. FOR THE
FISCAL YEARS ENDED SEPTEMBER 30, 2008 AND 2007. 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" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995. THESE STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES AND ARE BASED
ON THE BELIEFS AND ASSUMPTIONS OF OUR MANAGEMENT AS OF THE DATE HEREOF BASED ON
INFORMATION CURRENTLY AVAILABLE TO OUR MANAGEMENT. USE OF WORDS SUCH AS
"BELIEVES," "EXPECTS," "ANTICIPATES," "INTENDS," "PLANS," "ESTIMATES," "SHOULD,"
"FORECASTS," "GOAL," "LIKELY" OR SIMILAR EXPRESSIONS, INDICATE A FORWARD-LOOKING
STATEMENT. FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE
AND INVOLVE RISKS, UNCERTAINTIES AND ASSUMPTIONS. ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS WE MAKE. SEE "RISK FACTORS"
ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K FOR A DISCUSSION OF CERTAIN RISKS
ASSOCIATED WITH OUR BUSINESS. WE DISCLAIM ANY OBLIGATION TO UPDATE
FORWARD-LOOKING STATEMENTS FOR ANY REASON.
OVERVIEW
We are a life sciences company with two distinct business segments. Our
Laboratory Information Services business, which we consider our primary
business, is 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. Our Clinical Services
business operated by Neuro-Therapy Clinic, P.C. ("NTC") is a full service
psychiatric practice.
LABORATORY INFORMATION SERVICES
In connection with our Laboratory Information Services business, we
have developed an extensive proprietary database (the "CNS Database") consisting
of over 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(R) ("rEEG(R)"), this patented technology
allows us to create and provide simple reports ("rEEG 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
abnormalities. The rEEG process then identifies a set of patients having similar
abnormalities as recorded in our CNS Database and reports on historical relative
medication success for this stratified group. Upon completion, the physician is
provided the analysis in a report detailing and ranking classes of agents (and
specific agents within the class) by treatment success for patients having
similar abnormal electrophysiology.
46
Our business is focused on increasing the demand for our rEEG services.
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 payers,
expansion of our sales force and increased marketing efforts.
CLINICAL SERVICES
In January 2008, we acquired our largest customer, the Neuro-Therapy
Clinic, P.C. ("NTC") located in Colorado. Upon the completion of the
transaction, NTC became a wholly-owned subsidiary of ours. NTC operates one of
the largest psychiatric medication management practices in the state of
Colorado, with nine full time and four part time employees including
psychiatrists and clinical nurse specialists with prescribing privileges. Daniel
A. Hoffman, M.D. is the medical director at NTC, and, after the acquisition,
became our Chief Medical Officer.
NTC, having performed a significant number of rEEG's, serves an
important resource in our product development, the expansion of our CNS
Database, production system development and implementation, along with the
integration of our rEEG services into a medical practice. Through NTC, we also
expect to successfully develop marketing and patient acquisition strategies for
our Laboratory Information Services business. Specifically, NTC is learning how
to best communicate the advantages of rEEG to patients and referring physicians
in the local market. We will share this knowledge and developed communication
programs learned through NTC with other physicians using our services, which we
believe will help drive market acceptance of our services. In addition, we plan
to use NTC to train practitioners across the country in the uses of rEEG
technology.
We view our Clinical Services business as secondary to our Laboratory
Information Services business, and we have no current plans to expand this
business.
BUSINESS OPERATIONS
Since our inception, we have generated significant net losses. As of
September 30, 2008, we had an accumulated deficit of $16.7 million. We incurred
operating losses of $5.5 million and $3.3 million for the fiscal years ended
September 30, 2008 and 2007, respectively. 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 of our commercial organization, and other general corporate purposes.
Research and development projects include the completion of clinical trials
which are essential to validate the efficacy of our products and services
relating to our rEEG technology across different type of behavioral disorders,
the enhancement of the CNS Database and, to a lesser extent, the identification
of new medication that are often combinations of approved drugs.
OUR HISTORY
Prior to January 16, 2007, CNS Response, Inc. (then called
Strativation, Inc.) 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 January 16, 2007, we entered into an Agreement and
Plan of Merger (the "Merger Agreement") with CNS Response, Inc., a California
corporation ("CNS California"), and CNS Merger Corporation, a California
corporation and our wholly-owned subsidiary ("MergerCo") pursuant to which we
agreed to acquire CNS California in a merger transaction wherein MergerCo would
merge with and into CNS California, with CNS California being the surviving
corporation (the "Merger"). On March 7, 2007, the Merger closed, CNS California
became our wholly-owned subsidiary, and on the same date we changed our
corporate name from Strativation, Inc. to CNS Response, Inc.
47
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
CNS California, the separate existence of MergerCo ceased, and CNS California
continued as the surviving corporation at the subsidiary level. We issued an
aggregate of 17,827,958 shares of our common stock to the stockholders of CNS
California in exchange for 100% ownership of CNS 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 CNS California.
Immediately prior to the closing of the Merger, we had outstanding
868,990 shares of common stock. Immediately after the closing of the Merger, and
without taking into consideration the Private Placement offering described
below, we had 18,696,948 outstanding shares of common stock, and options and
warrants to purchase 8,407,517 shares of common stock.
PRIVATE PLACEMENT TRANSACTION
On March 7, 2007, simultaneous with the closing of the Merger, we
received gross proceeds of approximately $7,008,450 in a private placement
transaction (the "Private Placement") with institutional investors and other
high net worth individuals ("Investors"). On May 16, 2007, we received
additional gross proceeds of $797,300 from the second closing of the Private
Placement. Pursuant to Subscription Agreements entered into with these
Investors, we sold 6,504,758 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 Warrants"). After
commissions and expenses, we received net proceeds of approximately $6,748,400
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 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 (520,380 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 $88,000 in costs, fees
and expenses incurred by Brean Murray in connection with the Private Placement.
REGISTRATION RIGHTS AGREEMENTS
Under the terms of the Subscription Agreements between us and the
Investors in the Private Placement, we were obligated to file a Registration
Statement on Form SB-2 with the Securities and Exchange Commission (the "SEC")
48
within 45 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 Company's
Registration Statement on Form SB-2 was filed on May 22, 2007 with the
Securities and Exchange Commission.
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 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. The Company's Registration Statement on Form SB-2 became
effective on June 22, 2007.
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 were also obligated to include up to 767,103 shares of our common
stock on the Registration Statement described above. The registration rights
attaching to the shares held by these stockholders are not transferable with
such shares. Our former 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. A total of
484,250 shares of our Common Stock held by one of our former majority
shareholder were registered for resale on our registration statement on Form
SB-2.
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 CNS California Series A Preferred Stock, CNS California Series B
Preferred Stock and certain shares of CNS 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.
After the completion of the Private Placement and the Merger, we had an
aggregate of 25,303,462 shares of common stock outstanding, with the former CNS
California shareholders and the investors in the Private Placement owning in the
aggregate 24,351,139 shares of our common stock, which represented approximately
96.2% of our issued and then outstanding shares of common stock. Our
stockholders immediately prior to the Merger and Private Placement owned
approximately 3.4% of our outstanding common stock (or, 868,990 shares of our
common stock) immediately after completion of these transactions.
ACQUISITION OF NEURO-THERAPY CLINIC
On January 11, 2008, we acquired all of the outstanding common stock of
NTC in exchange for a non-interest bearing $300,000 note payable in equal
monthly installments over 36 months. The acquisition was accounted under the
purchase method of accounting, and accordingly, the purchase price was allocated
49
to NTC's net tangible assets based on their estimated fair values as of January
11, 2008. The excess purchase price over the value of the net tangible assets
was recorded as goodwill. The purchase price and the allocation thereof are as
follows:
Fair value of note payable issued ............. $ 265,900
Direct transaction costs ...................... 43,700
Purchase price ................................ 309,600
Allocated to net tangible liabilities,
including cash of $32,100 .................. (10,600)
---------
Allocated to goodwill ......................... $ 320,200
=========
The acquisition was not material, and accordingly, no pro forma results
are presented.
FINANCIAL OPERATIONS OVERVIEW
REVENUES
Our Laboratory Information Services revenues are derived from the sale
of rEEG Reports to physicians. Physicians are generally billed upon delivery of
a rEEG Report. The list prices of our rEEG Reports to physicians range from $200
to $800 with $400 being the most frequent charge.
Patient service revenue is generated as a result of providing services
to patients on an outpatient basis. Patient service revenue is recorded at our
established billing rates less contractual adjustments. Generally, collection in
full is not expected on our established billing rates. Contractual adjustments
are recorded to state our patient service revenue at the amount we expect to
collect for the services provided based on amounts due from third-party payors
at contractually determined rates.
COST OF REVENUES
Cost of revenues are for Laboratory Information Services and represent
the cost of direct labor, the amortization of a 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 continually evaluate the feasibility
of hiring our own personnel to perform most of the processing and analysis
necessary to render an rEEG Report.
Cost of revenues for Clinical Services are not broken out separately
but are included in general and administrative expenses.
RESEARCH AND DEVELOPMENT
Research and development expenses are associated with our Laboratory
Information Services and primarily represent costs incurred to design and
conduct clinical studies, improve rEEG processing, add data to the CNS 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.
50
SALES AND MARKETING
For our Laboratory Information Services, our selling and marketing
expenses consist primarily of personnel costs and the costs of educating
physicians, laboratory personnel and other healthcare professionals regarding
our products and services.
For our Clinical Services, selling and marketing costs relate to
advertising to attract patients to the clinic.
GENERAL AND ADMINISTRATIVE
Our general and administrative expenses consist primarily of personnel,
occupancy, legal, accounting and other professional and administrative costs for
both our Laboratory Information Services and Clinical Services businesses.
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 consolidated 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 Note 3 to our
consolidated financial statements included elsewhere in this report. We believe
the following critical accounting policies reflect our more significant
estimates and assumptions used in the preparation of our consolidated financial
statements.
REVENUE RECOGNITION
We have generated limited revenues since our inception. Revenues for
our Laboratory Service product are recognized when an rEEG Report is delivered
to a Client-Physician. For our Clinical Services, revenues are recognized when
the services are performed.
STOCK-BASED COMPENSATION EXPENSE
Stock-based compensation expense, which is a non-cash charge, results
from stock option grants. 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.
51
RESULTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 2008 AND 2007
As earlier described, we operate in two business segments: Laboratory
Information Services and Clinical Services. Our Laboratory Information Services
business focuses on the delivery of reports ("rEEG Reports") that assist
physicians with treatment strategies for patients with behavioral (psychiatric
and/or addictive) disorders based on the patient's own physiology. Our Clinical
Services business operated through NTC provides full service psychiatric
services. For comparative purposes below, our Laboratory Information Services
business represents all of the company's business in 2007 and our Clinical
Services business represents the operations of Neuro-Therapy Clinic since its
acquisition on January 11, 2008.
The following table presents consolidated statement of operations data
for each of the periods indicated as a percentage of revenues.
YEAR ENDED
SEPTEMBER 30,
---------------------
2008 2007
------ ------
Revenues ......................................... 100% 100%
Cost of revenues ................................. 21 70
------ ------
Gross profit ..................................... 79 30
Research and development ......................... 271 605
Sales and marketing .............................. 114 52
General and administrative expenses .............. 402 745
------ ------
Operating loss ................................... (708) (1,372)
Other income (expense), net ...................... 13 (4)
------ ------
Net income (loss) ................................ (695)% (1,376)%
====== ======
REVENUES
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Laboratory Service Revenues ........ $ 178,500 $ 238,400 (25%)
Clinical Service Revenues .......... 595,000 --
----------- -----------
Total Revenues ..................... $ 773,500 $ 238,400 224%
For Laboratory Information Services the number of rEEG Reports
delivered for the period decreased from 630 in 2007 to 476 in 2008 while the
price per report decreased from approximately $378 in 2007 to $375 in 2008. The
reduction in revenues from the sale of our rEEG Reports is largely due to the
acquisition of NTC, which was our largest customer in 2007. We hired a president
in October of 2007 whose main focus is the commercialization of our products,
and accordingly, we have begun to scale up our sales and marketing efforts.
However, we do not expect to drive broader adoption of reports based on our rEEG
technology until the completion in 2009 of our multi-site clinical study to
validate the efficacy of our products. Accordingly, we anticipate that revenues
will not increase materially until fiscal 2010.
52
Our Clinical Services revenue is as a result of patient billings for
psychiatric services rendered. Currently, we do not plan to expand our Clinical
Services business, and therefore we do not anticipate a significant increase in
revenues generated by this business segment.
COST OF REVENUES
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Cost of Laboratory Information
Services revenues .............. $ 163,200 $ 166,200 (2%)
Cost of Laboratory Information Services revenues consists of payroll
costs, consulting costs, charges relating to the amortization of the CNS
Database and other miscellaneous charges. Consulting costs primarily represent
external costs associated with the processing and analysis of rEEG Reports and
range between $75 and $100 per rEEG Report. For the year ended September 30,
2008, cost of revenues was $163,200 consisting primarily of direct labor and
benefit costs of $83,000, consulting fees of $49,000, and stock-based
compensation of $16,000. For the year ended September 30, 2007, cost of revenues
was $166,200 consisting primarily of direct labor and benefit costs of $67,000,
consulting fees of $53,000, amortization of the purchased database of $20,000
and stock-based compensation of $20,000. We expect costs of revenues will
increase as an absolute number as we deliver more rEEG Reports. However, we
expect cost of revenues to decrease as a percentage of revenues as we improve
our operating efficiency.
RESEARCH AND DEVELOPMENT
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Laboratory Information Services
research and development ........ $ 2,097,300 $ 1,442,600 45%
Research and development expenses consist of clinical studies, costs to
identify indications of approved medications, projects for training doctors
associated with our research studies, patents costs, consulting fees, payroll
costs (including stock-based compensation), expenses related to database
enhancements and maintenance, and other miscellaneous costs. Research and
development costs increased for the year ended September 30, 2008 from the
comparable period for 2007 as a result of increases in: (i) expenses relating to
clinical studies, (ii) payroll and stock compensation costs, (iii) patent costs
as a result of increased filings and (iv) database enhancements and maintenance
costs; offset by reduced (v) consulting fees, as this expertise was brought
in-house.
The increase in expenses relating to clinical studies is attributable
to our completion of our first pilot study and to our expansion and acceleration
of a second larger clinical study with the goal of driving market acceptance of
our rEEG technology. The increase in payroll costs is attributable to the hiring
of our Chief Medical Officer and increases in stock-based compensation.
53
In an effort to reduce our costs, we deferred projects associated with
the expansion of our rEEG technology to additional medications in order to focus
our efforts and funds on the clinical study and the commercialization of our
product. Similarly, the cost of identifying indications of approved drugs and
drug candidates decreased as we deferred these projects to concentrate our
efforts in the clinical study and the commercialization of our product. We
expect that research and development expenses will continue to increase as we
continue to accelerate and grow our clinical study to validate the efficacy of
our rEEG technology.
SALES AND MARKETING
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Sales and Marketing
Laboratory Information Services . $ 847,600 $ 123,600 586%
Clinical Services ............... 33,800 --
----------- -----------
Total Sales and Marketing .......... $ 881,400 $ 123,600 613%
=========== ===========
Sales and marketing expenses associated with our Laboratory Information
Services business consist primarily of consulting fees, payroll costs, marketing
costs and travel costs. Sales and marketing expenses increased in fiscal 2008
versus fiscal 2007 due to the hiring of consultants to expand our sales and
marketing efforts, increases in marketing activities, such as attendance at
conferences, increased travel and the hiring of (i) a Vice President for
commercial operations, (ii) an additional salesperson and (iii) a marketing
assistant. We expect sales and marketing costs to increase in as we continue to
expand our sales and marketing efforts.
The Clinical Services sales and marketing expenses consists of
advertising in various media so as to attract patients to the clinic. We
currently do not plan to expand our Clinical Services business, and therefore we
expect that our sales and marketing expenses associated with this business
segment will not materially change.
GENERAL AND ADMINISTRATIVE
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
General and administrative
Laboratory Information Services .... $ 2,349,000 $ 1,775,600 33%
Clinical Services .................. 756,700 --
----------- -----------
Total General and administrative .... $ 3,105,700 $ 1,775,600 75%
=========== ===========
General and administrative expenses for our Laboratory Information
Services business for the fiscal year ended September 30, 2007 primarily related
to salaries (including stock-based compensation), professional and consulting
services and dues. The increase in general and administrative expenses for the
fiscal year ended September 30, 2008 is primarily related to increased payroll
and benefits (including stock based compensation) costs. This is partly
attributed to the hiring a of a new president. These personnel costs amounted to
$1.4 million for the year ended September 2008, as compared to $0.7 million for
the year ended September 30, 2007. Professional and consulting fees and dues
increased to $470,000 for 2008 versus $213,000 for 2007. This increase was
offset by a one-time $475,000 advisory fee paid to Richardson & Patel, LLP in
2007 which did not recur in 2008. This advisory fee was in connection with our
merger transaction.
54
General and administrative expenses of $756,700 for our Clinical
Services business for the year ended September 30, 2008 includes all costs
associated with running NTC. This includes all payroll costs, medical supplies,
occupancy costs and other general and administrative costs.
INTEREST INCOME (EXPENSE)
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Laboratory Information Services
(Expense), net ................. $ 104,600 $ (115,600) *
Clinical Services (Expense) ........ (600) --
----------- -----------
Total interest income (expense) .... $ 104,000 $ (115,600) *
=========== ===========
* Not meaningful
With respect to our Laboratory Information Services business, we earned
interest income of $127,000 for the fiscal year ended September 30, 2008 from
interest bearing accounts. This was offset by $22,000 of interest expense on the
promissory note issued in connection with our acquisition of NTC and interest
expenses incurred in connection with an equipment lease. For the fiscal year
2007, net interest expense was $115,600 and consisted of $190,000 relating to
interest expense from the ascribed value of a warrant issued to NuPharm
Database, LLC. Additional interest expense relating to promissory notes and
other interest bearing accounts amounted $17,000. These expenses were partly
offset by interest income of $90,700.
With respect to our Clinical Services business, the interest expense of
$600 relates to an equipment lease.
NET LOSS
YEAR ENDED SEPTEMBER 30,
------------------------- PERCENT
2008 2007 CHANGE
----------- ----------- -----------
Laboratory Information Services
net loss ....................... $(5,166,200) $(3,279,100) 58%
Clinical Services net loss ........ (205,300) -- *
----------- -----------
Total Net Loss .................... $(5,371,500) $(3,279,100) 64%
=========== ===========
* Not meaningful
The increase in net loss of $2,092,400 is due primarily to increases in
our research and development, sales and marketing, and general and
administrative costs as described above, offset by revenue generated by our
Clinical Services business. 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, increase the penetration of our products in the marketplace,
and hire additional personnel.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have incurred significant losses and, as of
September 30, 2008, we had an accumulated deficit of approximately $16.7
million. We have not yet achieved profitability and anticipate that we will
continue to incur net losses for the foreseeable future. We expect that our
research and development, selling and marketing and general and administrative
expenses will continue to grow and, as a result, we will need to generate
significant product revenues to achieve profitability. We may never achieve
profitability.
55
As of September 30, 2008 we had approximately $2 million in cash and
cash equivalents and a working capital balance of approximately $830,000
compared to approximately $5.8 million in cash and cash equivalents and a
working capital balance of approximately $5.3 million at September 30, 2007.
SOURCES OF LIQUIDITY
Since our inception substantially all of our operations have been
financed primarily from equity and debt financings. Through September 30, 2008,
we had received proceeds of $8.6 million from the sale of stock, $3,116,000 from
the issuance of convertible promissory notes and $220,000 for the issuance of
common stock to employees in connection with expenses paid by such employees on
behalf of the company.
CASH FLOWS
Net cash used in operating activities was $3.7 million for the fiscal
year ended September 30, 2008 compared to $3.0 million for fiscal year ended
September 30, 2007. The increase in cash used of $0.7 million was primarily
attributable to an increase in research and development expenses and increases
in payroll, professional and consulting fees, offset by the non-recurrence of a
payment of an advisory fee of $475,000 to Richardson & Patel, LLP which occurred
in 2007.
Net cash used in investing activities was $74,600 for the fiscal year
ended September 30, 2008 as compared to $7,200 for the fiscal year ended
September 30, 2007. Our 2008 investing activities related to the acquisition of
our Neuro-Therapy Clinic and the purchase of furniture and equipment for our
headquarters and Laboratory Information Services offices. In 2007, our investing
activities consisted of loans made to employees and deposits.
Net cash used by financing activities in 2008 primarily resulted from
the payment of $60,600 on a promissory note issued to Daniel Hoffman in
connection with our acquisition of NTC. In 2007 net cash provided by financing
activities was $8.6 million from the sale of stock.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of September 30, 2008, our major contractual obligations were the
remaining balance on a promissory note of $205,300 plus interest at 8% issued in
connection with our acquisition of NTC and operating leases for office space
totaling $130,000. As of September 30, 2007, our only significant contractual
obligation was for leased space. Please see Note 15 to our Consolidated
Financial Statements included elsewhere in this report for further details.
OPERATING CAPITAL AND CAPITAL EXPENDITURE REQUIREMENTS
Our continued operating losses and limited capital raise substantial
doubt about our ability to continue as a going concern. 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 development, regulatory requirements, commercialization efforts and
the amount of cash used by operations.
56
We currently anticipate that our cash and collections from sale of our
services, will not be sufficient to fund our operations for at least the next 12
months. Consequently we anticipate raising additional funds in 2009.
Our future funding requirements will depend on many factors, including
the following:
a. the cost of expanding our commercial operations, including our
selling and marketing efforts;
b. the rate of progress and cost of research and development
activities associated with our products;
c. the rate of progress and cost of research and development
activities associated with the identification, development and
commercialization of new indications of approved medications
and medication candidates;
d. the cost of filing, prosecuting, defending and enforcing any
patent claims and other intellectual property rights; and
e. the effect of technological and market developments.
Until we can generate a sufficient amount of revenues to finance our
cash requirements, which we may never do, we expect to finance future cash needs
primarily through public or private equity offerings, debt financings,
borrowings or strategic collaborations. The issuance of equity securities may
result in dilution to stockholders. We do not know whether additional funding
will be available on acceptable terms, or at all, especially given the market
conditions that currently prevail. If we are not able to secure additional
funding when needed, we may have to delay, reduce the scope of or eliminate one
or more research and development programs or selling and marketing initiatives,
and implement other cost saving measures.
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, 2008, we had net operating loss carryforwards for
federal income tax purposes of $12.4 million. 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.
OFF-BALANCE SHEET ARRANGEMENTS
We have no off-balance sheet arrangements or financing activities with
special purpose entities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
57
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to financial statements
PAGE
----
Report of Independent Registered Public Accounting Firm................. 59
Consolidated Balance Sheets as of September 30, 2008 and 2007........... 60
Consolidated Statements of Operations for the Years Ended
September 30, 2008 and 2007............................................. 61
Consolidated Statement of Changes in Stockholders' Equity (Deficit)
for the Years Ended September 30, 2008 and 2007......................... 62
Consolidated Statements of Cash Flows for the Years Ended
September 30, 2008 and 2007............................................. 63
Notes to Consolidated Financial Statements for the Years Ended
September 30, 2008 and 2007............................................. 65
58
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
CNS Response, Inc.
We have audited the accompanying consolidated balance sheets of CNS Response,
Inc. and its subsidiaries (the "Company") as of September 30, 2008 and 2007, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the years in the two-year period ended
September 30, 2008. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company at
September 30, 2008 and 2007, and the results of its operations and it cash flows
for each of the years in the two-year period ended September 30, 2008 in
conformity with accounting principles generally accepted in the United States of
America.
The accompanying consolidated 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 and limited
capital 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
January 13, 2009
59
CNS RESPONSE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30,
2008 2007
------------ ------------
ASSETS
CURRENT ASSETS:
Cash ................................................... $ 1,997,000 $ 5,790,100
Accounts receivable (net of allowance for doubtful
accounts of $17,200 and $17,200 in 2008 and 2007
respectively) ........................................ 98,200 59,200
Prepaids and other ..................................... 189,400 159,000
------------ ------------
Total current assets ................................. 2,284,600 6,008,300
Other assets .............................................. 28,700 4,100
Goodwill .................................................. 320,200 --
------------ ------------
TOTAL ASSETS .............................................. $ 2,633,500 $ 6,012,400
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable (including $6,800 and $5,000 to related
parties in 2008 and 2007 respectively) ............... $ 335,700 $ 219,400
Accrued liabilities .................................... 207,500 207,500
Deferred compensation (including $107,000 and $56,700
to related parties in 2008 and 2007 respectively) ... 264,900 73,400
Accrued patient costs .................................. 397,500 --
Accrued consulting fees ................................ 67,600 73,200
Accrued interest ....................................... 42,600 35,800
Convertible promissory note ............................ 50,000 50,000
Current portion of long-term debt ...................... 88,500 --
------------ ------------
Total current liabilities ............................ 1,454,300 659,300
------------ ------------
LONG-TERM LIABILITIES
Note payable to officer ................................ 118,600 --
Capital lease .......................................... 7,700 --
------------ ------------
Total long-term liabilities .......................... 126,300 --
------------ ------------
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value; authorized
750,000,000 shares; 25,299,547 outstanding ........... 25,300 25,300
Additional paid-in capital ............................. 17,701,300 16,630,000
Accumulated deficit .................................... (16,673,700) (11,302,200)
Total stockholders' equity ........................... 1,052,900 5,353,100
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................ $ 2,633,500 $ 6,012,400
============ ============
See accompanying Notes to Consolidated Financial Statements
60
CNS RESPONSE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
YEARS ENDED
SEPTEMBER 30,
----------------------------
2008 2007
------------ ------------
REVENUES
Laboratory Information Services ...................... $ 178,500 $ 238,400
Clinical Services .................................... 595,000 --
------------ ------------
773,500 238,400
------------ ------------
OPERATING EXPENSES:
Cost of Laboratory Service revenues (including
amortization expense of $0 and $19,900 for the years
ended September 30, 2008 and 2007 respectively) .... 163,200 166,200
Research and development ............................. 2,097,300 1,442,600
Sales and marketing .................................. 881,400 123,600
General and administrative ........................... 3,105,700 1,775,600
------------ ------------
Total operating expenses ........................... 6,247,600 3,508,000
------------ ------------
OPERATING LOSS .......................................... (5,474,100) (3,269,600)
------------ ------------
OTHER INCOME (EXPENSE):
Interest Income, net ................................. 104,000 (115,600)
Other ................................................ -- 106,900
------------ ------------
Total other income (expense) ......................... 104,000 (8,700)
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES .................. (5,370,100) (3,278,300)
PROVISION FOR INCOME TAXES .............................. 1,400 800
------------ ------------
NET LOSS ................................................ $ (5,371,500) $ (3,279,100)
============ ============
BASIC NET LOSS PER SHARE ................................ $ (0.21) $ (0.17)
============ ============
DILUTED NET LOSS PER SHARE .............................. $ (0.21) $ (0.17)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic ................................................ 25,299,547 18,778,077
============ ============
Diluted .............................................. 25,299,547 18,778,077
============ ============
See accompanying Notes to Consolidated Financial Statements
61
CNS RESPONSE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED SEPTEMBER 30, 2008 AND 2007
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
------------ ------------ ------------ ------------ ------------
Balance at October 1, 2006 ........................ 7,903,107 $ 7,900 $ 2,822,100 $ (8,023,100) $ (5,193,100)
Forgiveness of accrued interest from NuPharm and
issuance and exercise of warrants by NuPharm .. 2,800,000 2,800 334,800 -- 337,600
Conversion of convertible promissory notes and
accrued interest .............................. 5,993,515 6,000 4,061,100 -- 4,067,100
Issuance of stock in connection with mezzanine
financing, net of offering costs of $47,600 ... 1,905,978 1,900 1,875,500 -- 1,877,400
Issuance of stock for settlement of debt .......... 11,015 -- 1,300 -- 1,300
Issuance of options in settlement of accrued
consulting fees ............................... -- -- 27,000 -- 27,000
Issuance of stock in connection with private
placement, net of offering costs of $1,057,300 6,504,758 6,500 6,741,900 -- 6,748,400
Issuance of stock as payment of placement agent fee 83,333 100 (100) -- --
Issuance of stock to repay note to NuPharm and
related accrued interest ...................... 244,509 200 293,200 -- 293,400
Collection of loans receivable through the receipt
of stock ...................................... (146,668) (100) (175,900) -- (176,000)
Stock-based compensation .......................... -- -- 649,100 -- 649,100
Derivative instrument liability ................... -- -- (2,273,700) -- (2,273,700)
Reclassify fair value of derivative instrument
liability ..................................... -- -- 2,273,700 -- 2,273,700
Net loss for the year ended September 30, 2007 .... -- -- -- (3,279,100) (3,279,100)
------------ ------------ ------------ ------------ ------------
Balance at September 30, 2007 ..................... 25,299,547 $ 25,300 $ 16,630,000 $(11,302,200) $ 5,353,100
------------ ------------ ------------ ------------ ------------
Stock- based compensation ......................... -- -- 1,071,300 -- 1,071,300
Net loss for the year ended September 30, 2008 .... -- -- -- (5,371,500) (5,371,500)
------------ ------------ ------------ ------------ ------------
Balance at September 30, 2008 ..................... 25,299,547 $ 25,300 $ 17,701,300 $(16,673,700) $ 1,052,900
============ ============ ============ ============ ============
See accompanying Notes to Consolidated Financial Statements
62
CNS RESPONSE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
2008 2007
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ....................................................... $(5,371,500) $(3,279,100)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................................ 6,300 19,900
Other ........................................................ -- (106,900)
Stock based compensation ..................................... 1,071,300 649,100
Non-cash interest expense .................................... -- 189,800
Changes in operating assets and liabilities:
Accounts receivable ........................................ (39,000) (32,900)
Prepaids and other ......................................... (30,400) (87,900)
Accounts payable ........................................... 116,300 (271,200)
Deferred compensation and others ........................... 192,600 (39,700)
Accrued patient costs ...................................... 397,500 --
----------- -----------
Net cash used in operating activities ...................... (3,656,900) (2,958,900)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deferred offering relating to acquisition ...................... (43,700) --
Furniture and fixtures ......................................... (30,900) --
Increase in deposits ........................................... -- (3,000)
Loans to employees ............................................. -- (4,200)
----------- -----------
Net cash used in investing activities ...................... (74,600) (7,200)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of note .............................................. (60,600) --
Repayment of lease payable ..................................... (1,000) --
Repayment of debt .............................................. -- (5,000)
Proceeds from the sale of preferred stock, net of offering costs -- 1,779,900
Proceeds from the sale of common stock, net of offering costs .. -- 6,748,400
Proceeds from exercise of warrants ............................. -- 28,000
----------- -----------
Net cash provided (used) by financing activities ........... (61,600) 8,551,300
----------- -----------
NET INCREASE (DECREASE) IN CASH ................................... (3,793,100) 5,585,200
CASH- BEGINNING OF YEAR ........................................... 5,790,100 204,900
----------- -----------
CASH- END OF YEAR ................................................. $ 1,997,000 $ 5,790,100
=========== ===========
63
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ..................................................... $ 22,440 $ 2,300
=========== ===========
Income taxes ................................................. $ 5,972 $ 800
=========== ===========
Fair value of note payable to officer issued for acquisition ... $ 265,900 --
=========== ===========
Fair value of equipment acquired through lease ................. $ 10,500 --
=========== ===========
Conversion of preferred stock into common stock ................ -- 5,958,200
=========== ===========
Conversion of promissory notes and related accrued interest
into preferred stock ......................................... -- 4,067,100
=========== ===========
Common stock received as collection of loans receivable ........ -- 176,000
=========== ===========
Derivative instrument liability ................................ -- 2,273,700
=========== ===========
See accompanying Notes to Consolidated Financial Statements
64
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
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.
In addition, as a result of its acquisition of Neuro-Therapy Clinic,
P.C. ("NTC") on January 11, 2008, the Company provides behavioral health care
services. NTC is a center for highly-advanced testing and treatment of
neuropsychiatric problems, including learning, attentional and behavioral
challenges, mild head injuries, as well as depression, anxiety, bipolar and all
other common psychiatric disorders. Through this acquisition, the Company
expects to advance neurophysiology data collection, beta-test planned
technological advances in rEEG, advance physician training in rEEG and
investigate practice development strategies associated with rEEG.
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 and equity 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 is currently exploring
additional sources of capital but there can be no assurances that any financing
arrangement will be available in amounts and terms acceptable to the Company.
2. REVERSE MERGER AND FINANCING
COMPLETION OF MERGER
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 ("CNS California"),
pursuant to which CNS California would be acquired by the Company in a merger
transaction wherein Merger Sub would merge with and into CNS California, with
CNS California being the surviving corporation (the "Merger"). On March 7, 2007,
the Merger closed and CNS California became a wholly-owned subsidiary of the
Company. At the closing, the Company changed its name to CNS Response, Inc.
65
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
From a historical perspective, CNS California was deemed to have been
the acquirer in the reverse merger and CNS California is deemed the survivor of
the reorganization. As a result, the consolidated financial statements of the
Company presented reflect the historical results of CNS 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 CNS 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.
PRINCIPAL TERMS OF THE MERGER
On March 7, 2007, Merger Sub was merged with and into CNS California,
the separate existence of Merger Sub ceased, and CNS California continued as the
surviving corporation at the subsidiary level. Pursuant to the Merger, the
issued and outstanding shares of common stock of CNS California were converted
into an aggregate of 9,845,132 shares of Company Common Stock, and the issued
and outstanding shares of Series A and B preferred stock of CNS California were
converted into 5,993,515 and 1,905,978 shares of Company Common Stock,
respectively. In addition warrants and options to purchase shares of common
stock of CNS California were converted into warrants and options to purchase
4,271,414 and 4,136,103 shares of Company Common Stock, respectively. Following
the Merger, the business conducted by the Company is the business conducted by
CNS California.
Pursuant to the terms of the Merger Agreement, CNS Response, Inc.
(formerly Strativation, Inc.) paid an advisory fee of $475,000 to Richardson &
Patel, 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 CNS California described below, the Company had outstanding
18,696,948 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.
ACCOUNTING TREATMENT OF THE MERGER AND FINANCIAL STATEMENT PRESENTATION
The Company accounted for the Merger as a reverse merger under
generally accepted accounting principles, and accordingly, the consolidated
financial statements of the Company for the periods before March 7, 2007,
reflect only the operations of CNS California. No goodwill or other intangible
asset was recorded as a result of the Merger. Immediately prior to the reverse
merger on March 7, 2007, the Company had no material operations, assets, or
liabilities. Therefore, pro forma financial statements are not presented.
THE PRIVATE PLACEMENT
Immediately following the closing of the Merger, the Company 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"). On May 15, 2007, the Company
received additional gross proceeds of $797,300 from the second closing of the
Private Placement. Pursuant to Subscription Agreements entered into with these
Investors, the Company sold 6,504,758 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
66
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
Company common stock at an exercise price of $1.80 per share. The value of the
warrants was determined to be $1,674,600 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 was recorded as a liability in accordance with SFAS No.
133 and EITF 00-19. As of June 22, 2007, the common shares underlying the
warrants were registered satisfying the warrant liability. As of such date, the
value of the warrants had not changed and thus the recorded amount was
reclassified to Stockholders' Equity.
As partial 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 520,380 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 $599,100 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 was recorded as a liability in accordance with SFAS No.
133 and EITF 00-19. As of June 22, 2007, the common shares underlying the
warrants were registered satisfying the warrant liability. As of such date, the
value of the warrants had not changed and thus the recorded amount was
reclassified to Stockholders' Equity.
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 subsidiaries
CNS California and NTC. 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 assets and liabilities that are not readily apparent from
other sources. Actual results may differ materially from these estimates.
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.
67
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
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 collectability 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.
FIXED ASSETS
Fixed assets which are recorded at cost consist of office furniture and
equipment and are depreciated over their estimated useful life on a
straight-line basis. The useful life of these assets is estimated to be from 3
to 5 years. Depreciation and accumulated depreciation for the year ended
September 30, 2008 is $6,300.
GOODWILL
In accordance with SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS,
goodwill will not be amortized but instead will be tested for impairment at
least annually, or more frequently if certain indicators are present.
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, 2008
and 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.
68
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
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 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, 2008 and 2007.
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 two measurements of profitability and does disaggregate its business for
internal reporting and therefore operates two business segments which are
comprised of a reference laboratory and a clinic. The Reference Laboratory
provides reports ("rEEG Reports") that assist physicians with treatment
strategies for patients with behavioral (psychiatric and/or addictive) disorders
based on the patient's own physiology. The Clinic operates NTC, a full service
psychiatric practice.
RECLASSIFICATIONS
Certain amounts in prior years have been reclassified to conform to
current year presentation. These reclassifications had no effect on previously
reported operating loss or net income.
69
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE
MEASUREMENTS ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
and expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, this Statement does not require any new fair value measurements.
SFAS No. 157 is effective for fiscal years beginning after December 15, 2007.
The adoption of SFAS No. 157 did not have a material impact on the Company's
consolidated operating results and financial condition.
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.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
"Business Combinations," or SFAS No. 141R. SFAS No. 141R replaces SFAS No. 141,
"Business Combinations." SFAS No. 141R establishes principles and requirements
for how an acquiror recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree, and the goodwill acquired or a gain from a bargain
purchase. SFAS No. 141R also determines disclosure requirements to enable the
evaluation of the nature and financial effects of the business combination. SFAS
No. 141R applies prospectively to business combinations for which the
acquisition date is on or after the beginning of a fiscal year that begins on or
after December 15, 2008 and has implications for acquisitions that occur prior
to this date. The Company does not expect the adoption of SFAS No. 141R will
have a material impact on its current financial position, results of operations
and cash flows.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements," or SFAS No. 160. SFAS No. 160
amends Accounting Research Bulletin 51, "Consolidated Financial Statements," or
ARB 51, and requires all entities to report noncontrolling (minority) interests
in subsidiaries within equity in the consolidated financial statements, but
separate from the parent shareholders' equity. SFAS No. 160 also requires any
acquisitions or dispositions of noncontrolling interests that do not result in a
change of control to be accounted for as equity transactions. Further, SFAS No.
160 requires that a parent recognize a gain or loss in net income when a
subsidiary is deconsolidated. SFAS No. 160 is effective for fiscal years
beginning on or after December 15, 2008. The Company does not expect the
adoption of SFAS No. 160 will have a material, if any, impact on its financial
position, results of operations and cash flows.
In May 2008, the FASB issued the final version of Staff Position No.
APB 14-1, ACCOUNTING FOR CONVERTIBLE DEBT INSTRUMENTS THAT MAY BE SETTLED IN
CASH UPON CONVERSION (INCLUDING PARTIAL CASH SETTLEMENT ("APB 14-1") that
requires the liability and equity components of convertible debt instruments
that may be settled in cash upon conversion (including partial cash settlement)
to be separately accounted for in a manner that reflects the issuer's
nonconvertible debt borrowing rate. APB 14-1 is effective for fiscal years
beginning after December 15, 2008, which for the Company will be fiscal 2010,
and interim periods within those fiscal years and must be applied
retrospectively to all periods presented, which for the Company would include
the comparative quarterly presentations for fiscal 2009. Accordingly, commencing
in fiscal 2010, the Company will present prior period comparative results
reflecting the impact of APB 14-1 if determined to apply to the Company at that
time. The Company is currently evaluating the impact APB 14-1 will have on its
consolidated financial statements, if any.
70
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
In March 2008, the FASB issued SFAS No. 161, DISCLOSURES ABOUT
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -- AN AMENDMENT OF FASB STATEMENT
133 ("SFAS No. 161"). SFAS No. 161 requires companies with derivative
instruments to disclose information that should enable financial-statement users
to understand how and why a company uses derivative instruments, how derivative
instruments and related hedged items are accounted for under SFAS No. 133
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES and how derivative
instruments and related hedged items affect a company's financial position,
financial performance and cash. SFAS No. 161 is effective for fiscal years and
interim periods beginning after November 15, 2008. The Company is currently
evaluating the impact of this pronouncement on its consolidated financial
statements, if any.
In April 2008, the FASB issued Staff Position No. FAS 142-3,
DETERMINATION OF THE USEFUL LIFE OF INTANGIBLE ASSETS ("FAS 142-3") that amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent
of FAS 142-3 is to improve the consistency between the useful life of a
recognized intangible asset under Statement 142 and the period of expected cash
flows used to measure the fair value of the asset under SFAS No. 141 and other
U.S. generally accepted accounting principles. FAS 142-3 is effective for fiscal
years and interim periods beginning after December 15, 2008. The Company is
currently evaluating the impact of this pronouncement on its consolidated
financial statements, if any.
4. LOANS TO RELATED PARTIES
From September 2006 through February 2007, CNS California loaned
certain officer, employees and a consultant $171,800 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 CNS California following the date on which CNS
California 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 notes provided that repayment of the notes
could be made in one of the following ways, or in combination of both:
(a) in cash, or
(b) by tendering Common Stock of CNS California 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 and the terms of the merger
described in Note 2 above, the Company demanded payment of all such notes upon
the completion of the merger and private placement in which the Company raised
approximately $7,805,000. The officer who owed the Company $93,900, including
interest, repaid the loan by tendering 78,219 shares of the Company's Common
Stock to the Company. Certain other employees and consultants repaid their loans
by tendering an aggregate of 68,449 shares of the Company's common stock to the
Company. None of the aforementioned notes remained outstanding as of September
30, 2008.
71
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
5. CONVERTIBLE PROMISSORY NOTES
Prior to September 30, 2006, CNS California 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 CNS
California 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).
In October 2006, CNS California and the note holders of certain
convertible promissory notes converted 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 CNS California Series A Preferred
Stock. In addition, the exercise price of warrants to purchase 1,062,116 shares
of the CNS California common stock issued to such note holders was changed to
$0.59 per share. As described in Note 2, upon the merger with Strativation, the
preferred shares were converted into 5,993,515 shares of the Company's common
stock and the warrants were converted into warrants to purchase 1,062,116 shares
of the Company's common stock at $0.59 per share. The consolidated financial
statements of the Company presented reflect the issuance of these shares as
common stock.
As of September 30, 2008 and 2007, one note with a principal balance of
$50,000 was outstanding.
6. NOTE PAYABLE TO NUPHARM DATABASE, LLC
In connection with the January 2000 Asset Purchase Agreement between
CNS California and NuPharm Database, LLC (NuPharm) providing for the purchase of
a database and the assumption of certain NuPharm liabilities, CNS California
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
2,800,000 shares of CNS California's common stock at $0.01 per share. The
warrant was not exercised before expiring in 2005.
In October 2006, CNS California and 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 CNS California's common stock at
$0.01 per share. The note was due and payable on demand five years from the date
of issuance, could be prepaid by the Company at any time without penalties and
was convertible into shares of common stock of CNS California upon the
completion of a financing (as defined) at a price per share of the common stock
issued in such financing. The warrant was exercised in October 2006. CNS
California valued the warrant at $309,500 using the Black-Scholes model and
recorded the excess of the value of the warrant over the forgiven accrued
interest of $119,800 as a prepaid asset. The excess was being amortized as
interest expense over a period of one year, the expected term of the note when
it was issued.
Pursuant to the abovementioned terms, the note payable to NuPharm and
accrued interest thereon were converted into 244,509 shares of the Company's
Common Stock upon the completion of the merger and private placement described
in Note 2 above. Upon conversion, the entire balance of the unamortized prepaid
interest was charged to interest expense.
72
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
7. STOCKHOLDERS' EQUITY
COMMON AND PREFERRED STOCK
As of September 30, 2008 the Company is authorized to issue 750,000,000
shares of common stock.
As of September 30, 2008, CNS California is 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.
As of September 30, 2008, Colorado CNS Response, Inc. is authorized to
issue 1,000,000 shares of common stock.
As of September 30, 2008, Neuro-Therapy Clinic, P.C., a wholly-owned
subsidiary of Colorado CNS Response, Inc., is authorized to issue ten thousand
shares of common stock, no par value per share.
As described in Note 6 above, in October 2006, NuPharm exercised the
warrant to purchase 2,800,000 shares of CNS California's common stock at a price
of $0.01 per share. These common shares were converted into 2,800,000 shares of
the Company's common stock upon the completion of the merger described in Note 2
above.
As described in Note 5 above, in October 2006, CNS California and the
note holders of certain of the convertible promissory notes converted promissory
notes with an aggregate outstanding balance of $3,061,700 and related accrued
and unpaid interest of $1,005,400 at September 30, 2006 into 5,993,515 shares of
the CNS California's Series A Preferred Stock. These 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 above.
In October, 2006, CNS California sold 1,905,978 Units in a private
financing resulting in net proceeds of $1,877,400. Each Unit consists of one
share of Series B Preferred Stock and 5-year warrants to purchase 0.6 shares of
the CNS California's common stock at $1.51 per share. Holders of the Series B
Preferred Stock were 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 CNS California
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 Note 6) 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. All shares of preferred stock were converted into
1,905,978 shares of common stock concurrently with the completion of the Merger
as described in Note 2 above.
73
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
As described in Note 2 above, in March and May 2007, the Company sold
6,504,758 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.
As described in Note 2 above, as partial consideration for services
rendered further to the private placement, the Company's placement agent was
issued 83,333 shares of the Company's common stock.
As described in Note 6 above, the note payable to NuPharm and accrued
interest thereon were converted into 244,509 shares of the Company's Common
Stock upon the completion of the merger and private placement described in Note
2 above.
As described in Note 4 above, an officer and certain employees and
consultants repaid their loans to the Company by tendering 146,668 shares of the
Company's common stock.
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 could be granted only to
eligible employees. At September 30, 2008, there were no options outstanding
under this plan and the Company intends to terminate this plan.
In connection with the Merger described in Note 2, the Company assumed
the CNS California stock option plan described below and all of the options
granted thereunder at the same price and terms.
On August 3, 2006, CNS California adopted the CNS 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 non-statutory 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 September
30, 2008, there were 8,964,567 options and 183,937 restricted shares outstanding
under the 2006 Plan and 498,739 shares available for issuance of awards.
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
74
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
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:
RISK-FREE
DIVIDEND INTEREST EXPECTED EXPECTED
OPTIONS GRANTED IN: YIELD RATE VOLATILITY LIFE
- ------------------- -------- --------- ---------- --------
Fiscal 2006 0% 5.46% 100% 5 years
November 2006 0% 5.00% 100% 10 years
August 2007 0% 4.72% 91% 5 years
October 2007 0% 4.60% 105% 5 years
December 2007 0% 4.00% 113% 5 years
April 2008 0% 3.78% 172% 5 years
September 2008 0% 3.41% 211% 5 years
The expense is recognized over the employees' requisite service period,
generally the vesting period of the award. Stock-based compensation expense
included in the accompanying statements of operations for the years ended
September 30, 2008 and 2007 is as follows:
For the fiscal year ended
September 30,
-----------------------
2008 2007
---------- ----------
Operations $ 16,100 $ 20,100
Research and development 321,200 212,000
Sales and marketing 83,100 --
General and administrative 651,000 417,000
---------- ----------
Total $1,071,400 $ 649,100
========== ==========
Total unrecognized compensation as of September 30, 2008 amounted to
$2,004,500.
A summary of stock option activity is as follows:
Weighted
Average
Number of Exercise
Shares Price
--------- ---------
Outstanding at September 30, 2006 .................... 4,000,403 $ 0.13
Granted ......................................... 3,436,300 $ 1.07
Exercised ....................................... -- --
Forfeited ....................................... -- --
Outstanding at September 30, 2007 .................... 7,436,703 $ 0.57
Granted ......................................... 1,880,621 $ 0.85
Exercised ....................................... -- --
Forfeited ....................................... (352,757) $ 1.09
Outstanding at September 30, 2008 .................... 8,964,567 $ 0.60
Weighted average fair value of options granted during:
Year ended September 30, 2006 ................... -- $ 0.09
Year ended September 30, 2007 ................... -- $ 0.77
Year ended September 30, 2008 ................... -- $ 0.73
75
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
Following is a summary of the status of options outstanding at
September 30, 2008:
Weighted Average Weighted Average
Exercise Price Number of Shares Contractual Life Exercise Price
$0.12 859,270 10 years $0.12
$0.132 3,112,545 7 years $0.132
$0.30 135,700 10 years $0.30
$0.59 28,588 10 years $0.59
$0.80 140,000 10 years $0.80
$0.89 968,875 10 years $0.89
$0.96 496,746 10 years $0.96
$1.09 2,614,232 10 years $1.09
$1.20 333,611 5 years $1.20
$0.51 275,000 10 Years $0.51
----------------- -----------------
Total 8,964,567 $0.60
================= =================
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.
During the year ended September 30, 2007, the following additional
3,784,199 warrants were granted and are outstanding as of such date:
Warrants to Purchase Exercise Price Issued in Connection With:
1,143,587 shares $1.51 Private placement described in Note 2
7,921 shares $1.01 To placement agent for private
placement described in Note 2
4,752 shares $1.812 To placement agent for private
placement described in Note 2
1,951,445 shares $1.80 Private placement completed
immediately after the merger and
described in Note 2
520,380 shares $1.44 To placement agent for private
placement completed immediately after
the merger and described in Note 2
156,114 shares $1.80 To placement agent for private
placement completed immediately after
the merger and described in Note 2
76
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
As described in Note 2, the warrants to purchase 2,107,559 shares of
common stock at $1.80 per share and the warrants to purchase 520,380 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. As of June 22, 2007,
the common shares underlying the warrants were registered satisfying the warrant
liability. As of such date, the value of the warrants had not changed and thus
the recorded amount was reclassified to Stockholders' Equity.
At September 30, 2007, there were warrants outstanding to purchase
6,899,353 shares of the Company's common stock at exercise prices ranging from
$0.01 to $1.812 with a weighted average exercise price of $1.04. The warrants
expire at various times through 2017. No warrants were issued or exercised
during the 12 months ended September 30, 2008. Accordingly, all warrants are
outstanding at September 30, 2008.
8. 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:
2008 2007
----- -----
Federal income tax (benefit) at statutory rates .............. (34)% (34)%
Gain from troubled debt restructured with related parties .... 0% 0%
Stock-based compensation ..................................... 20% 17%
Non deductible interest expense .............................. 0% 6%
Change in valuation allowance ................................ 14% 11%
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, 2008 and 2007:
77
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
2008 2007
----------- -----------
Deferred income tax assets:
Net operating loss carryforward .......................... $ 4,953,000 $ 3,257,800
Deferred interest, consulting and compensation liabilities 17,000 14,300
Amortization ............................................. 223,300 223,300
----------- -----------
5,193,300 3,495,400
Deferred income tax liabilities--other ....................... (12,300) (12,100)
----------- -----------
Deferred income tax asset--net before valuation allowance .... 5,181,000 3,483,300
Valuation allowance .......................................... (5,181,000) (3,483,300)
----------- -----------
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, 2008 we have net
operating loss carryforwards of approximately $12.4 million. The net operating
loss carryforwards expire by 2027. 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.
9. ACQUISITION OF NEURO THERAPY CLINIC, PC
On January 11, 2008, the Company, through its wholly owned subsidiary,
Colorado CNS Response, Inc., acquired all of the outstanding common stock of
Neuro-Therapy Clinic, PC ("NTC") in exchange for a non-interest bearing note
payable of $300,000 payable in equal monthly installments over 36 months. Upon
the completion of the acquisition, the sole shareholder of NTC was appointed
Chief Medical Officer of the Company. Prior to the acquisition, NTC was the
Company's largest customer.
The acquisition was accounted under the purchase method of accounting,
and accordingly, the purchase price was allocated to NTC's net tangible assets
based on their estimated fair values as of January 11, 2008. The excess purchase
price over the value of the net tangible assets was recorded as goodwill. The
purchase price and the allocation thereof are as follows:
Fair value of note payable issued ............. $ 265,900
Direct transaction costs ...................... 43,700
---------
Purchase price ................................ 309,600
Allocated to net tangible liabilities,
including cash of $32,100 .................. (10,600)
---------
Allocated to goodwill ......................... $ 320,200
=========
Upon the occurrence of certain events, as defined in the purchase
agreement, the prior sole Shareholder of NTC has a repurchase option for a
period of three years subsequent to the closing, as well as certain rights of
first refusal, in relation to the assets and liabilities acquired by the
Company.
The acquisition was not material, and accordingly, no pro forma results
are presented.
10. LONG-TERM DEBT
As described in Note 9 above, during the year ended September 30, 2008
the Company issued a note payable to an officer in connection with the
acquisition of NTC. The note is non-interest bearing and the Company determined
its fair value by imputing interest at an annual rate of 8%. As of September 30,
2008 the note has an outstanding principal balance in the amount of $205,300.
78
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
11. REPORTABLE SEGMENTS
The Company operates in two business segments: reference laboratory and
clinic. Reference laboratory provide reports ("rEEG Reports") that assist
physicians with treatment strategies for patients with behavioral (psychiatric
and/or addictive) disorders based on the patient's own physiology. Clinic
operates NTC, a full service psychiatric practice.
The following tables show operating results for our reportable
segments, along with reconciliation from segment gross profit to (loss) from
operations, the most directly comparable measure in accordance with generally
accepted accounting principles in the United States, or GAAP:
Year ended September 30, 2008
------------------------------------------------------------
Reference
Laboratory Clinic Eliminations Total
------------ ------------ ------------ ------------
Revenues ................... 197,400 595,000 (18,900) 773,500
Operating expenses:
Cost of revenues ......... 163,200 9,200 (9,200) 163,200
Research and development . 2,097,300 -- -- 2,097,300
Sales and marketing ...... 847,600 33,800 -- 881,400
General and administrative 2,358,700 756,700 (9,700) 3,105,700
------------ ------------ ------------ ------------
Total operating expenses . 5,466,800 799,700 (18,900) 6,247,600
------------ ------------ ------------ ------------
Loss from operations ....... $ (5,269,400) $ (204,700) $ 0 $ (5,474,100)
============ ============ ============ ============
The following table includes selected segment financial information as of
September 30, 2008, related to goodwill and total assets:
Reference
Laboratory Clinic Total
---------- ---------- ----------
Goodwill .......................... $ 320,200 $ -- $ 320,200
========== ========== ==========
Total assets ...................... $2,550,200 $ 83,300 $2,633,500
========== ========== ==========
79
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
12. 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. For the years ended September 30, 2008 and 2007, 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, 2008 and 2007 is as
follows:
2008 2007
------------ ------------
Net loss for computation of basic net income
(loss) per share ............................ $ (5,371,500) $ (3,279,100)
------------ ------------
Net income (loss) for computation of dilutive
net income (loss) per share ................. $ (5,371,500) $ (3,279,100)
============ ============
Basic net income (loss) per share .............. $ (0.21) $ (0.17)
============ ============
Diluted net income (loss) per share ............ $ (0.21) $ (0.17)
============ ============
Basic weighted average shares outstanding ...... 25,299,547 18,778,077
Dilutive common equivalent shares .............. -- --
------------ ------------
Diluted weighted average common shares ......... 25,299,547 18,778,077
============ ============
Anti-dilutive common equivalent shares not
included in the computation of dilutive
net loss per share:
Convertible debt ....................... 4,995,000 6,283,989
Warrants ............................... 6,899,353 5,372,566
Options ................................ 8,767,212 4,598,260
Preferred Stock ........................ -- 767,324
15. COMMITMENTS AND CONTINGENT LIABILITIES
LITIGATION
From time to time 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.
80
CNS RESPONSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED
SEPTEMBER 30, 2008 AND 2007
LEASE COMMITMENTS
The Company leases its headquarters and Laboratory Information Services
space under an operating lease. In November 2008, the Company entered into a new
six-month lease for its headquarters at the same location expiring in May 2009
and requiring monthly rentals of $3,610.
The Company leases space for its Clinical Services operations under an
operating lease. The base rental as of September 2008 is $5,726 per month. This
increases to $6,021 per month in March 2009 through to the termination of the
lease on February 28, 2010.
The Company also sub-leases space for its Clinical Services operations
on a month-to-month basis for $1,075 per month.
The Company leases a copier for $216 per month which it accounts for as
a capital lease with an interest rate of 9% per year. The lease terminates in
February 2013 at which time the copier can be purchased at fair value.
FUTURE MINIMUM LEASE PAYMENT AND DEBT MATURITIES
At September 30, 2008, the estimated future minimum lease payment under
non-cancelable operating and capital leases and debt maturities were as follows:
OPERATING CAPITAL DEBT
YEAR ENDING SEPTEMBER 30, LEASES LEASE MATURITIES TOTAL
- ----------------------------------- --------- --------- --------- ---------
2009 .............................. $ 99,700 $ 2,600 $ 100,000 $ 202,200
2010 .............................. 30,100 2,600 100,000 132,600
2011 .............................. -- 2,600 25,000 27,500
2012 .............................. -- 2,600 -- 2,500
2013 .............................. -- 1,100 -- 1,500
--------- --------- --------- ---------
Total ........................... $ 129,800 $ 11,500 $ 225,000 $ 366,300
Less interest ..................... (6,700) (2,000) (19,700) (28,400)
--------- --------- --------- ---------
Net present value ................. 123,100 9,500 205,300 337,900
Less current portion .............. (95,800) (1,800) (86,700) (184,300)
--------- --------- --------- ---------
Long-term debt and lease obligation $ 27,300 $ 7,700 $ 118,600 153,600
========= ========= ========= =========
16. SIGNIFICANT CUSTOMERS
For the year ended September 30, 2008, two customers accounted for 29%
of Laboratory Information Services revenue and 24% of accounts receivable at
September 30, 2008.
For the year ended September 30, 2007, four customers accounted for 58% of
the Laboratory Information Services revenue and 48% of accounts receivable at
September 30, 2007.
81
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A(T). CONTROLS AND PROCEDURES
CONTROLS AND PROCEDURES
Our management, including our principal executive officer (PEO) and
principal financial officer (PFO), conducted an evaluation of the effectiveness
of our disclosure controls and procedures, as defined by paragraph (e) of
Exchange Act Rules 13a-15, as of September 30, 2008, the end of the period
covered by this report. Based on this evaluation, our PEO and PFO concluded that
our disclosure controls and procedures were not effective as of September 30,
2008 for the reasons described below.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. As defined in Rule 13a-15(f) under
the Exchange Act, internal control over financial reporting is a process
designed by, or under the supervision of, our PEO and PFO and effected by our
board of directors, management, and other personnel, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and procedures that:
1. Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of our assets;
2. Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that our receipts and expenditures
are being made only in accordance with authorization of our management and
directors; and
3. Provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.
Management, including our Chief Executive Officer (who is our Principal
Executive Officer and Principal Financial Officer), do not expect that our
disclosure controls and procedures or our internal control over financial
reporting will prevent all errors or all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within our company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management's override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions.
Also, over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate.
82
ASSESSMENT OF INTERNAL CONTROLS OVER FINANCIAL REPORTING
Under the supervision and with the participation of our management,
including Leonard Brandt our PEO and PFO, we evaluated the effectiveness of our
internal control over financial reporting as of September 30, 2008, based on the
framework and criteria established by the Committee of Sponsoring Organizations
of the Treadway Commission ("COSO"), and we concluded that our internal controls
over financial reporting were not effective.
In reaching our conclusion, we considered the findings of an external
finance and accounting advisory firm with relevant SEC compliance experience,
who informed management of "material weaknesses" and several "significant
deficiencies" that collectively constituted a "material weakness" in our
internal control over financial reporting.
A "material weakness" is a deficiency, or combination of deficiencies,
in internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of our annual or interim financial
statements will not be prevented or detected on a timely basis.
A "significant deficiency" is a deficiency, or combination of
deficiencies, in internal control over financial reporting that is less severe
than a material weakness, yet important enough to merit attention by those
responsible for oversight of our financial reporting.
The following material weaknesses were identified:
o We do not have proper segregation of duties within the
accounting and finance function.
o We do not have proper oversight and review by upper management
of the accounting and finance function.
The following significant deficiencies were identified, which in
combination with other deficiencies may constitute a material weakness:
o We do not have a comprehensive and formalized accounting and
procedures manual.
o We do not always retain proper documentation for audit
support.
To the knowledge of our management, including our PEO and PFO, none of
the aforementioned material weaknesses or significant deficiencies led to a
misstatement of our results of operations for the year ended September 30, 2008,
or statement of financial position as of September 30, 2008.
This annual report does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by our registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit us to provide only management's report in this
annual report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarterly period ending September 30, 2008, there were no
changes in our internal controls over financial reporting that have materially
83
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. Since our year ended September 30, 2008, due to the
departure of our VP Finance and Controller which occurred on December 19, 2008,
we do not have personnel with sufficient financial expertise. For this reason,
we have retained the services of outside consultants to perform various
accounting and finance functions for us.
ITEM 9B. OTHER INFORMATION
None.
84
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Information regarding directors and executive officers will appear in
the definitive proxy statement for the 2009 annual meeting of CNS Response
shareholders, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear in the
definitive proxy statement for the 2009 annual meeting of CNS Response
stockholders, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners
and management and related stockholder matters will appear in the definitive
proxy statement for the 2009 annual meeting of CNS Response shareholders, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information regarding certain relationships and related transactions
will appear in the definitive proxy statement for the 2009 annual meeting of CNS
Response shareholders, and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information regarding principal accounting fees and services will
appear in the definitive proxy statement for the 2009 annual meeting of CNS
Response shareholders, and is incorporated herein by reference.
85
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. The information required by this item is included in Item 8 of
Part II of this annual report.
2. The information required by this item is included in Item 8 of
Part II of this annual report.
3. Exhibits: See Index to Exhibits, which is incorporated by
reference in this Item. The Exhibits listed in the
accompanying Index to Exhibits are filed or incorporated by
reference as part of this annual report.
(b) Exhibits. See Index to Exhibits, which is incorporated by reference in
this Item. The Exhibits listed in the accompanying Index to Exhibits
are filed or incorporated by reference as part of this annual report.
(c) Not applicable.
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CNS RESPONSE, INC.
By: /S/ LEONARD BRANDT
-----------------------
Leonard J. Brandt
Chief Executive Officer
Date: January 13, 2009
POWER OF ATTORNEY
The undersigned directors and officers of CNS Response, Inc. do hereby
constitute and appoint Leonard J. Brandt with full power of substitution and
resubstitution, as their true and lawful attorney and agent, to do any and all
acts and things in their name and behalf in their capacities as directors and
officers and to execute any and all instruments for them and in their names in
the capacities indicated below, which said attorney and agent, may deem
necessary or advisable to enable said corporation to comply with the Securities
Exchange Act of 1934, as amended and any rules, regulations and requirements of
the Securities and Exchange Commission, in connection with this Annual Report on
Form 10-K, including specifically but without limitation, power and authority to
sign for them or any of them in their names in the capacities indicated below,
any and all amendments hereto, and they do hereby ratify and confirm all that
said attorneys and agents, or either of them, shall do or cause to be done by
virtue hereof.
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/S/ LEONARD BRANDT Chief Executive Officer, January 13, 2009
- --------------------------- Director (Principal Executive,
Leonard J. Brandt Financial and Accounting
Officer)
/S/ DAVID B. JONES Director January 13, 2009
- ---------------------------
David B. Jones
- --------------------------- Director
Jerome Vaccaro, M.D.
/S/ HENRY HARBIN Director January 13, 2009
- ---------------------------
Henry T. Harbin, M. D.
87
INDEX TO EXHIBITS
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 Amendment of Certificate of Incorporation, dated
September 7, 2005. Incorporated by reference to Exhibit 4.4 to
the Registrant's Registration Statement on Form S-8 (File No.
333-150398) filed with the Commission on April 23, 2008.
3.1.5 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.
10.1 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.
10.2 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.
10.3 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.
10.4 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.
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EXHIBIT
NUMBER EXHIBIT TITLE
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10.5 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.
10.6 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.
10.7 Employment Agreement by and between the Registrant and George
Carpenter dated October 1, 2007. Incorporated by reference to
Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on October 3, 2007.*
10.8 Employment Agreement by and between the Registrant and Daniel
Hoffman dated January 11, 2008. Incorporated by reference to
Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File
No. 000-26285) filed with the Commission on January 17, 2008.*
10.9 Stock Purchase Agreement by and among Colorado CNS Response,
Inc., Neuro-Therapy, P.C. and Daniel A. Hoffman, M.D. dated
January 11, 2008.
14.1 Code of Ethics. Incorporated by reference to Exhibit 14.1 to the
Registrant's Annual Report on Form 10-KSB/A (File No. 000-26285)
filed with the Commission on January 24, 2008.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Registered Public Accounting Firm.
24.1 Power of Attorney (included as part of the Signature Page).
31.1 Certification by Chief Executive Officer pursuant to Rule
13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934,
as amended.
31.2 Certification by Principal Financial Officer pursuant to Rule
13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934,
as amended.
32.1 Certification of Chief Executive Officer (Principal Accounting
and Financial Officer) pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Figures 1-6.
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* Management contract or compensatory plan or arrangement.
89