[May 15, 2013] CNS RESPONSE, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The information contained in this Form 10-Q is intended to update the information contained in our Annual Report on Form 10-K for the year ended September 30, 2012 and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operation" and other information contained in such Form 10-K. The following discussion and analysis also should be read together with our consolidated financial statements and the notes to the consolidated financial statements included elsewhere in this Form 10-Q. 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 three and six months ended March 31, 2013 and 2012. Except for historical information, the matters discussed in this management's discussion and analysis or plan of operation and elsewhere in this Quarterly Report on Form 10-Q, are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that include information relating to, among other things, 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: · our limited capital and inability to raise additional funds to support operations and capital expenditures; · our inability to gain widespread acceptance of our PEER Reports in existing and new market segments; · our inability to prevail in convincing the FDA that our rEEG or PEER Online service does not constitute a medical device and should not be subject to regulation; · our inability to successfully compete against existing and future competitors; · our inability to manage and maintain the growth of our business; · our inability to protect our intellectual property rights; and · other factors discussed under the headings "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" in our Annual Report on Form 10-K for the year ended September 30, 2012 and in this Quarterly Report on Form 10-Q. 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. Overview We are is a clinical decision support Company with a commercial neurometric platform to predict drug response for treatment of brain disorders, including depression, anxiety, bipolar disorder and post-traumatic stress disorder. We have commenced a reimbursed 2,000 patient trial at Walter Reed National Military Medical Center ("Walter Reed" or "WRNMMC") and Fort Belvoir Community Hospital (Fort Belvoir) in Virginia focused on patients suffering from depression, post-traumatic stress disorder ("PTSD") and mild traumatic brain injury ("mTBI") in order to support clinical decisions in the treatment of depression and related disorders. We will be reimbursed by Walter Reed and Fort Belvoir at a standard rate of $540 for each PEER Outcome report rendered in the study. PEER stands for Psychiatric EEG Evaluation Registry ("PEER"). During the quarter the Company completed training of physicians and implemented testing services at Walter Reed, and began implementation of testing services at Ft. Belvoir. Additionally, under an agreement with Henry Jackson Foundation, the Company is placing study personnel in each location including a study monitor, EEG technicians, and clinical research coordinators. 39 Neurometric Services Because of the lack of objective neurophysiology data available to physicians, the underlying pathology and physiology of behavioral disorders such as depression, bipolar disorder, eating disorder, addiction, anxiety disorders and attention deficit hyperactivity disorder (ADHD) can rarely be analyzed effectively by treating physicians. Doctors are ordinarily forced to make prescription decisions based only on symptomatic factors. As a result, treatment can often be ineffective, costly and may require multiple courses of treatment before the effective medications are identified, if at all. We believe that our technology offers an improvement over traditional methods for evaluating pharmacotherapy options in patients suffering from non-psychotic behavioral disorders, because our technology is designed to correlate the success of courses of medication with the neurophysiological characteristics of a particular patient. 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. This treatment outcome information is contained in what we believe to be the largest outcomes database for mental health care pharmacotherapy. There are now over 34,000 outcomes within the database from over 9,000 unique patients with psychiatric or addictive problems. We refer to this database as the PEER Online database (it was formerly known as the "CNS Database"). For each patient in the PEER Online database, we have compiled neurophysiology data from electroencephalographic ("EEG") scans, symptoms and outcomes often across multiple treatments from multiple psychiatrists and other physicians. This patented technology, called PEER Online™ (based on a technology known as "Referenced-EEG®" or "rEEG®"), represents an innovative approach to describing effective medications for patients suffering from debilitating behavioral disorders. This technology allows us to create and provide simple reports ("PEER Outcome Reports" or "PEER Reports") to medical professionals that summarize historical treatment success of specific medications for those patients with similar neurometric brain patterns. PEER Reports provide neither a diagnosis nor a specific treatment, but like all lab results, provide objective, evidenced-based information to help the prescriber in their decision-making. With PEER Reports, physicians order a digital EEG for a patient, which is then referenced to the PEER Online database. By providing this reference correlation, an attending physician can better establish a treatment strategy with the knowledge of how other patients with similar brain function have previously responded to a myriad of treatment alternatives. Analysis of this complete data set yielded a platform of neurometric variables that have shown utility in characterizing patient response to diverse medications. This platform then allows a new patient to be characterized based on these neurometric variables, and the database to be queried to understand the statistical response of patients with similar brain patterns to the medications currently in the database. Our Neurometric Services business is focused on increasing the demand for our PEER Reports. We believe the key factors that will drive broader adoption of our PEER Reports will be the acceptance by healthcare providers and patients of their benefit, the demonstration of the cost-effectiveness of using our technology, the reimbursement by third-party payers, the expansion of our sales force and increased marketing efforts. It is the company's present intention to expand from the first few military treatment sites involved in the current trial during 2013, to up to seven more military treatment facilities during 2014 representing approximately 70% of the active military patient volume. The PEER Interactive trial led by Walter Reed will provide a significant and visible demonstration of the utility of PEER for wounded warriors and their families, which we believe will support broader adoption of PEER by consumers. In addition to its utility in providing psychiatrists and other physicians/prescribers with medication sensitivity data, our PEER Online technology provides us with significant opportunities in the area of pharmaceutical development. Our PEER Online™ technology, in combination with the information contained in the PEER Online database, offers the potential to enable the identification of novel uses for neuropsychiatric medications currently on the market and in late stages of clinical development, as well as in aiding 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, although no relationships are currently contemplated. The development of pathophysiological markers as the new method for identifying the correct patient population to research is being encouraged by both the National Institute of Mental Health (NIMH) and the Food and Drug Administration (FDA). Indeed, the NIMH made an extraordinary announcement in April 2013, declaring that it will no longer fund research in mental health that uses the Diagnostic and Statistical Manual (DSM) -- often called "the bible" of Psychiatry -- because of its inherent lack of scientific validity. Director Thomas R. Insel, MD explains: "While DSM has been described as a "Bible" for the field, it is, at best, a dictionary, creating a set of labels and defining each. The strength of each of the editions of DSM has been "reliability" - each edition has ensured that clinicians use the same terms in the same ways. The weakness is its lack of validity. Unlike our definitions of ischemic heart disease, lymphoma, or AIDS, the DSM diagnoses are based on a consensus about clusters of clinical symptoms, not any objective laboratory measure. In the rest of medicine, this would be equivalent to creating diagnostic systems based on the nature of chest pain or the quality of fever. Indeed, symptom-based diagnosis, once common in other areas of medicine, has been largely replaced in the past half century as we have understood that symptoms alone rarely indicate the best choice of treatment. Patients with mental disorders deserve better." The implications for mental health care in general, and for CNS Response in particular, are profound. As the only objective, evidence-based physiological biomarker report in the category, we believe this is welcome news for products like PEER. In the coming quarters, we anticipate the potential realignment of payers, physicians and specialties around the use of objective markers of treatment response. Clinical Services- Discontinued Operation In January 2008, we acquired our then largest customer, the Neuro-Therapy Clinic, Inc. Upon the completion of the transaction, NTC became a wholly-owned subsidiary of ours. NTC operated one of the larger psychiatric medication management practices in the state of Colorado, with five full time and six 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 and served as our President from April 2009 to April 2011. NTC, having performed a significant number of PEER Reports, served as an important resource in our product development, the expansion of our PEER Online database, production system development and implementation, along with the integration of our PEER Online services into a medical practice. However, due to the Company's inability to raise sufficient funding and due to NTC's continued operating losses, it was decided to discontinue the operations of NTC effective September 30, 2012, as the Company chose to focus its limited cash resources on its Walter Reed clinical trial. Consequently, NTC is accounted for as a discontinued operation. 40 Working Capital We have limited ability to meet our current obligations as they become due and we are in arrears on paying most of our creditors. Because of our substantial indebtedness, we are insolvent and need to raise additional funds and to restructure our debt to continue our operations. If we are not able to raise additional funds within the next 90 days and reach some accommodations with our creditors, we will likely be required to cease our operations. Since our inception, we have generated significant net losses. As of March 31, 2013, we had an accumulated deficit of approximately $48.1 million, and as of December 31, 2012, our accumulated deficit was approximately $46.6 million. We incurred operating losses of $1.8 million and $2.6 million for the six months ended March 31, 2013 and 2012 respectively and incurred net losses of $2.5 million and $11.1 million for those respective periods. Assuming we are able to continue our operations, we expect our net losses to continue for at least the next couple of years. We anticipate that a substantial portion of any capital resources and efforts would be focused on our clinical trial being conducted at Walter Reed National Military Medical Center ("Walter Reed") and Fort Belvoir Community Hospital, followed by the scale-up of our commercial organization, further research, product development and other general corporate purposes. We anticipate that future research and development projects would be funded by grants or third-party sponsorship, along with funding by the Company. As March 31, 2013 our current liabilities of approximately $12.5 million exceeded our current assets of approximately $0.8 million by approximately $11.6 million and, assuming we are able to continue our operations, our net losses will continue for the foreseeable future. As part of the $12.5 million of current liabilities we have approximately $7.3 million of secured convertible debt. This includes a $2 million round of convertible bridge note financing which we completed at November 30, 2012. We will need additional funding and to restructure our debt to complete our clinical trial at Walter Reed and to continue our operations, plus substantial additional funding before we can significantly increase the demand for our PEER Online services. We will have to repay all our outstanding notes plus interest starting October 1, 2013 unless the note holders convert to common stock. Since January 18, 2013, note holders have converted approximately $2.9 million of notes including interest, to common stock and we have raised a further approximately $1 million as part of our private placement of common stock at $0.25 per share. We are actively exploring additional sources of capital; however, we cannot offer assurances that additional funding will be available on acceptable terms, or at all, especially given the economic and market conditions that currently prevail and the Company's failure to consummate the public offering of securities it had pursued during fiscal 2012. Even if we were to raise additional funds, any additional equity funding may result in significant dilution to existing stockholders, and, if we incur additional debt financing, a substantial additional portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, thus limiting the funds available for our business activities. If adequate funds are not available, it will likely force us to cease operations or would otherwise have a material adverse effect on our business, financial condition and/or resultsof operations. Recent Developments On January 23, 2013, we received a memorandum from the Commander, Walter Reed National Military Medical Center ("WRNMMC" or "Walter Reed"). The memorandum officially confirmed the approval on November 30, 2012, by the WRNMMC Institutional Review Board, of the Company's protocol to conduct a multi-site clinical trial. The project title of the clinical trial is "Use of PEER Interactive to inform the prescription of psychotropic medications to patients with behavioral disorders." During the clinical trial at Walter Reed and Fort Belvoir Community Hospital ("Fort Belvoir"), military and civilian physicians will treat 2,000 volunteer study patients with a primary diagnosis of depression. The patients may also have comorbid disorders such as post-traumatic stress disorder (PTSD), mild traumatic brain injury (mTBI), and other psychiatric disorders. Additional sites, including at least one region of the Veterans Administration, are anticipated during 2013. The Henry M. Jackson Foundation has joined the Company as a research partner, providing clinical trial support in all locations. The clinical trial is a prospective, randomized, multi-site, double blind study of the utility of PEER Interactive in improving medication outcomes in mental health. Patients are now being enrolled and tracked in the study at Walter Reed and enrollment will continue throughout the year. Fort Belvoir is commencing enrollment in May 2013. We anticipate analysis of the interim data by the end of 2013 or early 2014. The military will pay $540 per PEER Report generated for the trial. We have located EEG equipment at both Walter Reed and Fort Belvoir. Col (Ret) Stewart Navarre, who is our Vice President of Government Accounts, has relocated to Bethesda, MD, to oversee the clinical trial. 41 2010, 2011 & 2012 Private Placement Transactions From June 3, 2010 through to November 12, 2010, we raised $3.0 million through the sale of senior secured convertible notes ("October 2010 Notes") and warrants. Of such amount $1.75 million was purchased by members of our Board of Directors or their affiliate companies. From January 20, 2011 through to April 25, 2011, we raised $2.50 million through the sale of subordinated convertible notes ("January 2011 Notes") and warrants. Of such amount, $1.00 million was purchased by members of our Board of Directors or their affiliate companies. These January Notes have subsequently been amended to add a second position security interest. From October 12, 2011 through January 30, 2012, we raised an additional $2.00 million through the sale of subordinated secured convertible notes ("October 2011 Notes") and warrants. Of such amount, $1.04 million was purchased by members of our Board of Directors or their affiliate companies. On February 29, 2012, we raised an additional $90,000 through the sale of an unsecured convertible note and warrants. This note was purchased by an affiliate company of a member of our Board of Directors. From August 17, 2012 through November 30, 2012, we raised an additional $2,000,000 through the sale of senior secured convertible promissory notes ("October 2012 Notes"). Of such amount $1,115,000 was purchased by current members of our Board of Directors or their affiliate companies and $50,000 was purchased by the President and Chief Executive Officer of the Company. Refer to Note 4. Convertible Debt and Equity Financings to the Consolidated Financial Statements for details of the abovementioned transactions. From January 1, 2013 through May 10, 2013, holders of convertible notes in the aggregate principal amount of $2,652,300, and $264,100 of interest thereon, have converted their notes into 32,128,974 shares of common stock. Of these conversions, October 2012 Notes in the aggregate principal amount of $1,402,300 together with interest of $44,200 converted into 30,659,158 shares of common stock at a conversion price of $0.04718. The remaining conversions were of October 2010 Notes and January 2011 Notes in the aggregate principal amount of $1,250,000 together with interest of $219,800, which converted into 1,469,816 shares of common stock at a conversion price of $1.00. Of these conversions, 10,838,809 shares were issued upon conversion by John Pappajohn, a Director of the Company; 5,631,699 shares were issued upon conversion by Walter Schindler, also a Director of the Company, on behalf of the various SAIL entities; 4,403,349 shares were issued upon conversion by the Tierney Family Trust, of which our Chairman of the Board, Thomas Tierney, is a trustee; 550,021 shares were issued upon conversion by our Director Andy Sassine and 1,091,299 shares were issued upon conversion by George Carpenter, our Chief Executive Officer. From February 22, 2012 through May 10, 2013, we have raised gross proceeds of $1,045,000 from 19 accredited investors through the private placement of 4,180,000 shares of common stock at a price of $0.25 per share pursuant to a subscription agreement. These investors included our Chairman, Mr. Tierney, who purchased 400,000 shares for $100,000, Mr. Buck, our Chief Financial Officer, who purchased 50,000 shares for $12,500; and Extuple Limited Partners, a greater than 5% shareholder which is managed by Philip Deck, which purchased 1,200,000 shares for $300,000. Change in a Majority of our Board of Directors In connection with our 2012 Bridge Financing, we entered into Governance Agreements with Equity Dynamics, owned by our Director John Pappajohn, and SAIL Capital Partners, one of our principal stockholders, pursuant to which (i) on November 18, 2012, Henry Harbin resigned from the Board of Directors, (ii) effective November 28, 2012, the Board of Directors appointed Walter Schindler, one of four managing members of SAIL Venture Partners, LLC and the managing member of four additional entities affiliated with SAIL Capital Partners, to fill the resulting vacancy, (iii) effective November 30, 2012, George Carpenter, George Kallins, David Jones, and Maurice DeWald resigned from the Board of Directors (Mr. Carpenter retains his position as Chief Executive Officer of the Company) and (iv) on December 10, 2012, the Board of Directors approved the appointment of Richard W. Turner, Robert J. Follman, Andrew H. Sassine and Thomas T. Tierney (collectively, the "New Board Members") to the Board of Directors to fill the resulting vacancies. The New Board Members took office as directors on February 25, 2013. Messrs. Turner and Sassine are being appointed to the Board to join Mr. Pappajohn and Zachary McAdoo as nominees of Equity Dynamics pursuant to the terms of the Governance Agreement between the Company and Equity Dynamics. Messrs. Tierney and Follman are being appointed to the Board to join Mr. Schindler as nominees of SAIL Capital Partners pursuant to the terms of the Governance Agreement between the Company and SAIL Capital Partners. Mr. Tierney was subsequently appointed Chairman of the Board. 42 Pursuant to the Governance Agreements, the Company experienced a change in a majority of our Board of Directors, effective February 25, 2013. In the Governance Agreements with Equity Dynamics and SAIL Capital Partners the Company agreed, subject to providing required notice to stockholders, to appoint a certain number of persons nominated by Equity Dynamics and SAIL Capital Partners to the Company's Board of Directors and to create vacancies for that purpose, if necessary. The Company agreed to nominate for election, at each meeting of our stockholders at which directors are nominated and elected, four designees of Equity Dynamics and three designees of SAIL Capital Partners and to take all necessary action to support their election and oppose any challenges to such designees. Under the terms of the agreements, the Company may not increase the number of directors to more than seven without the consent of Equity Dynamics and SAIL Capital Partners. The Governance Agreements terminate in the event of the sale of substantially all of the Company's assets or a change of control, or upon any issuance of securities by the Company to parties not including Equity Dynamics and SAIL Capital Partners, from which the Company receives gross proceeds of at least $10 million. Financial Operations Overview Revenues Our Neurometric Services revenues are derived from the sale of PEER Reports to physicians. Physicians are generally billed upon delivery of a PEER Report. The list price of our PEER Reports to physicians is $400. Follow-up reports and more complex work-ups can range from $200 to $800. Clinical Services revenue, which is now accounted for as a discontinued operation, was generated as a result of providing services to patients on an outpatient basis. Patient service revenue was recorded at our established billing rates less contractual adjustments. Generally, collection in full was not expected on our established billing rates. Contractual adjustments were recorded to state our patient service revenue at the amount we expected to collect for the services provided based on amounts due from third-party payers at contractually determined rates. Cost of Revenues Cost of revenues are for Neurometric Services and represent the cost of direct labor, the costs associated with external processing, analysis and consulting review necessary to render an individualized test result and any miscellaneous support expenses. 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 a PEER Outcome Report. Cost of revenues for Clinical Services, is now accounted for as a discontinued operation. Research and Development Research and development expenses are associated with our Neurometric Services and primarily represent costs incurred to design and conduct clinical studies, to recruit patients into the studies, to improve PEER Outcome processing, to add data to the CNS Database, to improve analytical techniques and advance application of the methodology. We charge all research and development expenses to operations as they are incurred. Sales and Marketing For our Neurometric Services, our selling and marketing expenses consist primarily of personnel, media, support and travel costs to inform user organizations and consumers of our products and services. Additional marketing expenses are the costs of educating physicians, laboratory personnel, other healthcare professionals regarding our products and services. General and Administrative Our general and administrative expenses consist primarily of personnel, occupancy, legal, consulting and administrative and support costs for our Neurometric Services. 43 Critical Accounting Policies and Significant Judgments and Estimates This management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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 2 to our consolidated financial statements. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our consolidated financial statements. Discontinued Operation Due to our cessation of our Clinical Services operation as described in Note 3 to our consolidated financial statements, we have segregated the revenues and expenses associated with the Clinical Services and accounted for them as discontinued operations. Revenue Recognition We have generated limited revenues since our inception. Revenues for our Neurometric Service product are recognized when a PEER Report is delivered to a Client-Physician. For our Clinical Services, revenues were recognized whenthe services were 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. The fair value of the stock option grants was determined for each of the grants as follows: Stock Option Grant on December 10, 2012: Based on the volume of shares traded on the open market, during the period October 1, 2012 through to December 10, 2012, the date of the option grant, management judged that the Company's stock was not actively traded as only $15,000 worth of stock was traded on 11 of 48 trading days during this period at prices ranging from $0.76 to $0.83. There was a contemporaneous transaction whereby $2 million of Senior Secured Convertible Notes ("October 2012 Notes") with a conversion price of $0.04718 were purchased by accredited third party investors. Given the very low volume of stock that was traded, compared to the volume of October 2012 Notes purchased, management's judgment was that the pricing of the October 2012 Notes at $0.04718 represented a better determinant of fair value of the Company's common stock and the options granted on December 10, 2012. Stock Option Grant on January 14, 2013: Based on the volume of shares traded on the open market, during the period October 1, 2012 through to January 14, 2013, the date of the option grant, management judged that the Company's stock was not actively traded as only $36,700 worth of stock was traded on 21 of 50 trading days during this period at prices ranging from $0.49 to $2.50. There had been a recent transaction which closed on November 30, 2012 whereby $2 million of Senior Secured Convertible Notes ("October 2012 Notes") with a conversion price of $0.04718 were purchased by accredited third party investors. Given the very low volume of stock that was traded, compared to the volume of October 2012 Notes purchased, management's judgment was that the pricing of the October 2012 Notes at $0.04718 represented a better determinant of fair value of the Company's common stock and the options granted on January 14, 2013. Stock Option Grant on March 24, 2013: Based on the volume of shares traded on the open market, during the period January 1, 2013 through to March 26, 2013, the date of the option grant, management judged that the Company's stock was not actively traded as only $283,400 worth of stock was traded on 22 of 58 trading days during this period at prices ranging from $0.46 to $0.83. There was a contemporaneous transaction whereby shares corresponding to $695,000 of a $2.5 million private placement of common stock purchased at a price of $0.25 per share by accredited third party investors. Given the low volume of stock that was traded, compared to the volume of the private placement of common stock, management's judgment was that the pricing of the private placement of common stock at $0.25 per share represented a better determinant of fair value of the Company's common stock and the options granted on March 26, 2013. 44 Offering Costs The Company applies ASC topic 505-10, "Costs of an Equity Transaction", for recognition of offering costs. In accordance with ASC 505-10, the Company treats incremental direct costs incurred to issue shares classified as equity, as a reduction of the proceeds. Direct costs incurred before shares classified as equity are issued, are classified as an asset until the stock is issued. Indirect costs such as management salaries or other general and administrative expenses and deferred costs of an aborted offering are expensed. Long-Lived Assets and Intangible Assets Property and equipment and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying value of the assets may not be recoverable. If the Company determines that the carrying value of the asset is not recoverable, a permanent impairment charge is recorded for the amount by which the carrying value of the long-lived or intangible asset exceeds its fair value. Intangible assets with finite lives are amortized on a straight-line basis over their useful lives of ten years. Derivative accounting for convertible debt and warrants The Company analyzes all financial instruments with features of both liabilities and equity under ASC-480-10 and ASC 815-10 whereby the Company determines the fair market carrying value of a financial instrument using the Black-Scholes model and revalues the fair market value on a quarterly basis. Any changes in carrying value flow through as other income (expense) in the income statement. Results of Operations for the three months ended March 31, 2013 and 2012 Since closing our Clinical Services operation in September, 2012, we now only operate our Neurometric Services business which is focused on the delivery of reports ("PEER Reports") that enable psychiatrists and other physician/prescribers to make more informed, patient-specific decisions when treating individual patients for behavioral (psychiatric and/or addictive) disorders based on the patient's own physiology. After a significant slowdown in operations during the period of October through December 2012 due to the severe lack of cash resources, the Company's operations have increased slightly with the increase in publicity and general awareness of the PEER technology. During the quarter ended March 31, 2013, the Company has not spent any funds on marketing to psychiatrists or consumers, as its limited resources remain focused on the Walter Reed and Fort Belvoir clinical trial. However, we have experienced increased interest from doctors, outside of the clinical trial, who are new to using the PEER report. We can offer no assurances that this increased level of interest will continue. The Company needs to raise additional funds to support the clinical trial. The following table presents consolidated statement of operations data for each of the periods indicated as a percentage of revenues. Three Months Ended March 31, 2013 2012 Revenues 100 % 100 % Cost of revenues 122 142 Gross profit (22 ) (42 ) Research 163 267 Product Development 827 646 Sales and marketing 274 1,207 General and administrative expenses 2,566 3,130 Operating loss (3,852 ) (5,292 ) Other income (expense), net (1,389 ) (27,685 ) Net income (expense) before discontinued operations (5,240 )% (32,977 )% Loss from Discontinued Operations (4 ) (334 ) Net income (loss) (5,244 )% (33,311 )% 45 Revenues The following table presents revenues for each of the periods indicated and the corresponding percent change. Three Months Ended March 31, 2013 2012 Percent Change Neurometric Service Revenues $ 29,200 $ 25,200 16 % With respect to our Neurometric Services business, the number of third party paid PEER Reports delivered increased from 63 for the three months ended March 31, 2012, to 71 for the three months ended March 31, 2013. The average revenue per report stayed constant at approximately $399 per test. Our discontinued Clinical Services operation ordered no PEER Reports during this 2013 period, but had ordered 30 reports during the same period in 2012. The total numbers of free PEER Reports processed were 5 and 39 for the periods ended 2013 and 2012 respectively. These free PEER Reports are used for training, database-enhancement and compassionate-use purposes. The increase in tests for the 2013 period was partly due to the increase in publicity associated with our clinical trial at Walter Reed. Cost of Revenues Three Months Ended March 31, 2013 2012 Percent ChangeCost of Neurometric Services Revenues $ 35,600 $ 35,900 (1 )% Cost of Neurometric Services revenues consisting of payroll costs, consulting costs, and other miscellaneous charges were as follows: Three Months Ended March 31,Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 27,100 $ 25,100 $ 2,000 Consulting fees 8,500 10,300 (1,800 ) Other miscellaneous costs - 500 (500 ) Total Costs of Revenues $ 35,600 $ 35,900 $ (300 ) Consulting costs associated with the processing of PEER Reports are $75 per PEER Report. We expect the cost of revenues to decrease as a percentage of revenues once we improve our operating efficiency and increase the automation of certain processes. (1) Salary and benefit expenses for the 2013 and 2012 periods remained substantially the same; however, for the 2013 period 67% of the salary was paid in cash and 33% of the salary was accrued as a result of the Company's limited cash resources. (2) Consulting fees declined for the 2013 quarter, partly due to the lack of funds during this period. (3) Other miscellaneous costs declined for the 2013 quarter as a result of the lack of funds. Research Three Months Ended March 31, 2013 2012 Percent Change Neurometric Services Research $ 47,500 $ 67,400 (30 )% 46 Research expenses consist of clinical studies expenses, doctor training costs, consulting fees, payroll costs (including stock-based compensation costs), travel and conference costs and other miscellaneous costs which were as follows: Three Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 52,300 57,800 $ (5,500 ) Consulting fees (6,000 ) 3,000 (9,000 ) Other miscellaneous costs 1,200 6,600 (5,400 ) Total Research $ 47,500 $ 67,400 $ (19,900 ) Comparing the three months ended March 31, 2013 with the corresponding period in 2012: (1) Salary and benefit costs decreased for the 2013 quarter as we renegotiated our arrangement with Dr. Hoffman to be our part-time medical director, which resulted in a slight reduction in salary and benefit costs; (2) Consulting costs decreased over the prior quarter as we recaptured anticipated accrued costs which did not materialize; (3) Other miscellaneous costs were reduced as travel related expenses were curtailed for the 2013 period. Product Development Three Months Ended March 31, 2013 2012 Percent ChangeNeurometric Services Product Development $ 241,400 $ 162,800 48 % Product Development expenses consist of payroll costs (including stock-based compensation costs), consulting fees, programming fees on the production system, database costs and miscellaneous costs which are detailed in the table below. We are aggregating most of our clinical trial costs within this cost center. Three Months Ended March 31,Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 120,800 $ 63,900 $ 56,900 Consulting fees 56,800 41,400 15,400 System development costs 18,700 52,000 (33,300 ) Conference & travel 34,500 1,000 33,500 Other miscellaneous costs 10,600 4,500 6,100 Total Product Development $ 241,400 $ 162,800 $ 78,600 Comparing the three months ended March 31, 2013 with the corresponding period in 2012: (1) Salaries and benefits increased for the 2013 period due to (a) an increase in stock-based compensation and health insurance costs and (b) a realignment of staff from Sales and Marketing to Product Development: the role of our VP of Government Accounts, Col (Ret) Stewart Navarre has changed from Sales and Marketing to Product Development in connection with the Walter Reed/Fort Belvoir clinical trial effective January 2013. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Consulting fees were increased for the 2013 period as the Company was gearing up for the Walter Reed clinical trial. (3) System development and maintenance costs decreased for the 2013 period as there were no new major system initiatives undertaken during this period. However, expenditures were focused on clinical study software to be used in the Walter Reed clinical trial. In the 2012 period we had effected major upgrades to the PEER Online system with the development of the Physician's Portal to provide greater web-enabled capabilities and the conversion to the newer Neuroguide platform, which provides superior capabilities to the PEER Online system. (4) Conference and travel costs increased for the 2013 period as we initiated our Walter Reed clinical trial; our VP of Government Accounts has relocated to Maryland to manage the clinical trial. (5) Other miscellaneous costs remained substantially the same for the two periods. 47 Sales and marketing Three Months Ended March 31, 2013 2012 Percent Change Neurometric Services Sales and Marketing Expenses $ 80,100 $ 304,200 (74 )% Sales and marketing expenses associated with our Neurometric Services business consist primarily of payroll and benefit costs, including stock-based compensation, advertising and marketing, consulting fees and conference and travel expenses. Three Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 69,900 $ 185,200 $ (115,300 ) Consulting fees 3,200 30,000 (26,800 ) Advertising and marketing costs - 65,400 (65,400 ) Conferences and travel costs 6,000 18,100 (12,100 ) Other miscellaneous costs 1,000 5,500 (4,500 ) Total Sales and marketing $ 80,100 $ 304,200 $ (224,100 ) Comparing the three months ended March 31, 2013 with the corresponding period in 2012: (1) Salaries and benefits decreased for the 2013 quarter as our Executive Vice President of Marketing left the Company in September 30 2012; he continues to be a resource to the Company on a consulting basis. Secondly, as mentioned above, we realigned our staff from the Sales and Marketing cost center to the Product Development cost center due to a change in the roles from sales to project management of the Walter Reed clinical trial. These adjustments resulted in a decline of roughly $115,000 in this line item. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Consulting fees decreased for the 2013 quarter as the Company cut back on all marketing consulting services due to limited cash resources available. (3) Advertising and marketing expenses in the 2013 quarter were curtailed due to the limited cash resources available. (4) Conference and travel related expenditures were curtailed for the 2013 quarter compared to the 2012 period due to limited cash resources and the reductions in staff and consultants. (5) Miscellaneous expenditures for the 2013 quarter decreased from the prior period as expenses were kept to a minimum due to limited cash resources available. General and administrative Three Months Ended March 31, 2013 2012 Percent Change Neurometric Services General and Administrative Expenses $ 749,200 $ 788,800 (5 )% General and administrative expenses for our Neurometric Services business are largely comprised of payroll and benefit costs, including stock based compensation, legal fees, patent costs, other professional and consulting fees, general administrative and occupancy costs, dues and subscriptions, conference and travel costs and miscellaneous costs. Three Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 388,900 $ 404,200 $ (15,300 ) Legal fees 235,000 203,200 31,800Other professional and consulting fees (1,800 ) 56,400 (58,200 ) Patent costs 33,400 25,600 7,800 Marketing and investor relations costs 1,700 6,100 (4,400 ) Conference and travel costs 26,000 16,700 9,300 Dues and subscriptions fees 13,200 18,300 (5,100 ) General admin and occupancy costs 52,800 58,300 (5,500 ) Total General and administrative costs $ 749,200 $ 788,800 $ (39,600 ) 48 With respect to our Neurometric Services business, in the three months ended March 31, 2013, compared to the same period in 2012 we had the following changes: (1) Salaries and benefit expenses decreased for the 2013 period as part of the stock compensation accrual became fully invested. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Legal fees showed a net increase for the 2013 period; this was partly due to the mix of legal services used. The Brandt litigation costs increased by $6,000. Legal fees for our general and SEC matters increased by $40,000 due to the work done on financing, changes in the Board membership and the timing of filings during this period. We also renegotiated our accrued fees with our lobbying firm which enabled us to recapture $12,000 that were expensed in a prior period. (3) Professional and consulting fees decreased due to the mix of consulting services used in the respective periods. The decrease for the 2013 period was due to the fees of our clinical trial/FDA consulting firm being charged to general and administrative expenses in the 2012 period and subsequently being moved to our Product Development cost center in the 2013 period. (4) Patent costs increased slightly due to the timing of patent application and maintenance costs which had been deferred for as long as possible due to the limited cash resources available; however these costs now needed to be paid to ensure that no patents or applications would be lost due to non-payment of fees. (5) Corporate marketing and investor relations expenses declined for the 2013 period due to limited cash resources available. (6) Conference and travel costs increased in the 2013 period as the Walter Reed clinical trial was begun. Furthermore, additional travel expenses were incurred in support of our fundraising efforts. (7) Dues and subscriptions had decreased in the 2013 period due to cost containment given the limited cash resources. (8) General administrative and occupancy cost declined for the 2013 period due to reductions in insurance costs and general expenditures. Other expense The following table presents other non-operating expense for each of the periods indicated and the corresponding percent change. Three Months Ended March 31, 2013 2012 Percent ChangeNeurometric Services expense, net $ (405,500 ) $ (6,976,500 ) (95 )% For the three months ended March 31, 2013 and 2012 net other non-operating expense for Neurometric Services was as follows: • For the 2013 period we incurred non-cash interest charges totaling $432,100 of which $186,400 was accrued interest on our promissory notes at 9% per annum; the remaining balance was comprised of $245,100 of the note conversion benefit discount on the notes issued in August and September of 2012; only $400 was for actual net interest paid in cash for the period. For the 2012 period non-cash interest charges totaled $1,135,700, of which $166,300 was accrued interest on our promissory notes at 9% per annum; the remaining balance was comprised of $968,500 of warrant discount amortization on derivative liability for warrants and note conversions; only $900 was for actual net interest paid in cash for the period. • For the 2013 period we incurred finance fees totaling $60,900 of which $30,400 was paid in cash and $30,500 was the fair value of the warrants issued to the placement agents, in association with our prior private placement of convertible notes. For the 2012 period, finance fees totaled $106,200 in connection with our private placement of convertible notes. Of these finance fees, $55,100 were paid in cash and $51,100 was the fair value of warrants that were issued to the placement agents. • For the three months ended March 31, 2013, we incurred $2,500 in offering costs, whereas for the same period in 2012 we incurred offering costs of $900 related to our Canadian and United States fund raising efforts. 49 • Under ASC 815, all derivative instruments are required to be measured subsequently at fair value and the change in fair value of non-hedging derivative instrument are to be recognized in current earnings. Revaluation of our derivative liabilities for the promissory note conversion feature and associated warrants for the three months ended March 31, 2013 were $0 as all derivative liabilities had been eliminated. For the same period in 2012 we had a non-cash loss of $5,733,700 on the valuation of derivative liabilities. The Company experienced substantial changes in the valuation of derivative liabilities from quarter to quarter as a result of the volatility in its stock price. However, since all ratchet features have been removed from the convertible notes and all the note-related warrants have been forfeited pursuant to the Amended and Restated Consent, Note Amendment and Warrant Forfeiture Agreement which was agreed to by the majority of each tranche of noteholders, there will be no US GAAP requirement for derivative accounting in the foreseeable future. • For the 2013 period we benefited from a non-cash gain of $90,000 as a result of the forgiveness of debt by Dr. Harbin for consulting services due to him. This transaction is treated as an extinguishment of debt. No similar transaction occurred in the 2012 period. Net Loss from Continuing Operations Three months ended Percent March 31, Change 2013 2012 Neurometric Services net loss $ (1,530,100 ) $ (8,310,400 ) (82 )% The net loss for our Neurometric Services business of approximately $1.5 million for the three months ended March 31, 2013 compared to the $8.3 million loss in the same period in the prior year is primarily due to the reduction of approximately $6.6 million in non-cash charges as described in our Other Expense category above. The remaining reduction of approximately $0.2 million is due to reduced operating expenditures partly as the Company has minimal cash resources. Loss from Discontinued operations: Three months ended Percent March 31, Change 2013 2012 Clinical Services net loss (1,100 ) (84,100 ) (99 )% For our Clinical Services business, the net loss for the three month period ended March 31, 2013 of $1,100 is a decrease of $83,000 over the same three months of the prior year. As there were no ongoing operations during the 2013 period, the loss incurred was largely for expenses related to the storage of records. The decision to discontinue the Clinical Services operations was due to NTC's persistent losses and its inability to function as a standalone entity within the foreseeable future. As the Company was unsuccessful in raising funds in its registered public offering, there were insufficient cash resources to continue to support NTC. Results of Operations for the Six Months Ended March 31, 2013 and 2012 Since closing our Clinical Services operation in September, 2012, we now only operate our Neurometric Services business which is focused on the delivery of reports ("PEER Reports") that enable psychiatrists and other physician/prescribers to make more informed, patient-specific decisions when treating individual patients for behavioral (psychiatric and/or addictive) disorders based on the patient's own physiology. The following table presents consolidated statement of operations data for each of the periods indicated as a percentage of revenues. Six Months Ended March 31, 2013 2012 Revenues 100 % 100 % Cost of revenues 117 131 Gross profit (17 ) (31 ) Research 180 240 Product Development 572 481 Sales and marketing 299 1,032 General and administrative expenses 2,109 2,792 Operating loss (3,177 ) (4,576 ) Other income (expense), net (1,163 ) (14,475 ) Net income (expense) before discontinued operations (4,340 )% (19,051 )% Loss from Discontinued Operations (23 ) (399 ) Net income (loss) (4,363 )% (19,450 )% 50 Revenues The following table presents revenues for each of the periods indicated and the corresponding percent change. Six Months Ended March 31, 2013 2012 Percent Change Neurometric Service Revenues $ 57,400 $ 57,200 - % With respect to our Neurometric Services business, the number of third party paid PEER Reports delivered decreased from 146 for the six months ended March 31, 2012, to 144 for the six months ended March 31, 2013. The average revenue per report stayed constant at approximately $399 per test. Our discontinued Clinical Services operation ordered no PEER Reports during this 2013 period, but had ordered 30 reports during the same period in 2012. The total numbers of free PEER Reports processed were 24 and 76 for the periods ended 2013 and 2012 respectively. These free PEER Reports are used for training, database-enhancement and compassionate-use purposes. Cost of Revenues Six Months Ended March 31, 2013 2012 Percent ChangeCost of Neurometric Services Revenues $ 67,000 $ 75,100 (11 )% Cost of Neurometric Services revenues consisting of payroll costs, consulting costs, and other miscellaneous charges were as follows: Six Months Ended March 31,Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 54,600 $ 53,000 $ 1,600 Consulting fees 12,400 20,900 (8,500 ) Other miscellaneous costs 0 1,200 (1,200 ) Total Costs of Revenues $ 67,000 $ 75,100 $ (8,100 ) Consulting costs associated with the processing of PEER Reports are $75 per PEER Report. We expect the cost of revenues to decrease as a percentage of revenues as we improve our operating efficiency and increase the automation of certain processes. (1) Salary and benefit expenses for the 2013 and 2012 periods remained substantially the same; however, for the 2013 period 67% of the salary was paid in cash and 33% of the salary was accrued as a result of the Company's limited cash resources. (2) Consulting fees declined for the 2013 period, partly due to the lack of funds during this period. (3) Other miscellaneous costs declined for the 2013 period as a result of the lack of funds. Research Six Months Ended March 31, 2013 2012 Percent Change Neurometric Services Research $ 103,400 $ 137,100 (25 )% 51 Research expenses consist of clinical studies expenses, doctor training costs, consulting fees, payroll costs (including stock-based compensation costs), travel and conference costs and other miscellaneous costs which were as follows: Six Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 103,600 117,400 $ (13,800 ) Consulting fees (3,000 ) 6,100 (9,100 ) Other miscellaneous costs 2,800 13,600 (10,800 ) Total Research $ 103,400 $ 137,100 $ (33,700 ) Comparing the six months ended March 31, 2013 with the corresponding period in 2012: (1) Salary and benefit costs decreased for the 2013 period as we renegotiated our arrangement with Dr. Hoffman to be our part-time medical director, which resulted in a slight reduction in salary and benefit costs; (2) Consulting costs decreased due to a reduction of consulting services as we recaptured an anticipated accrued costs which did not materialize: (3) Other miscellaneous costs were reduced as travel related expenses were curtailed for the 2013 period. Product Development Six Months Ended March 31, 2013 2012 Percent ChangeNeurometric Services Product Development $ 328,600 $ 275,300 19 % Product Development expenses consist of payroll costs (including stock-based compensation costs), consulting fees, programming fees on the production system, database costs and miscellaneous costs which are detailed in the table below. We are aggregating most of our clinical trial costs within this cost center. Six Months Ended March 31,Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 184,800 $ 116,300 $ 68,500 Consulting fees 45,500 41,400 4,100 System development costs 46,800 105,900 (59,100 ) Conference & travel 37,700 1,100 36,600 Other miscellaneous costs 13,800 10,600 3,200 Total Product Development $ 328,600 $ 275,300 $ 53,300 Comparing the six months ended March 31, 2013 with the corresponding period in 2012: (1) Salaries and benefits increased for the 2013 period due to (a) an increase in stock-based compensation and health insurance costs and (b) a realignment of staff from sales and marketing to product development: the role of our VP of Government Accounts, Col (Ret) Stewart Navarre has changed from Sales and Marketing to Product Development in connection with the Walter Reed/Fort Belvoir clinical trial effective January 2013. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Consulting fees remained about the same for both periods. (3) System development and maintenance costs decreased for the 2013 period as there were no new major system initiatives undertaken during this period. However, expenditures were focused on clinical study software to be used in the Walter Reed clinical trial. In the 2012 period we had effected major upgrades to the PEER Online system with the development of the Physician's Portal to provide greater web-enabled capabilities and the conversion to the newer Neuroguide platform, which provides superior capabilities to the PEER Online system. (4) Other miscellaneous costs remained substantially the same for the two periods. 52 Sales and marketing Six Months Ended March 31, 2013 2012 Percent Change Neurometric Services Sales and Marketing Expenses $ 171,500 $ 590,400 (71 )% Sales and marketing expenses associated with our Neurometric Services business consist primarily of payroll and benefit costs, including stock-based compensation, advertising and marketing, consulting fees and conference and travel expenses. Six Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 152,800 $ 362,900 $ (210,100 ) Advertising and marketing costs - 93,100 (93,100 ) Consulting fees 5,300 85,100 (79,800 ) Conferences and travel costs 9,600 39,200 (29,600 ) Other miscellaneous costs 3,800 10,100 (6,300 ) Total Sales and marketing $ 171,500 $ 590,400 $ (418,900 ) Comparing the six months ended March 31, 2013, with the same period in 2012: (1) Salaries and benefits decreased for the 2013 period as our Executive Vice President of Marketing left the Company; he continues to be a resource to the Company on a consulting basis. Secondly, compensation that had been accrued in a prior period was forfeited in exchange for common stock. Thirdly, we realigned our VP of Operations from sales and marketing to product development to project manage the Walter Reed clinical trial. These adjustments resulted in a decline of roughly $210,000 in this line item. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Advertising and marketing expenses in the 2013 period were curtailed due to the limited available cash resources. In the 2012 period, we spent $65,000 on a test marketing campaign targeting Denver, Boston, and Southern California and we also incurred $26,000 as part of a marketing/economic analysis undertaken with Medco Health Solutions. (3) Consulting fees decreased for the 2013 period as the Company cut back on all marketing consulting services due to limited cash resources available. (4) Conference and travel related expenditures were curtailed for the 2013 period compared to the 2012 period, due to reductions and realignment of staff. (5) Miscellaneous expenditures for the 2013 period decreased from the prior period as expenses were kept to a minimum due to the limited cash resources available. General and administrative Six Months Ended March 31, 2013 2012 Percent Change Neurometric Services General and Administrative Expenses $ 1,210,400 $ 1,597,200 (24 )% General and administrative expenses for our Neurometric Services business are largely comprised of payroll and benefit costs, including stock based compensation, legal fees, patent costs, other professional and consulting fees, general administrative and occupancy costs, dues and subscriptions, conference and travel costs and miscellaneous costs. 53 Six Months Ended March 31, Key Expense Categories 2013 2012 Change Salaries and benefit costs $ 647,800 $ 803,700 $ (155,900 ) Legal fees 262,100 334,700 (72,600 )Other professional and consulting fees 96,700 178,900 (82,200 ) Patent costs 35,500 72,600 (37,100 ) Marketing and investor relations costs 3,000 10,700 (7,700 ) Conference and travel costs 36,100 50,100 (14,000 ) Dues and subscriptions fees 27,300 31,800 (4,500 )General admin and occupancy costs 101,900 114,700 (12,800 ) Total General and administrative costs $ 1,210,400 $ 1,597,200 $ (386,800 ) With respect to our Neurometric Services business, in the six months ended March 31, 2013, compared to the same period in 2012 we had the following changes: (1) Salaries and benefit expenses decreased for the 2013 period as $133,000 of previously accrued salaries and bonuses were forfeited by the CEO and CFO in exchange for common stock. Salaries for the 2013 period are being paid at 67% of the normal salary with 33% being accrued. (2) Legal fees showed a net decrease for the 2013 period; this was partly due to the mix of legal services used and the timing of those services. The Brandt litigation costs decreased by $50,000. We also renegotiated our accrued fees with our lobbying firm which enabled us to recapture $12,000 that were expensed in a prior period. Other legal fees were also reduced as the Company minimized all expenditure during this period for financial reasons. (3) Professional and consulting fees decreased due to the mix of consulting services used in the respective periods. The decrease for the 2013 period was due to the fees of our clinical trial/FDA consulting firm being charged to general and administrative expenses in the 2012 period; these were subsequently booked to our Product Development cost center in the 2013 period; additionally, in 2012 period our financial consultants were assisting the Company with its public offering, in 2013 those similar expenses were not incurred. (4) Patent costs decreased largely due to the timing and volume of patent applications and maintenance costs. Where possible costs were deferred due to the limited available cash resources; no patents or applications lapsed due to delayed payment of maintenance or application fees. (5) Corporate marketing and investor relations expenses declined for the 2013 period due to limited available cash resources. (6) Conference and travel costs were curtailed for the 2013 period due to limited available cash resources. (7) Dues and subscriptions fees were slightly lower for the 2013 period. (8) General administrative and occupancy costs declined for the 2013 period due to reductions in insurance costs and general costs. Other expense The following table presents other non-operating expense for each of the periods indicated and the corresponding percent change. Six Months Ended March 31, 2013 2012 Percent ChangeNeurometric Services expense, net $ (666,900 ) $ (8,278,600 ) (92 )% For the six months ended March 31, 2013 and 2012 net other non-operating expenses for Neurometric Services was as follows: • For the 2013 period we incurred non-cash interest charges totaling $1,000,000 of which $391,900 was accrued interest on our promissory notes at 9% per annum; the remaining balance was comprised of $637,200 of the note conversion benefit discount on the notes issued in August and September of 2012; only $1,200 was for actual net interest paid in cash for the period. For the 2012 period non-cash interest charges totaled $2,617,700, of which $305,200 was accrued interest on our promissory notes at 9% per annum; the remaining balance was comprised of $2,308,100 of warrant discount amortization on derivative liability for warrants and note conversions; only $4,300 was for actual net interest paid in cash for the period. • For the 2013 period we incurred finance fees totaling $92,700 of which $62,200 was paid in cash, and $30,500 was the fair value of the warrants issued to the placement agents, in association with our private placement of convertible notes. For the 2012 period, finance fees totaled $151,500 in connection with our private placement of convertible notes. Of these finance fees, $94,700 were paid in cash and $56,800 was the fair value of warrants that were issued to the placement agents. 54 • For the 2013 period, we incurred $2,500 in offering costs, whereas for the same period in 2012 we incurred offering costs of $7,700 in expenses relating to our Canadian and United States fund raising efforts. • Under ASC 815, all derivative instruments are required to be measured subsequently at fair value and the change in fair value of non-hedging derivative instrument are to be recognized in current earnings. Revaluation of our derivative liabilities for the promissory note conversion feature and associated warrants for the six months ended March 31, 2013 resulted in a non-cash loss of $97,600. For the same period in 2012 we had a non-cash loss of $5,501,700 on the valuation derivative liabilities. The Company experienced substantial changes in the valuation of derivative liabilities from quarter to quarter as a result of the volatility in its stock price. However since all ratchet features have been removed from the convertible notes and all the note-related warrants have been forfeited pursuant to the Amended and Restated Consent, Note Amendment and Warrant Forfeiture Agreement which was agreed to by the majority of each tranche of noteholders, there will be no US GAAP requirement for derivative accounting in the foreseeable future. • For the 2013 period we benefited from a non-cash gain of $556,300 as a result of the accounting for the extinguishment of debt. No similar transaction occurred in the 2012 period. The debt extinguishment accounting is precipitated by the changes in the fair value of existing notes pursuant to the Amended and Restated Consent, Note Amendment and Warrant Forfeiture Agreement which extended the maturity date and eliminated the ratchet feature of the notes in question. Additionally, for the 2013 period we benefited from a non-cash gain of $90,000 as a result of the forgiveness of debt by Dr. Harbin for consulting services due to him. Net Loss from Continuing Operations Six Months Ended Percent March 31, Change 2013 2012 Neurometric Services net loss $ (2,491,200 ) $ (10,897,400 ) (77 )% The net loss for our Neurometric Services business of approximately $2.5 million for the 2013 period ended March 31, 2013 compared to the $10.9 million loss in the same period in the prior year is primarily due to the reduction of approximately $7.6 million in non-cash charges as described in our Other Expense category above. The remaining reduction of approximately $0.8 million is due to a reduction in operating expenses which were scaled back largely due to limited cash resources during October and November of 2012. Loss from Discontinued operations: Six Months Ended Percent March 31, Change 2013 2012 Clinical Services net loss (13,300 ) (228,300 ) (94 )% For our Clinical Services business, the net loss for the three month period ending March 31, 2013 of $13,300 is a decrease of $215,000 compared to the same period of the prior year. As there were no ongoing operations during the 2013 period, the loss incurred was largely due to the write down of assets, namely receivables, which were unlikely to be collected and to the storage fees for medical records. The decision to discontinue the Clinical Services operations was due to NTC's persistent losses and its inability to function as a standalone entity within the foreseeable future. As the Company was unsuccessful in raising funds in its registered public offering, there were insufficient cash resources to continue to support NTC. Liquidity and Capital Resources Since our inception, we have incurred significant losses. As of March 31, 2013, we had an accumulated deficit of approximately $48.1 million, and as of December 31, 2012, our accumulated deficit was approximately $46.6 million. We have not yet achieved profitability and anticipate that we will continue to incur net losses for the foreseeable future. We expect that with our Walter Reed clinical trial, sales and marketing and general and administrative cost, our expenditures 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 March 31, 2013, we had approximately $717,200 in cash and cash equivalents and a working capital deficiency of approximately $11.6 million compared to approximately $821,100 in cash and cash equivalents and a working capital deficiency of approximately $13.9 million at December 31, 2012. The working capital deficiency as of March 31, 2013 includes the $8.5 million of convertible promissory notes and interest outstanding of which approximately $7.5 million are secured and $1 million is unsecured. The unsecured notes are largely the result of note conversions by the majority holders of the senior October 2012 Notes, which pursuant to the Second Amended and Restated Security Agreement results in the termination of the security interest of the remaining minority of the October 2012 Notes. 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 have limited ability to meet our current obligations as they become due and we are in arrears on paying most of our creditors. Because of our substantial indebtedness, we are insolvent and need to raise additional funds and to restructure our debt to continue our operations. If we are not able to raise additional funds within the next 90 days and reach some accommodations with our creditors, we will likely have to cease operations. 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. We need additional funds and to restructure our debt to complete our Walter Reed clinical trial and to continue our operations and will need substantial additional funds before we can increase demand for our PEER Online services. We are continuing to explore additional sources of capital; however, we do not know whether additional funding will be available on acceptable terms, or at all, especially given the economic conditions that currently prevail. In addition, any additional equity funding may result in significant dilution to existing stockholders, and, if we incur additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, thus limiting funds available for our business activities. We expect to continue to incur operating losses in the future. Although since September 30, 2012 we have raised gross cash proceeds of $1.4 million through the sale of senior secured convertible promissory notes plus a further $1 million from the sale of stock at $0.25 per share, we anticipate that our cash on hand and cash generated through our operations will not be sufficient to fund our operations for the next 12 months. In addition we will have to repay all the outstanding notes plus interest starting on October 1, 2013, unless we can raise additional funds, restructure the convertible debt or persuade the noteholders to convert to equity. If adequate funds are not available, it would have a material adverse effect on our business, financial condition and/or results of operations, and could cause us to have to cease operations. As of May, 10, 2013, holders of convertible notes in the aggregate of amount of $2,652,300 and $264,100 of interest thereon have converted their notes into 32,128,974 shares of common stock. Of these conversions 22,515,177 shares were issued upon conversion to directors and an officer. The amount of capital we will need to conduct our operations and the time at which we will require such capital may vary significantly depending upon a number of factors, such as: • the amount and timing of costs we incur in connection with our Walter Reed clinical trial and product development activities, including enhancements to our PEER Online Database and costs we incur to further validate the efficacy of our referenced EEG technology; • the amount and timing of costs we incur in connection with the expansion of our commercial operations, including our selling and marketing efforts; • whether we incur additional consulting and legal fees in our efforts to conducting a Non-Significant Risk study under an FDA requirements which will enable us to obtain a 510(k) clearance from the FDA; • if we expand our business by acquiring or investing in complimentary businesses. 56 Sources of Liquidity Since our inception, substantially all of our operations have been financed from equity and debt financings. Through March 31, 2013, we had received proceeds of approximately $14.4 million from the sale of stock, $17.7 million from the issuance of convertible promissory notes and $220,000 from the issuance of common stock to employees in connection with expenses paid by such employees on behalf of the Company. From June 3, 2010 through to November 12, 2010, we raised $3.0 million through the sale of secured convertible notes (October 2010 Notes) and warrants. From January 20, 2011 through to April 25, 2011, we raised $2.5 million through the sale of subordinated secured convertible notes (January 2011 Notes) and warrants. From October 11, 2011 through January 31, 2012, we raised $2.0 million through the sales of additional subordinated secured convertible notes (October 2011 Notes). On February 29, 2012 we raised a further $90,000 in an unsecured convertible note. From August 17, 2012 through November 30, 2012 we raised $2.0 million in senior secured notes (October 2012 Notes). Of such amounts, an aggregate of $1.2 million was purchased by current members of our Board of Directors, or their affiliate companies or Corporate Officers. See Note 4 of the Notes to the Unaudited Condensed Consolidated Financial Statements. From February 22, 2013 through May 10, 2013 we raised approximately $1.0 million from the issuance of common stock at $0.25 per share to accredited investors pursuant to a subscription agreement. Of such amount an aggregate of $112,500 was purchased by a member of the Board of Directors and an officer of the Company. Cash Flows Net cash used in operating activities was $1.3 million for the six months ended March 31, 2013 compared to $1.6 million for the same period in 2012. The decrease in cash used in operations of $0.3 million was primarily due to our increase in accrued compensation balances as a result of staff being paid at 67% of their normal salary and accruing the remaining 33%. Net cash from investing activities was a gain of $1,400 for the six months ended March 31, 2013 as compared to use of $25,500 for the same period in 2012. Our 2013 activity reflected the disposal of computer equipment, whereas in the 2012 period we acquired intellectual property pertaining to a Transcranial Magnetic Stimulation ("TMS") biomarker acquired from Brain Clinics. Net cash proceeds from financing activities for the six months ended March 31, 2013 were primarily net proceeds of $2.0 million. Of this amount, a net $1.3 million was raised through the sale of senior convertible promissory October 2012 Notes and a net $0.7 million was raised through the private placement of common stock with accredited investors at $0.25 per share. For the same period in 2012, net cash proceeds from financing activities were approximately $2.0 million from the sale of our October 2011 Notes. Contractual Obligations and Commercial Commitments As of March 31, 2013, our combined lease obligations are $41,500. On January 29, 2013, we signed a 12 month extension to our lease at our Aliso Viejo office. The lease period started on February 1, 2013 and ends January 31, 2014. The monthly rent remains the same as our 2012 monthly rate at $4,147 with the 9th month of the lease, October 2013, being a rent-free month. Our remaining lease obligation on our office in Greenwood Village, CO, which was occupied by our now discontinued clinical services operation and expired on April 30, 2013, is $5,100 in total with an average monthly rental of $5,100over the entire lease period. Payments due by period Less than 1 More than 5 Contractual Obligations Total year 1 to 3 years 3-5 years years Capital Lease Obligations $ 8,700 $ 4,900 $ 3,800 - - Operating Lease Obligations, current operations 41,500 41,500 - - - Operating Lease Obligations, discontinued operations 5,100 5,100 - - - Total $ 55,300 $ 51,500 $ 3,800 - - 57 Derivative Liability The Company's derivative liability is comprised of a warrant liability which was carried at fair value totaling $520,700, as of September 30, 2012, and the conversion option liability which was carried at a fair value of $0 as of September 30, 2012. The warrant liability and conversion option liability were removed pursuant to the Amended and Restated Consent, Note Amendment and Warrant Forfeiture Agreement dated November 24, 2012 and agreed to by the majority of each tranche of noteholders on November 28, 2012. Consequently, warrants were eliminated and the ratchet feature removed from the convertible notes. As a result the warrant liability and conversion option liability are both $0 asof March 31, 2013. 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, 2012, we had net operating loss carryforwards for federal income tax purposes of $29.1 million. If not utilized, the federal net operating loss carryforwards will begin expiring in 2030. 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. [ Back To TMCnet.com's Homepage ]