UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K




(mark
one)





Annual
Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934




For
the fiscal year ended September 30, 2010




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.
      Employerof
      incorporation or organization)
            Identification
      No.)




85
Enterprise, Suite 410


Aliso
Viejo, CA 92656


(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
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes    xNo      ̈




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes     ̈No      ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§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      ̈ (Do
      not check if smaller reporting company)
            Smaller
      reporting company x





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, 2010, the last business day of the registrant's
most recently completed second fiscal quarter was $64,427,500 (based on the
closing sales price of the registrant's common stock on that date).





At
December 16, 2010, the registrant had 56,023,921 shares of Common Stock, $0.001
par value, issued and outstanding.





CNS RESPONSE, INC.




2009
FORM 10-K ANNUAL REPORT





TABLE OF
CONTENTS





PART
      I
                    
                    3ITEM
      1.
                    Business
                    4ITEM
      1A.
                    Risk
      Factors
                    12ITEM
      1B.
                    Unresolved
      Staff Comments
                    22ITEM
      2.
                    Properties
                    23ITEM
      3.
                    Legal
      Proceedings
                    23ITEM
      4.
                    (Removed
      and Reserved)
                    23PART
      II
                    
                    24ITEM
      5.
                    Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                    24ITEM
      6.
                    Selected
      Financial Data
                    28ITEM
      7.
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    28ITEM
      7A.
                    Quantitative
      and Qualitative Disclosures about Market Risk
                    37ITEM
      8.
                    Financial
      Statements and Supplementary Data
                    38ITEM
      9.
                    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                    62ITEM 9A.
                    Controls
      and Procedures
                    63ITEM
      9B.
                    Other
      Information
                    64PART
      III
                    
                    65ITEM
      10.
                    Directors,
      Executive Officers and Corporate Governance
                    65ITEM
      11.
                    Executive
      Compensation
                    69ITEM
      12.
                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                    77ITEM
      13.
                    Certain
      Relationships and Related Transactions, and Director
      Independence
                    79ITEM
      14.
                    Principal
      Accounting Fees and Services
                    86PART
      IV
                    
                    86ITEM
      15.
                    Exhibits,
      Financial Statement Schedules
                    86




2


PART I




CAUTIONARY STATEMENT
REGARDING FORWARD-LOOKING STATEMENTS




This 2010
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:




·
            our
      inability to raise additional funds to support operations and capital
      expenditures;




·
            our
      inability to achieve greater and broader market acceptance of our products
      and services in existing and new market
  segments;




·
            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.”




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, Inc., a Colorado professional medical corporation and a
wholly-owned subsidiary of CNS Colorado (“NTC”).





Background





CNS
Response, Inc. was incorporated in Delaware on March 16, 1987, under the name
Age Research, Inc.   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 formed on January 11, 2000 (“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.





Our
address is 85 Enterprise, Suite 410, Aliso Viejo, CA 92672 and we maintain a
website at www.CNSResponse.com. The reference to our web address does not
constitute incorporation by reference of the information contained at this
site




Overview





CNS
Response is a web-based neuroinformatic company with two distinct business
segments. Our primary business is Neurometric Information Services (formerly
called Laboratory Information Services) operated by CNS California, which is
focused on neurometric analysis, research, development and commercialization of
a patented system that provides data to psychiatrists and other
physicians/prescribers to enable them to make more informed decisions when
treating  patients with behavioral (psychiatric and/or addictive)
disorders. Our secondary business is Clinical Services business which is a full
service psychiatric clinic operated by NTC.





Financial
information with respect to our two segments is provided in Note 9 to our
consolidated financial statements appearing elsewhere in this annual report on
Form 10-K.





Neurometric
Information Services




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 our technology offers an improvement upon traditional methods for
determining a course of medication for 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 a proprietary outcomes database that
consists of over 17,000 medication trials for patients with psychiatric or
addictive problems (the “CNS
Database ”).  For each patient in the CNS Database, we have
compiled electroencephalographic (“EEG ”) scans, symptoms and
outcomes often across multiple treatments from multiple psychiatrists and
physicians.  This patented technology, called “Referenced-EEG®” or
“rEEG®” represents an innovative approach to identifying effective medications
for patients suffering from debilitating behavioral disorders.





With
rEEG®, physicians order a digital EEG for a patient, which is then evaluated
with reference to the CNS Database.  By providing this reference
correlation, an attending physician can choose a treatment strategy with the
knowledge of how other patients having similar brain function have previously
responded to a myriad of treatment alternatives.  Analysis of this
complete data set yielded a platform of 74 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 74 neurometrics, and the database to be queried to
understand the statistical probability of how patients with similar brain
patterns have previously responded to the medications currently in the database.
This technology allows us to create and provide simple reports (“rEEG Reports ”) to the
prescriber that summarizes historical treatment success of specific medications
for those patients with similar brain patterns.   It provides
neither a diagnosis nor specific treatment, but like all lab results, provides
objective, evidenced-based information to help the prescriber in their
decision-making.




4


Our
Neurometric Information Services business is focused on increasing the demand
for our rEEG Reports. We believe the key factors that will drive broader
adoption of our rEEG Reports will be acceptance by healthcare providers and
patients of their benefit, demonstration of the cost-effectiveness of using our
technology, reimbursement by third-party payers, expansion of our sales force
and increased marketing efforts.




In
addition to its utility in providing psychiatrists and other
physicians/prescribers 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 CNS Database, has the
potential to be able to identify novel uses for 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, 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).




Clinical
Services




In
January 2008, we acquired our largest customer, NTC, located in Colorado. Upon
the completion of the transaction, NTC became our wholly-owned subsidiary. At
the time, NTC operated one of the largest psychiatric medication management
practices in the state of Colorado, under contract with multiple national health
plans.  Daniel A. Hoffman, M.D. is the medical director at NTC, and,
after the acquisition, became our Chief Medical Officer and more recently, our
President.




NTC,
having performed a significant number of rEEGs, serves as 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 Neurometric
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 develop communication programs
which can be generalized to physicians using our services throughout the
country, 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 Neurometric Information
Services business, and we have no current plans to significantly expand this
business.




Neurometric
Information Services




The
Challenge and the Opportunity




The
1990’s were known as “the Decade of the Brain,” a period in which basic
neuroscience yielded major advances in drug discovery and
neurotherapy.  Several trends have emerged which may propel
significant adoption of these advances over the next decade:





·
            More
      than $29 billion in spending has been dedicated to the compulsory
      utilization of electronic health records and other IT services under the
      “HITECH” portion of the American Recovery and Reinvestment Act (ARRA),
      with most of that spending to occur between
      2011-2013.  Currently, less than 20% of healthcare providers
      utilize electronic records, yet all providers will be expected to have
      adopted such systems by 2015 (or face economic penalties under
      Medicare/Medicaid).  This extraordinary growth in the use of
      medical informatics tools creates a significant and expanding market for
      CNS Response.





·
            Similarly,
      Comparative Effectiveness Research has been made a key feature of the
      Obama health plan. The cost to treat Americans under care for depression
      and other mental illnesses rose by nearly two-thirds from $35 billion to
      $58 billion in the last 10 years, according to a recent report from the
      Agency for Healthcare Research and Quality.  Finding more
      cost-effective treatment modalities in mental disorders will be critical
      to successful health care reform;





·
            The
      Mental Health Parity Act (Parity Act) requires payers, beginning in 2010,
      to pay for behavioral medications and treatments using the same standards
      for evidence and coverage as they currently use for medical/surgical
      treatments;





·
            According
      to a recent RAND report, 275,000 returning military personnel from the
      Iraq and Afghanistan theatres suffer from Major Depression, Post Traumatic
      Stress Disorder (PTSD), traumatic brain injury;
  and





·
            Consumers
      have emerged as active decision makers in behavioral treatment, driven by
      over $4.8 billion in annual Pharma direct-to-consumer advertising and the
      internet.  At the same time, media costs for reaching those
      consumers are at historic lows.




5


Today,
there are over 100 prescription drugs available to patients suffering from a
behavioral disorder, representing one of the largest and fastest-growing drug
classes.  Unfortunately, psychotropic drugs often do not work, or lose
their effect over time, and over 17 million Americans who have failed two or
more medication treatments are now considered “treatment
resistant”.  For these patients, the conventional “trial and error”
method of prescribing psychotropic drugs has resulted in low efficacy, high
relapse and treatment discontinuation rates, significant patient suffering and
billions in additional cost to payers.




We
believe we are the first company to create a neurometric database that
correlates a patient’s response to major drug classes and specific medications
with their individual brain physiology.  We developed this tool to
improve pharmacotherapy outcomes, particularly in treatment resistant patients,
a particularly expensive patient population with profound unmet clinical
needs.  Our rEEG technology has been used by physicians to guide
prescribing in behavioral disorders such as depression, anxiety, anorexia, OCD,
bipolar, ADHD, addiction and others.




rEEG® was
developed by a pathologist/psychiatrist who recognized that correlation of a
patient’s unique brain patterns to known long-term medication outcomes in
similar patients might significantly improve therapeutic
performance.  This approach — commonly referred to as Personalized
Medicine, and exemplified by companies such as Genomic Health (GHDX) — is in the
process of transforming both clinical practice and the pharmaceutical
industry.  CNS Response brings this science to behavioral medicine,
where the unmet clinical need is well-documented, expensive, and
growing.




The
rEEG® Method




rEEG®
Reports are offered as a service, much like a reference lab, in which standard
electroencephalogram (EEG) readings are referenced to a database to suggest
patient-specific probabilities of response to different
medications.  EEG recording devices are widely available, inexpensive
to lease, and are available in most cities by independent mobile EEG
providers.





The
service works as follows:





·
            Patients
      are directed by an attending physician to a local rEEG® provider, who
      performs a standard digital EEG.


·
            EEG
      data file is uploaded over the web to our central analytical
      database.


·
            We
      analyze the data against the CNS Database for patients with similar brain
      patterns.


·
            We
      provide a report describing the probability of patient success with
      different medication options (much like an antibiotic sensitivity report
      commonly used in medicine).


·
            The
      rEEG® Report is sent back to the attending physician, usually by the next
      business day.





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 for
patients.  Physicians who 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 or
providers.  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, Physicians are presumed to administer and provide continuing care
treatment.




Estimated
Market for rEEG Reports




Currently,
the wholesale (direct to physician) price for standard rEEG testing is $400 per
test, and the retail (payer and consumer) price is approximately
$800.  Thus far, payments have typically been from psychiatrists whose
patients pay privately for the rEEG® Report.  The National Institute
of Mental Health (NIMH) estimates that only 12.7% of patients get minimally
effective treatment, with over 17 million Americans now classified as “treatment
resistant”, meaning that they have failed to find relief after trying two or
more medications.




We
therefore estimate the potential market for our rEEG Reports at $1.7 billion
annually, based on an addressable market of 17 million Treatment Resistant
patients, with only 12.5% of patients seeking care and complying with
treatment.




Path
to Adoption




Several
firms have successfully commercialized products that predict medication
response, including Genomic Health’s OncotypeDx which predicts response to
chemotherapy, and Roche/Affymetrix Cytochrome P450 test which shows how each
patient is likely to metabolize a given antidepressant.  We are
following the paths to adoption used by these successful firms by focusing on
growth in three stages:




6


(1)           
Private pay market.




Consumers
and private-pay psychiatrists drive over 33% of the market for psychiatric
visits, and a significant proportion of all licensed psychiatrists now describe
themselves as private pay only.  We believe consumers who have
experienced treatment failure will seek out our network of physicians once they
become aware of the successful outcomes demonstrated by our clinical
trial.




During
2008, the recruiting for our Depression Efficacy Trial (the Depression Efficacy
Trial is further described under the heading Neurometric Services
Accomplishments below) generated many important lessons about integrated
marketing for our rEEG® service.  By using a media mix of web, radio
and TV, interested patients were delivered into the trial at an average cost of
$40-$68 per contact.  We will continue to pursue integrated consumer
marketing as a means to introduce interested patients to our rEEG® provider
network.




To drive
growth in private pay, consumer-driven rEEG testing, we plan to do the
following:





·
            Grow
      our focused physician network:  We currently have 52 active
      practicing physicians utilizing rEEG in their practices, defined as having
      paid for testing within the last 12 months.  Over the same
      period 31 new physicians were trained.  Physicians who become
      “power users” (which we define as physicians who conduct several tests per
      month) report significantly better results than casual users of rEEG
      technology, and have certain economies of scale in using the test in their
      practices.  Similar to the adoption of LASIK technology in
      consumer-driven ophthalmology, successful practices using rEEG have
      reported that as their word-of-mouth referrals increase, their procedure
      billings increase, and their average patient visits decrease (as patients
      improve).  Accordingly, their patient turnover may increase over
      time, requiring additional marketing efforts to grow their practice
      volume.





We plan
to focus on supporting these power users through direct marketing, clinical
practice support (patient intake, scheduling, washout support and reporting),
and technical support.  This focused network approach has been
successful in other specialties (for example, in organ transplant networks and
in disease management) because it is easier to sell to payers, facilitates data
collection, and is more cost-effective in delivering care even at higher
provider margins.





·
            Increase
      unit pricing:  Currently, the wholesale (direct-to-physician)
      price for standard rEEG testing is $400 per test, and the retail (payer
      and consumer) price is approximately $800.   We anticipate
      that our pricing will be increased over time with greater acceptance of
      the test as a standard of care, rewarding power users for committed volume
      and affording improvement in test margins
  overall.





·
            Utilize
      our neurometric information service:  In 2008, we purchased the
      psychiatric clinic in Denver, co-founded by our Chief Medical Officer,
      Daniel Hoffman, MD.  The clinic currently serves as a platform
      for perfecting rEEG workflow, information systems, product development and
      research.  We also test local marketing strategies in Denver
      which can then be generalized to other rEEG® network
      clinics.  The Denver clinic may ultimately become a national
      Center of Excellence for neuropsychiatry, where insurers may direct
      certain treatment-resistant
patients.





·
            Scalable
      platform for delivery:  During 2009 and 2010, significant
      development effort was focused on production systems and lab
      infrastructure to accommodate potential growth in the production volume of
      our rEEG Reports.  Our current production application is able to
      accommodate up to 100 tests per week without additional
      manpower.  In addition to providing scalable capacity, the
      production system provides for online delivery of tests and delivery of
      test data to physicians’ desktops or iPAD.  Currently, we are
      investing in projects to reduce or eliminate the remaining manual
      processes in test production: including the “artifacting” of EEG data and
      the Neurologist review of each case.  It is estimated that these
      processes will, over time, be replaced with validated algorithms,
      exception-based reviews and/or post-facto sampling for quality
      assurance.





(2)           Payer
economic trials.




Health
plans currently spend over $30 billion on psychotropic medications each year
according to the Substance Abuse and Mental Health Services Administration
(SAMHSA), and most are aware that these agents only work on about 30% of
patients who take them.  The lack of medication adherence and poor
treatment outcomes in behavioral health has been a longstanding issue for
payers, but they have lacked a targeted, cost-efficient approach to solve the
problem.




Presently,
rEEG is not a reimbursable procedure for most health care
payers.  Initially, payer response to most new technologies is a
reflexive denial of coverage, regardless of the superiority of evidence or
economics.  Over time, however, certain payers may adopt technologies
which confer a clear marketing or underwriting advantage, or which protect them
from legal claims for reimbursement under new legislation (e.g.
Parity).  Because of this, it is possible that with sufficient
marketing efforts, we may shift payer “fear of adoption” to “fear of not
adopting” and increase the number of payers that approve our rEEG Reports as a
reimbursable expense.




7


We intend
to prove that our rEEG Reports are a compelling value for payers through
independent research, budget impact models, and payer pilots (economic
trials):





·
            Evidence for payers:
       We will share well-designed research on rEEG® efficacy, showing the
      weight of superior evidence in controlled and real-world clinical trials
      and case series.





·
            Parity:  In
      2010, the Mental Health Parity Act (Parity Act) will change all payers’
      coverage criteria, requiring equal coverage for behavioral and medical
      therapies, using the same coverage criteria and
      evidence.  Milliman Global Actuarial Services estimates a 1-3%
      increase in overall health costs resulting from a significant increase in
      behavioral health expenditures driven by the Parity Act.  Of
      particular interest to us, however, is the specific language in the Parity
      Act which requires that coverage of a scope-of-service for one type of
      diagnosis (for example: a Neurologist performing a diagnostic EEG for
      Epilepsy) be applied equally as the use of an EEG by a Psychiatrist for
      medication management.





·
            Budget Impact
      Model:  A Budget Impact Model for rEEG® has been
      developed by Analysis Group Economics based on the published research of
      Kessler, Russell and others covering the cost of treatment failure in
      mental disorders.  Modeling the economic impact of rEEG® in a
      health plan with five million members, we estimate that full utilization
      of rEEG® in treatment-resistant depression, anxiety, bipolar and ADHD
      could save $8,500 per treatment resistant member for a savings of $45
      million per year.





·
            Economic Trials:Economic Trials are intended to demonstrate the comparative
      effectiveness of rEEG versus prevailing Trial & Error medication
      management through pilot programs within a payer’s own
      population.  Although no payer is currently reimbursing
      physicians for the use of rEEG technology, we are currently negotiating
      pilot programs for reimbursement coverage with several of the nation’s
      largest payers, representing over 80 million covered
  lives.




(3)
            Full payer
      coverage.




Full
reimbursement of referenced-EEG is likely to follow successful
direct-to-consumer adoption of the rEEG test, along with continued release of
confirmatory rEEG research in peer-reviewed publications.  Following
the example of the firms discussed above, it appears possible to accelerate the
effect of these initiatives in the following ways:





·
            Patient Advocacy:
       We believe that some components of the rEEG test may be billable to
      payers under the Mental Health Parity Act.  Historically,
      patients of our physician network providers, and those in our own clinic
      in Colorado, have paid out of pocket for rEEG testing and then sought
      reimbursement from their insurance carrier.  Although these
      providers frequently furnish information to support these claims, the
      success of their prosecution by patients is
  unclear.





Accordingly,
we intend to follow the example of firms such as Genomic Health, which developed
Patient Advocacy services where patient claims were documented and tracked, and
the company helped organize the advocacy of each claim with third party
payers.  Using this approach, Genomic Health was able to win a
retrospective reversal of claim denials for its test from Medicare (the Centers
for Medicare and Medicaid Services) in 2006.





·
            Guideline development:
       We intend to continue internal and externally-sponsored
      clinical research to prove the efficacy of our technology to professional
      associations, such as the American Psychiatric Association.  We
      believe that with strong clinical results, professional associations may
      endorse rEEG in their treatment guidelines, which may drive full payer
      coverage.





We also
believe that the inclusion of historical and new rEEG research in Comparative
Effectiveness studies conducted under the Agency for Healthcare Research and
Quality (AHRQ) would be a significant milestone.  As a consequence of
this recent focus on cost-effective treatment, an unprecedented level of funding
has been made available under the Economic Recovery Act, the budgets for NIH and
AHRQ, and earmarked budgets for Defense and the Veterans Association
(VA).  We intend to pursue research opportunities with several
external sponsors of research, including:





·
            theNational Institutes of Mental
      Health, focusing on the cost-effectiveness of rEEG as a more
      deployable version of brain imaging to guide
  prescribing;





·
            theDepartment of Defense and the
      Veterans Administration, to address the potential for rEEG in
      treating returning soldiers with PTSD and Major Depression;
      and





·
            theCenters for Medicare and
      Medicaid Services (CMS), as a mechanism for improving quality and
      cost performance in programs that spend billions on psychotropic
      medications.




8


Neurometric
Services Accomplishments




Over the
last few years, we have been primarily focused on proving the efficacy of
rEEG-guided treatments through multiple clinical trials.  The largest
of these — the Depression Efficacy Trial — was a multi-center, randomized,
parallel controlled trial completed in 2009 at 12 medical centers,
including Harvard, Stanford, Cornell, UCI and Rush.  The study began
in late 2007 and was completed in September 2009, screening 465 potential
subjects with Treatment Resistant Depression and ultimately randomizing 114
participants to a 12-week course of treatment utilizing rEEG in the experimental
group and a modified STAR*D algorithm in the control group (STAR*D, or Sequenced
Alternatives to Relieve Depression, was a large, seven-year study sponsored by
the National Institute of Mental Health and completed in
2006).  Primary clinical outcome measures included the Quick Inventory
of Depression Symptomology (QIDS) and the Quality of Life Enjoyment and
Satisfaction Questionnaire (QLESQ).  Top-line results were consistent
with previous clinical trials of rEEG:





·
            The
      study found that rEEG significantly outperformed the modified STAR*D
      treatment algorithm from the beginning.  The difference, or
      separation, between rEEG and the STAR*D control group was 50 and 100
      percent for the study’s two primary endpoints.  By
      contrast, separation between a new treatment and a control group often
      averages less than 10 percent in antidepressant
      studies.  Interestingly, separation was achieved early (in week
      2) and was durable, continuing to grow through week
  12.





·
            The
      control group in this case, STAR*D, was a particularly tough comparator,
      representing a level of evidence-based depression care that is available
      to only 10% of the US population, according to one of the study’s
      authors.





·
            Statistical
      significance (p < .05) was achieved on all primary and most secondary
      endpoints.





In the
course of undertaking the study, we also gained insights into marketing of the
rEEG technology, highlighting aspects of marketing which proved to be more
successful than others.  Furthermore, we also developed a foundation
for commercialization of the rEEG technology with insurance companies, and
signed a payer group, Cal Optima (a Southern California health plan for
Medicare/Medicaid enrollees), to run a pilot study with us.  A second
large insurer is in the process of negotiating a pilot
study.  Additionally, over the course of the last few years, much time
has been spent securing sufficient financing to continue our operations and to
ensure that the clinical trial was completed.




Going
forward, we plan to continue expanding the CNS Database with the addition of
more pharmaceuticals and their respective outcomes.  Additionally, we
plan on improving the functionality and clinical utility of our rEEG Reports, in
order to improve adoption and compress the training period necessary for
physicians to become proficient with the report.  To this end we have
integrated an iPAD application as the user interface.  Finally, we
plan to increase and refine our marketing efforts to consumers and
psychiatrists, and expand our effort to obtain regular insurance reimbursement
for rEEG-guided therapies.





Use
of rEEG Technology in Pharmaceutical Development




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.  In the future, we aim to
use our propriety data and processes to advance central nervous system (CNS)
pharmaceutical development and economics, in one or more of the following
ways:




·
            Enrichment:
      Selecting patients for clinical trial who not only have the symptoms of
      interest, but are shown by rEEG® screening to likely respond to the
      developer’s drug.  An oft-cited example is the antidepressant
      Prozac, which failed several clinical trials before it achieved success in
      two separate trials.  The ability to design trials in which
      exclusion criteria identify and exclude patients who are clearly
      resistant, as determined by rEEG, has the potential to sharpen patient
      focus and productivity in clinical trials of psychotropic
      medications.





·
            Repositioning:  rEEG®
      may suggest new applications/indications of existing
      medications.  For example, Selective Serotonin Reuptake
      Inhibitors Antidepressants (SSRI’s) are now commonly given by primary care
      physicians for depression and other complaints, but often produce unwanted
      side effects or inadequate results.  The ability to define
      individual neurometrics for patients, who respond better to tricyclics
      (TCA’s), or combinations of TCA’s and stimulants, offers the potential for
      new indications for existing
compounds.





·
            Salvage:
       Resuscitation of medications that failed phase II or III
      studies.   One example of this opportunity is
      Sanofi-Aventis’ unsuccessful PMA filing for Rimonabant, a
      promising anti-obesity/cardio-metabolic compound which was denied
      approval in the U.S. due to central nervous system side-effects in their
      clinical trial populations.  Being able to screen out trial
      participants with resistance to a certain medication is an application for
      rEEG, and could create “theranostic” products (where an indication for use
      is combined with rEEG) for compounds which have failed to receive
      broader approval.




9


·
            New Combinations:
       Unwanted adverse effects occur with medications in fields from
      cancer to hepatitis. The ability to improve these medications, in
      combination with psychotropics, may improve safety, compliance, and
      sometimes, patient outcomes.





·
            Decision Support:
       Improved understanding supports improved decision making at all
      levels of pharmaceutical
development.





Competition




Comparable
Companies




Although
there are no companies offering a service directly comparable to rEEG, the
following companies might be noted as pursuing similar
strategies:




·
            GENOMIC
      HEALTH, Inc. is a life science company focused on the development and
      commercialization of genomic-based clinical laboratory services for cancer
      that allow physicians and patients to make individualized treatment
      decisions.





·
            ASPECT
      MEDICAL SYSTEMS, INC. (now part of Covidien) is developing a specific EEG
      measurement system that indicates a patient's likely response to some
      antidepressant medications.





·
            BRAIN
      RESOURCE COMPANY, is an Australian Clinical Research Organization (CRO)
      and neurosciences company focused on personalized medicine solutions for
      patients, clinicians, pharmaceutical trials and discovery
      research.





We
believe that we have a competitive advantage with respect to the behavioral
analytics firms such as Aspect Medical or Brain Resource Company as we offer
more comprehensive testing (e.g. to cover the full range of CNS medications, not
just certain antidepressants in the case of Aspect Medical) and have conducted
studies to validate the efficacy of our service.  We also believe that we
offer greater clinical utility (ease of use, rapid results) in day-to-day
clinical practice than our competitors.





Intellectual
Property




rEEG
Patents





We have
four issued U.S. Patents which we believe provide us with the right to exclude
others from using our rEEG technology.  In addition, we believe 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.





During
2009 and 2010 the Company was awarded additional patents for use of rEEG
technology in drug discovery, including clinical trial and drug efficacy
studies.  In addition, the company successfully defended its patents
by requesting reexamination of a patent issued to Aspect Medical (now Covidien),
resulting in a reduction and narrowing of claims awarded under the previously
issued Aspect patents.





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.




CNS
Database




The CNS
Database consists of over 17,000 medication trials across over 2,000 patients
who had psychiatric or addictive problems. The CNS 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.  The Company utilizes
two separate QEEG databases which provide statistical and normative information
in the rEEG process.




10


2.           The
Clinical Outcomes Database




The
Clinical Outcomes Database consists of physician provided assessments of the
clinical long-term outcomes (average of 405 days) of patients and their
associated medications. The clinical outcomes of patients are recorded using an
industry-standard outcome rating scale, 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.




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
Physician has access to his/her own patient data through the software tool that
captures clinical outcome data.




We
consider the information contained in the CNS Database to be a valuable trade
secret and are diligent about protecting such information.  The CNS
Database is stored on a secure server and only a limited number of employees
have access to it.





Research
and Development




Going
forward, we plan to 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 neurometrics, refinement of our report
generating system, and by reducing the time to turnaround a report to the
physician.  Research and development expenses during the fiscal years
ended September 30, 2010 and 2009 were $1,120,500 and $1,924,100,
respectively.




Government
Regulation




The FDA informed us that it believes
our rEEG service constitutes a medical device which is subject to regulation by
the FDA,  requiring pre-market approval or 510(k) clearance by the FDA
pursuant to the Federal Food, Drug and Cosmetic Act (the “Act”) before our
service can be marketed or sold.





In early 2010 we submitted an
application to obtain 510(k) clearance for our rEEG service, without waiving our
right to continue to take the position that our services do not constitute a
medical device.  We sought review of our rEEG service, based upon its
equivalence to predicate devices that already have FDA clearance, which appeared
to represent a sound mechanism in order to reduce regulatory risks.





On July 27, 2010 we received a letter
(the “NSE Letter”) from the FDA stating that they determined that our rEEG
service was not substantially equivalent to the predicate devices that had
previously been granted 510(k) clearance and that, among other options, we could
be required to file an approved premarket approval application (PMA) before our
rEEG service could be marketed legally, unless it was otherwise
reclassified.





We
currently plan to continue marketing our rEEG service as a non-device web-based
neurometric information service, while continuing to discuss alternative
approaches with the FDA.  Alternative approaches, which are not mutually
exclusive, may consist of (1) filing a request for reconsideration of the NSE
letter and/or (2) submitting a new 510(k) with revised claims for rEEG and/or
additional information about the predicate devices.  If we continue to
market our rEEG service and the FDA determines that we should be subject to FDA
regulation, it could seek enforcement action against the Company based upon its
position that our rEEG service is a medical device.





In
addition to the foregoing, federal and state laws and regulations relating to
the sale of our Neurometric Information Services are subject to future changes,
as are administrative interpretations of regulatory agencies. In the event that
federal and state laws and regulations change, we may need to incur additional
costs to seek government approvals for the sale of our Neurometric Information
Services.




In the
future, we may 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.





Employees




As of
September 30, 2010, we had approximately 15 full-time and 7 part-time employees,
and 3 independent contractors.  We offer all full-time employees medical
insurance, dental insurance and paid vacation.  We believe that our
relations with our employees are good.  None of our employees belong to a
union.





11


ITEM 1A.
              Risk
      Factors




INVESTING
IN CNS RESPONSE, INC. INVOLVES A HIGH DEGREE OF RISK.  YOU SHOULD
CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION
CONTAINED IN THIS 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




We
need immediate additional funding to support our operations and capital
expenditures, which may not be available to us and which lack of availability
could have a material adverse effect on our business.  The Company’s
continued operating losses and limited capital raise substantial doubt about its
ability to continue as a going concern.




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.  Our continued operating losses and limited capital raise
substantial doubt about our ability to continue as a going
concern.  Until we can generate a sufficient amount of revenues to
finance our operations and capital expenditures, we have to finance our cash
needs primarily through public or private equity offerings, debt financings,
borrowings or strategic collaborations. As of September 30, 2010, we had
approximately $62,000 in cash and cash equivalents at hand.  While we
received approximately $2.0 million from the sale of promissory notes and
warrants in October and November, 2010, we still need additional funds
immediately to continue our operations and will need substantial additional
funds before we can increase demand for our rEEG services.  We are
currently exploring 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.  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 ultimately cause us to have to cease
operations.  Our financial statements include a an opinion of our
auditors that the Company’s continued operating losses and limited capital raise
substantial doubt about its ability to continue as a going concern.




Our
liabilities exceed our assets; we have a working capital deficit.  Our
convertible notes, which are payable during 2011, are secured by all of our
assets.





As of
September 30, 2010 we had liabilities of $4.4 million and assets of only $0.2
million.  We had a working capital deficit of $4.2
million.  Since September 30, 2010, we raised $2 million by selling
secured convertible notes and warrants, we still have a negative net
worth.  Furthermore, as of December 15, 2010, we have outstanding
convertible notes having a principal amount of $3,023,938, which is repayable
beginning October 1, through November 11, 2011.  These notes are
secured by substantially all of the assets of the Company.  We
currently have no resources to repay such notes and we will be required to
either raise additional funds or seek conversion of these notes to avoid a
default.  If we default, the holders of the notes will be entitled to
take all of our assets, in satisfaction of the obligation we have to them,
thereby leaving no value for the holders of common stock.





We
have a history of operating losses.




We are a
company with a limited operating history. Since our inception, we have incurred
significant operating losses. As of September 30, 2010, our accumulated deficit
was approximately $33.4 million. Our future capital requirements will depend on
many factors, such as the risk factors described in this section, including our
ability to maintain our existing cost structure and to execute our business and
strategic plans as currently conceived.  Even if we achieve
profitability, we may be unable to maintain or increase profitability on a
quarterly or annual basis.




If
our rEEG reports do not gain widespread market acceptance, we will not sell
adequate services to maintain our operations.




We have
developed a methodology that aids psychiatrists and other physicians in
selecting appropriate and effective medications for patients with certain
behavioral or addictive disorders based on physiological traits of the patient’s
brain and information contained in a proprietary database that has been
developed over the last twenty years.  We began selling reports,
referred to as rEEG   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 and 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 hire 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, which could also negatively impact our stock
price.


12


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.  In addition, if we fail to upgrade
our CNS Database to account for new medications that are now available on the
market, psychiatrists and other physicians may be less inclined to utilize our
services if they believe that our reports only provide information about older
treatment options, which would further harm our operating results and stock
price.




The
United States Food & Drug Administration (FDA) believes that our rEEG
service constitutes a medical device, which is subject to regulation by the
FDA.  As we continue to market our rEEG service, there is risk that
the FDA will seek enforcement action against us and has informed us that our
marketing of our rEEG services without prior approval or re-classification by
the FDA constitutes a violation of the Federal Food , Drug and Cosmetic
Act.




Since
April of 2008, we have been in a dialogue with the FDA regarding its position
that our rEEG service constitutes a medical device which is subject to
regulation by the FDA.  On April 10, 2008 we received correspondence
from the FDA 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 or 510(k) 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 our rEEG services are not diagnostic and thus for this as
well as other reasons, do 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 our rEEG service met its definition of
medical devices. In response to the FDA communications, we 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 an aid to
diagnosis.  On September 4, 2009, through our regulatory counsel, we
responded to the December 14, 2008 FDA letter explaining our position in more
detail.





During
the intervening period of time, based upon conversations with FDA, we chose to
submit an application to obtain 510(k) clearance for our rEEG service, without
waiving our right to continue to take the position that our services do not
constitute a medical device.  We sought review of our rEEG service
based upon its equivalence to predicate devices that already have FDA clearance
which appeared to represent a sound mechanism to reduce regulatory
risks.





On July
27, 2010 we received a letter (the “NSE Letter”) from the FDA stating that they
determined that our rEEG service was not substantially equivalent to the
predicate devices that had previously been granted 510(k) clearance and that
among other options we could be required to file an approved premarket approval
application (PMA) before it can be marketed legally, unless it is otherwise
reclassified.





We
currently plan to continue marketing as a non-device web-based neurometric
information service, while continuing to discuss alternative approaches with the
FDA.  Alternative approaches, which are not mutually exclusive, may
consist of (1) filing a request for reconsideration of the NSE letter and/or (2)
submitting a new 510(k) with revised claims for rEEG and/or additional
information about the predicate devices.  If we continue to market our
rEEG service and the FDA determines that we should be subject to FDA regulation,
it could seek enforcement action against the Company based upon its position
that our rEEG service is a medical device.




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 announced 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.




13


Regulations
are constantly changing, and in the future our business may be subject to
additional regulations that increase our compliance costs.




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 addition to the
clearance we are currently seeking from the FDA (discussed above), in order to
sell market our rEEG service.  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.





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 Neurometric
Information Services business, currently generates the majority of our revenue
and is operated by our wholly-owned subsidiary, NTC.  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,
the Medical Director at NTC and our Chief Medical Officer and President, 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:





·
            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;





·
            the
      effectiveness of new marketing and sales
  programs;





·
            turnover
      among our employees;





·
            changes
      in management;





·
            the
      introduction of products or services that are viewed in the marketplace as
      substitutes for the services we
provide;





·
            communications
      published by industry organizations or other professional entities in the
      psychiatric and physician community that are unfavorable to our
      business;





·
            the
      introduction of regulations which impose additional costs on or impede our
      business; and





·
            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.




14


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 Neurometric 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.  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.




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 and incur significant legal expenses.  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 or at all.  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.




Our
industry is highly competitive, and we may not be able to compete successfully,
which could result in price reductions and decreased demand for our
products.




The
healthcare business in general, and the behavioral health treatment business in
particular, are highly competitive. In the event that we are unable to convince
physicians, psychiatrists and patients of the efficacy of our products and
services, individuals seeking treatment for behavioral health disorders may seek
alternative treatment methods, which could negatively impact our sales and
profitability.




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.


15


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:





·
            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;





·
            delays
      in enrolling patients and volunteers into clinical
  trials;





·
            lower
      than anticipated retention rates of patients and volunteers in clinical
      trials;





·
            negative
      results from clinical trials for any of our potential products;
      and





·
            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.





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.




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 important to our
business prospects.  We currently have four 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.




16


We also
utilize processes and technology that constitute trade secrets, such as our CNS
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.




The
liability of our directors and officers is limited.




The
applicable provisions of the Delaware General Corporate Law and our Certificate
of Incorporation limit the liability of our directors to the Company and our
stockholders for monetary damages for breaches of their fiduciary duties, with
certain exceptions, and for other specified acts or omissions of such persons.
In addition, the applicable provisions of the Delaware General Corporate Law and
of our Certificate of Incorporation and Bylaws, as well as indemnification
agreements we have entered into with our directors, officers and certain other
individuals, provide for indemnification of such persons under certain
circumstances.  In the event we are required to indemnify any of our
directors or any other person, our financial strength may be harmed, which may
in turn lower our stock price.




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 George Carpenter,
our Chief Executive Officer, our senior product development and clinical
managers, 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.  While we believe our relationships with our executives are
good and do not anticipate any of them leaving in the near future, the loss of
the services of any of our senior management could have a material adverse
effect on our ability to manage our business.  We do not carry key man
life insurance on any of our key employees.




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.  In the future, if we pursue our pharmaceutical
opportunities, we will also likely need to hire 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 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.




17


We
currently have general liability and medical professional liability insurance
coverage for up to $5 million per year for personal injury claims. We may
not be able to maintain adequate liability insurance, in accordance with
standard industry practice, with appropriate coverage based on the nature and
risks of our business, at acceptable costs and on favorable terms. Insurance
carriers are often reluctant to provide liability insurance for new healthcare
services companies and products due to the limited claims history for such
companies and products. In addition, based on current insurance markets, we
expect that liability insurance will be more difficult to obtain and that
premiums will increase over time and as the volume of patients treated by
physicians that are guided by our rEEG 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.




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.





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, in addition to the regulatory process and
dialogue in which we are now engaged with the FDA (please see the risk factor
above for further information). 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.




18


We
may be subject to regulatory and investigative proceedings, which may find that
our policies and procedures do not fully comply with complex and changing
healthcare regulations.




While we
have established policies and procedures that we believe will be sufficient to
ensure that we operate in substantial compliance with applicable laws,
regulations and requirements, the criteria are often vague and subject to change
and interpretation. We may become the subject of regulatory or other
investigations or proceedings, and our interpretations of applicable laws and
regulations may be challenged. The defense of any such challenge could result in
substantial cost and a diversion of management’s time and attention. Thus, any
such challenge could have a material adverse effect on our business, regardless
of whether it ultimately is successful. If we fail to comply with any applicable
laws, or a determination is made that we have failed to comply with these laws,
our financial condition and results of operations could be adversely
affected.




Failure
to comply with the Federal Trade Commission Act or similar state laws could
result in sanctions or limit the claims we can make.




The
Company’s promotional activities and materials, including advertising to
consumers and physicians, and materials provided to third parties for their use
in promoting our products and services, are regulated by the Federal Trade
Commission (FTC) under the FTC Act, which prohibits unfair and deceptive
acts and practices, including claims which are false, misleading or inadequately
substantiated. The FTC typically requires competent and reliable scientific
tests or studies to substantiate express or implied claims that a product or
service is effective. If the FTC were to interpret our promotional materials as
making express or implied claims that our products and services are effective
for the treatment of mental illness, it may find that we do not have adequate
substantiation for such claims. Failure to comply with the FTC Act or similar
laws enforced by state attorneys general and other state and local officials
could result in administrative or judicial orders limiting or eliminating the
claims we can make about our products and services, and other sanctions
including fines.





Our
business practices may be found to constitute illegal fee-splitting or corporate
practice of medicine, which may lead to penalties and adversely affect our
business.




Many
states, including California, in which our principal executive offices are
located, have laws that prohibit business corporations, such as us, from
practicing medicine, exercising control over medical judgments or decisions of
physicians, or engaging in certain arrangements, such as employment or
fee-splitting, with physicians. Courts, regulatory authorities or other parties,
including physicians, may assert that we are engaged in the unlawful corporate
practice of medicine 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 and
substantial legal costs, 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. 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.




19


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.




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 NASDAQ’s
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 increases price volatility and reduces the liquidity of our
Common Stock. As long as this condition continues, the sale of a significant
number of shares of Common Stock at any particular time could be difficult to
achieve at the market prices prevailing immediately before such shares are
offered. 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. 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:





·
            quarterly
      variations in our revenues and operating
  expenses;





·
            developments
      in the financial markets and worldwide or regional
    economies;





·
            announcements
      of innovations or new products or services by us or our
      competitors;




20


·
            announcements
      by the government relating to regulations that govern our
      industry;





·
            significant
      sales of our Common Stock or other securities in the open
      market;





·
            variations
      in interest rates;





·
            changes
      in the market valuations of other comparable companies;
  and





·
            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.




Future
sales of our Common Stock in the public market could cause our stock price to
fall.




Of our
56,023,921 shares of common stock outstanding, 47,095,675 shares are restricted
securities, as that term is defined under the Securities Act of 1933, as
amended.  In addition, as at December 15, 2010, 10,375,190 shares may
be issued upon the conversion of our convertible notes, 24,904,308 shares upon
the exercise of our warrants and 15,670,973 shares upon the exercise of stock
options. We have filed a registration statement covering the resale of
65,879,838 shares and 18,409,015 shares of underlying warrants. The sale of
shares of our common stock pursuant to Rule 144 of the Securities Act of 1933,
as amended, or otherwise, could depress the market price of our Common
Stock.  A reduced market price for our Common Stock could make it more
difficult to raise funds through future offering of Common Stock.




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 or public offering 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 or quoted on
the NASDAQ Stock Market if current price and volume information with respect to
transactions in such securities is provided by the exchange or
system).  Because our securities may constitute “penny stock” within
the meaning of the rules, the rules would apply to us and to our
securities.  Our stockholders may therefore find it more difficult to
sell their securities.




Stockholders
should be aware that, according to SEC, the market for penny stocks has suffered
in recent years from patterns of fraud and abuse.  Such patterns
include (i) control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer; (ii)
manipulation of prices through prearranged matching of purchases and sales and
false and misleading press releases; (iii) “boiler room” practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (iv) excessive and undisclosed bid-ask differentials and markups
by selling broker-dealers; and (v) the wholesale dumping of the same securities
by promoters and broker-dealers after prices have been manipulated to a desired
level, resulting in investor losses.  Our management is aware of the
abuses that have occurred historically in the penny stock
market.  Although we do not expect to be in a position to dictate the
behavior of the market or of broker-dealers who participate in the market,
management will strive within the confines of practical limitations to prevent
the described patterns from being established with respect to our
securities.




21


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 44% 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 44% of our issued and outstanding Common
Stock. Subsequent sales of our shares by these stockholders could have the
effect of lowering our stock price. The perceived risk associated with the
possible sale of a large number of shares by these stockholders, or the adoption
of significant short positions by hedge funds or other significant investors,
could cause some of our stockholders to sell their stock, thus causing the price
of our stock to decline. In addition, actual or anticipated downward pressure on
our stock price due to actual or anticipated sales of stock by our directors or
officers could cause other institutions or individuals to engage in short sales
of our Common Stock, which may further cause the price of our stock to
decline.




From time
to time our directors and executive officers may sell shares of our common stock
on the open market. These sales will be publicly disclosed in filings made with
the SEC. In the future, our directors and executive officers may sell a
significant number of shares for a variety of reasons unrelated to the
performance of our business. Our stockholders may perceive these sales as a
reflection on management's view of the business and result in some stockholders
selling their shares of our common stock. These sales could cause the price of
our stock to drop.




Anti-takeover
provisions may limit the ability of another party to acquire us, which could
cause our stock price to decline.




Delaware
law contains provisions that could discourage, delay or prevent a third party
from acquiring us, even if doing so may be beneficial to our stockholders, 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.


22


ITEM
2.              Properties





The
Company leases its headquarters and Neurometric Information Services space,
located at 85 Enterprise, Suite 410, Aliso Viejo, CA 92656, under an operating
lease which commenced on February 1, 2010 and terminates on January 30, 2013.
The 2,023 square foot facility has an average cost for the lease term of $3,600
per month.




The
Company leases space for its Clinical Services operations, located at 7800 East
Orchard Road, Suite 340, Greenwood Village, Co 80111, under an operating
lease.  A 37 month extension to the original 2005 lease was negotiated
commencing April 1, 2010 and terminating April 30, 2013. The 3,542 square foot
facility has an average cost for the lease term of $5,100 per
month.




We
believe that our current space is adequate for our 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 ordinary course of business. Other than as set forth below, 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.              (Removed
and Reserved.)




23


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 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
                
                
                LowYear
      Ended September 30, 2009First
      Quarter
                
                $
                1.01
                
                
                $
                0.10Second
      Quarter
                
                $
                0.90
                
                
                $
                0.05Third
      Quarter
                
                $
                0.69
                
                
                $
                0.15Fourth
      Quarter
                
                $
                0.72
                
                
                $
                0.20Year
      Ended September 30, 2010First
      Quarter
                
                $
                1.20
                
                
                $
                0.50Second
      Quarter
                
                $
                1.20
                
                
                $
                0.52Third
      Quarter
                
                $
                1.15
                
                
                $
                0.40Fourth
      Quarter
                
                $
                0.95
                
                
                $
                0.05




On
December 16, 2010, the closing sales price of our common stock as reported on
the OTC Bulletin Board was $0.40 per share.  As of December 16,
2010, there were 364 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.





Securities
Authorized for Issuance Under Equity Compensation Plans





The
required disclosure on our equity compensation plan is incorporated herein by
reference to “Item 13. Certain Relationships and Related Transactions, and
Director Independence - Securities Authorized for Issuance Under Equity
Compensation Plans.”





Recent
Sales of Unregistered Securities—Private Placement Transactions





2009 Private
Placement Transactions





On August 26, 2009, we received gross
proceeds of approximately $2,043,000 in the first closing of our private
placement transaction with six accredited investors.  Pursuant to
Subscription Agreements entered into with the investors, we sold approximately
38 Investment Units at $54,000 per Investment Unit.  Each “Investment
Unit” consists of 180,000 shares of our common stock and a five year
non-callable warrant to purchase 90,000 shares of our common stock at an
exercise price of $0.30 per share.  After commissions and expenses, we
received net proceeds of approximately $1,792,300 upon the first closing of our
private placement.  On December 24, 2009, we had a second closing of
our private placement in which we received additional gross proceeds of
approximately $2,996,000 from 24 accredited investors.  At the second
closing, we sold approximately 55 Investment Units on the same terms and
conditions as the Investment Units sold at the first closing.  After
commissions and expenses, we received net proceeds of approximately $2,650,400
in connection with this second closing of our private placement.  On
December 31, 2009, we had a third closing of our private placement in which we
received additional gross proceeds of approximately $432,000 from five
accredited investors.  At the third closing, we sold eight Investment
Units on the same terms and conditions as the Investment Units sold at the first
closing. After commissions and expenses, we received net proceeds of
approximately $380,200 in connection with this third closing of our private
placement.  On January 4, 2010, the Company completed its fourth and
final closing of its private placement, resulting in additional gross proceeds
to the Company of $108,000 from two accredited investors.  At this
fourth closing, we sold two Investment Units on the same terms and conditions as
the Investment Units sold at the first closing. After commissions and expenses,
we received net proceeds of approximately $95,000 in connection with this final
closing of our private placement.   These private placement
transactions are described in further detail in “Liquidity and Capital
Resources” below and Note 3 to the audited consolidated financial
statements.




24


Prior to our private placement, we
raised aggregate proceeds of $1,700,000 in fiscal year 2009 through the issuance
of secured convertible promissory notes on each of March 30, May 14, and June
12, 2009.  Upon the first closing of our private placement on August
26, 2009, these notes were converted into shares of our common stock, as more
fully described in Note 3 of the audited consolidated financial
statements.





2010
Private Placement Transactions





During
2010 we entered into a series of Bridge Note and Warrant Purchase Agreements as
described in detail below.  On September 26, 2010, the Company’s Board
approved an approximate aggregate offering amount of $3 million by January 31,
2011, including for the exchange of Bridge Notes and Deerwood Notes and interest
on those notes.  The fund raising efforts were successful and new
notes in the aggregate principal amount of approximately $3 million were issued
by November 12, 2010.





Bridge Notes and Warrants





On June 3, 2010, we entered into a
Bridge Note and Warrant Purchase Agreement with John Pappajohn to purchase two
secured promissory notes (each, a “Bridge Note”) in the aggregate principal
amount of $500,000, with each Bridge Note in the principal amount of $250,000
maturing on December 2, 2010.  On June 3, 2010, Mr. Pappajohn loaned
the Company $250,000 in exchange for the first Bridge Note (there were no
warrants issued in connection with this first note) and on July 25, 2010, Mr.
Pappajohn loaned us $250,000 in exchange for the second Bridge
Note.  In connection with his purchase of the second Bridge Note, Mr.
Pappajohn received a warrant to purchase up to 250,000 shares of our common
stock.  The exercise price of the warrant (subject to anti-dilution
adjustments, including for issuances of securities at prices below the
then-effective exercise price) was $0.50 per share.





Pursuant to a separate agreement that
we entered into with Mr. Pappajohn on July 25, 2010, we granted him a right to
convert his Bridge Notes into shares of our common stock at a conversion price
of $0.50.  The conversion price was subject to customary anti-dilution
adjustments, but would never be less than $0.30. Each Bridge Note accrued
interest at a rate of 9% per annum.





Deerwood Notes and
Warrants





On July 5, 2010 and August 20, 2010, we
issued unsecured promissory notes (each, a “Deerwood Note”) in the aggregate
principal amount of $500,000 to Deerwood Partners LLC and Deerwood Holdings LLC,
with each investor purchasing two notes in the aggregate principal amount of
$250,000.  Our director George Kallins and his spouse are the managing
members of these investors.  The Deerwood Notes mature on December 15,
2010.  We received $250,000 in gross proceeds from the issuance of the
first two notes on July 5, 2010 and another $250,000 in gross proceeds from the
issuance of the second two notes on August 20, 2010.   In
connection with the August 20, 2010 transaction, each of the two investors also
received a warrant to purchase up to 75,000 shares of our common stock at an
exercise price (subject to anti-dilution adjustments, including for issuances of
securities at prices below the then-effective exercise price) of $0.56 per
share.




SAIL Venture Partners L.P. (“SAIL”), of
which our director David Jones is a managing partner, issued unconditional
guaranties to each of the Deerwood investors, guaranteeing the prompt and
complete payment when due of all principal, interest and other amounts under
each Deerwood Note.  The obligations under each guaranty were
independent of our obligations under the Deerwood Notes and separate actions
could be brought against the guarantor.  We entered into an oral agreement
to indemnify SAIL and grant to SAIL a security interest in our assets in
connection with the guaranties. In addition, on August 20, 2010, we granted SAIL
warrants to purchase up to an aggregate of 100,000 shares of common stock at an
exercise price (subject to anti-dilution adjustments, including for issuances of
securities at prices below the then-effective exercise price) of $0.56 per
share.




Each Deerwood Note accrued interest at
a rate of 9% per annum and was convertible into shares of our common stock
at a conversion price of $0.50.  The conversion price was subject to
customary anti-dilution adjustments, but would never be less than
$0.30.





October Notes and Warrants




On October 1, 2010, we entered into a
Note and Warrant Purchase Agreement (the “Purchase Agreement”) with John
Pappajohn and SAIL as investors, pursuant to which we issued to the investors
secured convertible promissory notes (the “October Notes”) in the aggregate
principal amount of $1,011,688 and warrants to purchase up to 1,686,144 shares
of common stock. The Company received $500,000 in gross proceeds from the
issuance to these investors of October Notes in the aggregate principal amount
of $500,000 and related warrants to purchase up to 833,332 shares.  We
also issued October Notes in the aggregate principal amount of $511,688, and
related warrants to purchase up to 852,812 shares, to Mr. Pappajohn in exchange
for the cancellation of the two Bridge Notes originally issued to him on June 3,
2010 and July 25, 2010 in the aggregate principal amount of $500,000 (and
accrued and unpaid interest on those notes) and a warrant to purchase up to
250,000 shares originally issued to him on July 25, 2010. The transaction closed
on October 1, 2010.




25




On October 7 and October 12, 2010, a
third and fourth accredited investor, respectively, executed the Purchase
Agreement. In connection therewith, we issued October Notes in the aggregate
principal amount of $600,000 and warrants to purchase up to 999,999 shares of
common stock of the Company, to such investors on those dates.  We
received $588,000 in net proceeds from these investors, after paying $12,000 to
the placement agent as described below. Monarch Capital Group LLC (“Monarch”)
acted as non-exclusive placement agent with respect to the October 12 placement
of October Notes in the aggregate principal amount of $100,000 and related
warrants, pursuant to an engagement agreement, dated September 30, 2010, between
us and Monarch. Under the engagement agreement, in return for its services as
non-exclusive placement agent, Monarch was entitled to receive (a) a cash fee
equal to 10% of the gross proceeds raised from the sale of October Notes to
investors introduced to the Company by Monarch; (b) a cash expense allowance
equal to 2% of the gross proceeds raised from the sale of October Notes to such
investors; and (c) five-year warrants (the “Placement Agent Warrants”) to
purchase common stock of the Company equal to 10% of the shares issuable upon
conversion of October Notes issued to such investors.  In connection
with the October 12, 2010 closing, Monarch received a cash fee of $10,000 and a
cash expense allowance of $2,000 and, on October 25, 2010, received Placement
Agent Warrants to purchase 33,333 shares of the Company’s common stock at an
exercise price of $0.33 per share.




On October 21, 2010 and October 28, a
fifth and sixth accredited investor executed the Purchase Agreement. In
connection therewith, we issued October Notes in the aggregate principal amount
of $250,000 and warrants to purchase up to 416,666 shares of common stock to
such investors on that date. We received approximately $250,000 in net proceeds
from the issuance to these investors.




On
November 3, 2010, three affiliated entities, identified below, executed the
Purchase Agreement.  In connection therewith, we issued October Notes
in the aggregate principal amount of $762,250 and warrants to purchase up to
1,270,414 shares of common stock, as follows:  (a) We received
$250,000 in gross proceeds from the issuance to BGN Acquisition Ltd., LP, an
entity controlled by our director George Kallins, of October Notes in the
aggregate principal amount of $250,000 and related warrants to purchase up to
416,666 shares.  (b)  We also issued October Notes in the
aggregate principal amount of $512,250, and related warrants to purchase up to
512,250 shares, to Deerwood Holdings LLC and Deerwood Partners LLC, two entities
controlled by Mr. Kallins, in exchange for the cancellation of the Deerwood
Notes originally issued on July 5, 2010 and August 20, 2010 in the aggregate
principal amount of $500,000 (and accrued and unpaid interest on those notes)
and warrants to purchase an aggregate of up to 150,000 shares originally issued
on August 20, 2010.  The related guaranties and oral indemnification
and security agreement that had been entered into in connection with the
Deerwood Notes were likewise terminated.   SAIL, of which our
director David Jones is a managing partner, issued unconditional guaranties to
each of the Deerwood investors, guaranteeing the prompt and complete payment
when due of all principal, interest and other amounts under the October Notes
issued to such investors.  The obligations under each guaranty are
independent of our obligations under the October Notes and separate actions may
be brought against the guarantor.  In connection with its serving as
guarantor, we granted SAIL warrants to purchase up to an aggregate of 341,498
shares of common stock.  The warrants to purchase 100,000 shares of
common stock previously granted to SAIL on August 20, 2010 were
canceled.




On
November 12, a tenth accredited investor executed the Purchase
Agreement.  In connection therewith, the Company issued Notes in the
aggregate principal amount of $400,000 and Warrants to purchase up to 666,666
shares of common stock of the Company, to the investor on such
date.   The Company received $352,000 in net proceeds from the
investor.   Monarch acted as non-exclusive placement agent with
respect to the placement of the Note in the aggregate principal amount of
$400,000 and related Warrants, pursuant to the abovementioned engagement
agreement, dated September 30, 2010.  In connection with the November
12, 2010 closing, Monarch received a cash fee of $40,000 and a cash expense
allowance of $8,000 and will receive a Placement Agent Warrant to purchase
133,333 shares of the Company’s common stock at an exercise price of $0.33 per
share.





The
Purchase Agreement provides for the issuance and sale of October Notes, for cash
or in exchange for outstanding convertible notes, in the aggregate principal
amount of up to $3,000,000 plus an amount corresponding to accrued and unpaid
interest on any exchanged notes, and warrants to purchase a number of shares
corresponding to 50% of the number of shares issuable on conversion of the
October Notes.  The agreement provides for multiple closings, but
mandates that no closings may occur after January 31, 2011.  The
Purchase Agreement also provides that the Company and the holders of the October
Notes will enter into a registration rights agreement covering the registration
of the resale of the shares underlying the October Notes and the related
warrants.




The
October Notes mature one year from the date of issuance (subject to earlier
conversion or prepayment), earn interest equal to 9% per year with interest
payable at maturity, and are convertible into shares of common stock of the
Company at a conversion price of $0.30. The conversion price is subject to
adjustment upon (1) the subdivision or combination of, or stock dividends paid
on, the common stock; (2) the issuance of cash dividends and distributions on
the common stock; (3) the distribution of other capital stock, indebtedness or
other non-cash assets; and (4) the completion of a financing at a price below
the conversion price then in effect.  The October Notes are
furthermore convertible, at the option of the holder, into securities to be
issued in subsequent financings at the lower of the then-applicable conversion
price or price per share payable by purchasers of such
securities.  The October Notes can be declared due and payable upon an
event of default, defined in the October Notes to occur, among other things, if
the Company fails to pay principal and interest when due, in the case of
voluntary or involuntary bankruptcy or if the Company fails to perform any
covenant or agreement as required by the October Note.




Our
obligations under the terms of the October Notes are secured by a security
interest in the tangible and intangible assets of the Company, pursuant to a
Security Agreement, dated as of October 1, 2010, by and between us and John
Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.




26


The
warrants related to the October Notes expire seven years from the date of
issuance and are exercisable for shares of common stock of the Company at an
exercise price of $0.30.  Exercise price and number of shares issuable
upon exercise are subject to adjustment (1) upon the subdivision or combination
of, or stock dividends paid on, the common stock; (2) in case of any
reclassification, capital reorganization or change in capital stock and (3) upon
the completion of a financing at a price below the exercise price then in
effect.Any provision
of the October Notes or related warrants can be amended, waived or modified upon
the written consent of the Company and holders of a majority of the aggregate
principal amount of such notes outstanding.  Any such consent will
affect all October Notes or warrants, as the case may be, and will be binding on
all holders thereof.




The
Placement Agent Warrants have an exercise price equal to 110% of the conversion
price of the Notes and an exercise period of five years.  The terms of
the Placement Agent Warrants, except for the exercise price and period, are
identical to the terms of the warrants related to the October
Notes.




For a
table showing the differences in terms between the October Notes (and related
warrants), on the one hand, and the exchanged Bridge Notes and Deerwood Notes
(and related warrants), on the other hand, please refer to “Item 13 - Certain
Relationships and Related Transactions, and Director Independence - Differences
between October Notes and Bridge Notes/Deerwood Notes.”




In issuing the securities described in
this section without registration under the Securities Act, the Company relied
upon the exemption from registration contained in Section 4(2) of the Securities
Act and in Regulation D promulgated thereunder, as the
securities  were issued to accredited investors, without a view to
distribution, and were not issued through any general solicitation or
advertisement.


27




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 consolidated operating results, financial
condition and liquidity and cash flows of CNS Response, Inc. for the fiscal
years ended September 30, 2010 and 2009.  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
web-based neuroinformatic analysis company with two distinct business segments.
Our primary business is the Neurometric Information Services (formerly called
Laboratory Information Services) business operated by CNS California, which is
focused on neurometric analysis, research, development and the commercialization
of a patented system that provides data to psychiatrists and other physicians to
enable them to make more informed, patient-specific decisions when treating
individual patients with behavioral (psychiatric and/or addictive)
disorders.  Our secondary Clinical Services business, operated by our
wholly-owned subsidiary, Neuro-Therapy Clinic (“NTC”), is a full service
psychiatric clinic.




Neurometric
Information Services




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 can rarely be analyzed,
which often results in multiple ineffective, costly, and often lengthy, courses
of treatment before the effective medications are identified.  Some
patients never find effective medications.




We
believe that our technology offers an improvement upon traditional methods for
determining a course of medication for 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 a proprietary outcomes database which
consists of over 17,000 medication trials for patients with psychiatric or
addictive problems (the “CNS
Database ”).  For each patient in the CNS Database, we have
compiled electroencephalographic (“EEG ”) scans, symptoms and
outcomes often across multiple treatments from multiple psychiatrists and
physicians.  This patented technology, called “Referenced-EEG®” or
“rEEG®”, represents an innovative approach to identifying effective medications
for patients suffering from debilitating behavioral disorders.




With
rEEG®, physicians order a digital EEG for a patient, which is then evaluated
with reference to the CNS Database.  By providing this reference
correlation, an attending physician can better determine a treatment strategy
with the knowledge of how other patients having similar brain function have
previously responded to a myriad of different treatment
alternatives.  Analysis of this complete data set yielded a platform
of 74 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 74 neurometric variables, and the
database to be queried to understand the statistical probability of how patients
with similar brain patterns have previously responded to the medications
currently in the database. This technology allows us to create and provide
simple reports (“rEEG
Reports ”) to the prescriber that summarizes historical treatment success
of specific medications for those patients with similar neurometric brain
patterns.   It provides neither a diagnosis nor a specific
treatment, but like all lab results, provides objective, evidenced-based
information to help the prescriber in their decision-making.




Our
Neurometric Information Services business is focused on increasing the demand
for our rEEG Reports. We believe the key factors that will drive broader
adoption of our rEEG 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.




28


In
addition to its utility in providing psychiatrists and other
physicians/prescribers 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 CNS Database, has 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).




Clinical
Services




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 operates one of the larger psychiatric
medication management practices in the state of Colorado, with six full time and
seven 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 more recently, our President.




NTC,
having performed a significant number of rEEG’s, serves as 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 develop
marketing and patient acquisition strategies for our Neurometric 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 Neurometric 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, 2010,
we had an accumulated deficit of approximately $33.4 million, and as of
September 30, 2009, our accumulated deficit was approximately $25.2
million.  We incurred operating losses of $6.5 million and $6.7
million for the fiscal years ended September 30, 2010 and 2009, respectively and
incurred net losses of $8.2 million and $8.5 million for those respective
periods.  We expect our net losses to continue for at least the next couple
of years. We anticipate that a substantial portion of our capital resources and
efforts will be focused on the scale-up of our commercial organization, research
and product development and other general corporate purposes, including the
payment of legal fees incurred as a result of our
litigation.  Research and development projects include the completion
of more clinical trials which are necessary to further validate the efficacy of
our products and services relating to our rEEG technology across different types
of behavioral disorders; the enhancement of the CNS Database and rEEG process,
and to a lesser extent, the identification of new medications that are often
combinations of approved drugs.  We anticipate that future research
and development projects will be funded by grants or third-party
sponsorship.





As of
September 30, 2010, our current liabilities of approximately $4.4 million
exceeded our current assets of approximately $0.20 million by approximately
$4.2 million and our net losses will continue for the foreseeable
future.  As part of the $4.4 million of current liabilities we have
$1.0 million of secured convertible debt which is discounted to
$0.  Since September 30, 2010, we have raised an additional $2.0
million from the issuance of secured convertible debt; however, we will need
immediate additional funding to continue our operations plus substantial
additional funding before we can increase the demand for our rEEG
services.  We are currently exploring 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.  Furthermore, 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 the funds available for our business activities.  If adequate
funds are not available, we may be required to delay or curtail significantly
our development and commercialization activities.  This would have a
material adverse effect on our business, financial condition and/or results of
operations and could ultimately cause us to have to cease
operations.





The
Private Placement Transactions




From June
3, through to November 12, 2010, we raised $3.0 million through the sale of
secured convertible notes and warrants.  Of such amount $1.75 million
was purchased by members of our Board of Directors or their affiliate companies.
See Note 3 of the audited
financial statements, “Item 5. Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities - Recent Sales of
Unregistered Securities” and “Item 13. Certain Relationships and Related
Transactions, and Director Independence.”




29


Financial
Operations Overview




Revenues




Our
Neurometric 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.




Clinical
Services 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 Neurometric Information 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 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 Neurometric Information
Services and primarily represent costs incurred to design and conduct clinical
studies, to recruit patients into the studies, to improve rEEG 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 Information 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.




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, consulting and administrative and support costs for both our Neurometric
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.




30


Our
significant accounting policies are described in Note 2 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 Neurometric
Service product are recognized when a 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.





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 Years Ended September
30, 2010 and 2009




As earlier described, we operate in two business
segments: NeurometricInformationServices and Clinical Services.  Our
NeurometricInformationServices business focuses on the delivery of
reports ("rEEG 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. Our Clinical Services business
operated through NTC provides full service psychiatric
services.





The following table presents consolidated statement
of operations data for each of the periods indicated as a percentage of
revenues.




Year ended September 30,2010
                                          
                                          
                                          2009Revenues
                                          
                                          
                                          100
                                          %
                                          
                                          
                                          100
                                          %Cost
      of revenues
                                          
                                          
                                          21
                                          
                                          
                                          
                                          19Gross
      profit
                                          
                                          
                                          79
                                          
                                          
                                          
                                          81Research
      and development
                                          
                                          
                                          176
                                          
                                          
                                          
                                          305Sales
      and marketing
                                          
                                          
                                          136
                                          
                                          
                                          
                                          131General
      and administrative expenses
                                          
                                          
                                          785
                                          
                                          
                                          
                                          555Goodwill
      impairment
                                          
                                          
                                          0
                                          
                                          
                                          
                                          46Operating
      loss
                                          
                                          
                                          (1,018
                                          )
                                          
                                          
                                          (956
                                          )Other
      income (expense), net
                                          
                                          
                                          (262
                                          )
                                          
                                          
                                          (261
                                          )Net
      income (loss)
                                          
                                          
                                          (1,280
                                          )%
                                          
                                          
                                          (1217
                                          )%





Revenues




Year
      ended September 30,
                                                
                                                
                                                Percent2010
                                                
                                                2009
                                                
                                                
                                                ChangeNeurometric
      Service Revenues
                                                $
                                                136,100
                                                
                                                $
                                                120,400
                                                
                                                
                                                
                                                13
                                                %Clinical
      Service Revenues
                                                
                                                502,400
                                                
                                                
                                                579,700
                                                
                                                
                                                
                                                (13
                                                )%Total
      Revenues
                                                $
                                                638,500
                                                
                                                $
                                                700,100
                                                
                                                
                                                
                                                (9
                                                )%





With respect to our Neurometric Information
Services business the number of paid rEEG Reports delivered increased from 321
for the year ended September 30, 2009, to 358 for the year ended September 30,
2010, while the average revenue per report decreased from $380 to $375 per
report for the year ended September 30, 2010.  The total number of
free rEEG reports, which were not associated with our clinical trial, increased
from 158 for the year ended September 30, 2009, to 228 for the same period ended
September 30, 2010.  These free rEEG reports are used for training,
database-enhancement and compassionate-use purposes.




31


Cost of Revenues




Year ended September 30,
                      
                      
                      Percent2009
                      
                      
                      2008
                      
                      
                      ChangeCost
      of Neurometric Information Services revenues
                      
                      $
                      135,100
                      
                      
                      $
                      131,600
                      
                      
                      
                      3
                      %




Cost of Neurometric Information Services revenues
consists of payroll, consulting, and other miscellaneous
costs.  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, 2010, cost of
revenues of $135,100 consist primarily of direct labor and benefit costs of
$102,100, which includes stock-based compensation, and consulting fees of
$32,700.  For the year ended September 30, 2009, cost of revenues of
$131,600 consisted primarily of direct labor and benefit costs of $99,600,
including stock-based compensation, and consulting fees of
$29,200.  We expect costs of revenues will increase as an absolute
number as more rEEG Reports are processed. However, 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.




Research and Development




Year ended September 30,
                        
                        
                        Percent2010
                        
                        
                        2009
                        
                        
                        ChangeNeurometric
      Information Services research and development
                        
                        $
                        1,120,500
                        
                        
                        $
                        1,924,100
                        
                        
                        
                        (42
                        )%





Research
and development expenses consist of payroll costs (including stock-based
compensation costs), consulting fees, clinical study costs, patient marketing
and recruitment costs and other miscellaneous costs.  Research and
development costs for the year ended September 30, 2010, included the
following: payroll and benefit costs (including stock based
compensation) of $848,300, consultant costs of $201,700 and other
miscellaneous costs of $70,500 which include travel, database and support
costs.  There were negligible clinical study patient costs or patient
marketing and recruitment costs incurred for the year ended September 30,
2010.  For the comparable period for 2009, research and development
costs included: payroll and benefit costs (including stock based
compensation) of $792,100, consultant costs of $105,700 and other
miscellaneous costs of $76,200 which included travel, database and support
costs.  Additionally, as the clinical study was in full progress
during the 2009 period, research and development costs included clinical study
patient costs of $789,300 and patient marketing and recruitment costs of
$161,100.





Comparing
the year ended September 30, 2010 with the corresponding period in
2009, clinical study patient costs and patient marketing and recruitment
costs were eliminated in the 2010 period as the study was completed in September
2009.  Consequently, the focus of the research and development
department moved from conducting the clinical study to analyzing the data and
drafting scientific papers for publications; the department also generated
several applications for research grants for future
funding.  Additionally, the focus moved to enhancing the rEEG
production system and the preparation of the 510(k) application with the
FDA.  With this shift in focus, consulting fees increased by $96,100:
in total $50,200 was spent on research and $151,500 was spent on product
enhancements in the year ended September 30, 2010.  Of the $151,500,
$76,100 was spent on consulting resources assisting with the filing of our
510(k) application with the FDA, while the balance, $75,400, was spent on
programming resources to improve our database and the rEEG
process.  Payroll and benefits increased by $56,200 in the 2010 period
primarily due to the reassignment of a staff member between departments and due
to the increase in stock-based compensation.





Sales and
marketing




Year ended September 30,
                              
                              
                              Percent2010
                              
                              2009
                              
                              
                              ChangeSales
      and MarketingNeurometric
      Information Services
                              $
                              853,100
                              
                              $
                              908,500
                              
                              
                              
                              (6
                              )%Clinical
      Services
                              
                              17,800
                              
                              
                              7,300
                              
                              
                              
                              144
                              %Total
      Sales and Marketing
                              $
                              870,900
                              
                              $
                              915,800
                              
                              
                              
                              (5
                              )%




32


Sales and marketing expenses associated with our
Laboratory Information Services business consist primarily of payroll and
benefit costs, including stock-based compensation; advertising and marketing;
consulting fees and conference and travel expenses.  Sales and
marketing expenses for the year ended September 30, 2010 included the
following expenses: payroll and benefits $568,100, advertising and marketing
$59,100, consulting $122,700 and conferences and travel $62,000. For the
comparable period in 2009 expenses were as follows: payroll and benefits
$596,000, advertising and marketing $147,600, consulting $82,400 and conferences
and travel $34,100.





Comparing
the year ended September 30, 2010, with the same period in 2009; payroll
and benefits decreased by $27,900 in the 2010 period as a result a
reduction in staff and the reassignment of staff to another
department.  However, in July 2010 we recruited an Executive Vice
President and Chief Marketing Officer to lead our marketing efforts and pursue
contracts with key organizations.  Advertising and marketing expenses
decreased by $88,500 as advertising was curtailed while the Company awaited
resolution to its 510(k) application with the
FDA.  Consequently, in the year ended September 30, 2010,
marketing efforts were largely limited to planning and provider network
development, whereas for the 2009 period the Company was actively executing its
advertising and marketing plans.  Conference and travel expenses
increased by $27,900 in the 2010 period as the Company conducted its first
user-group conference in January 2010 and conducted multiple visits to potential
clients.





The
Clinical Services sales and marketing expenses consists of advertising to
attract patients to the clinic. During the year ended September 30, 2010,
Clinical Services also invested in re-launching its updated website and in the
development of a new marketing strategy, which accounted for much of the
increase in expenditure.  We anticipate a moderate increase in
marketing expenditure to attract new patients to the clinic as the capacity to
treat new patients has increased with the addition of our newly recruited
psychiatrist.




General and administrative




Year ended September 30,
                      
                      
                      Percent2010
                      
                      
                      2009
                      
                      
                      ChangeGeneral
      and administrativeNeurometric
      Information Services
                      
                      $
                      4,262,900
                      
                      
                      $
                      3,430,900
                      
                      
                      
                      24
                      %Clinical
      Services
                      
                      
                      754,100
                      
                      
                      
                      669,600
                      
                      
                      
                      13
                      %Total
      General and administrative
                      
                      $
                      5,017,000
                      
                      
                      $
                      4,100,500
                      
                      
                      
                      22
                      %




General and administrative expenses for our
Neurometric Information Services business are largely comprised of payroll
and benefit costs, including stock based compensation, legal, patent costs,
other professional and consulting fees, general administrative and occupancy
costs, conference and travel and miscellaneous costs.  For the year
ended September 30, 2010, General and Administrative costs included
the following: salaries and benefit costs of $1,203,200; legal fees of
$1,738,400; other professional and consulting fees of $727,700; general
administrative and occupancy costs of $234,600; patent costs of $77,300;
marketing and investor relations expenses of $96,400 and conference and travel
expenses of $103,300.  For the same period in 2009, General and
Administrative costs included the following: salaries and benefit costs of
$792,700; legal fees of $1,361,200; other professional and consulting fees of
$521,000; general administrative and occupancy costs of $263,000; patent costs
of $213,100; marketing and investor relations expenses of $86,500 and conference
and travel expenses of $69,800.  Additionally, other one-time
miscellaneous charges of $99,700 were booked for the 2009 period, which were the
result of a revised IRS assessment on 2006 payroll taxes and Delaware Franchise
Tax assessments for calendar years 2007 and 2008.





With
respect to our Neurometric Information Services business, in the year ended
September 30, 2010, compared to the same period in 2009, payroll and
benefit expenses increased by a net $410,500, of which $410,000 was due to an
increase in stock-based compensation due to the accounting for vested option
grants given to employees, directors, advisors and consultants in March and July
of 2010.  The balance of the change, $101,300 was due to the change of
staff mix with the former CEO, Mr. Brandt, leaving the Company in April 2009 and
the former President, Mr. Carpenter, becoming the CEO.  Additionally,
the Chief Financial Officer (CFO), who was previously engaged as a consultant,
joined the staff in mid February 2010.   Professional and
consulting fees increased by a net $206,600 which was partly due to the mix of
consulting services used in fiscal 2010: these fees included $284,000 associated
with financial advisory services used to obtain funding, $121,000 for accounting
services, $62,500 used for public relations services and $41,000 was used for
consultants associated with the Brandt litigation.  Legal fees
increased by a net $376,400 which was made up of a $567,600 increase in
litigation fees in defending against actions brought by Mr. Brandt,which was partly offset by
a reduction of $191,200 in non-litigation related legal expenses.  In
total $1,700,700 was directly incurred in the course of the litigation, of which
$566,600 was incurred in fiscal 2009 and $1,134,100 in fiscal
2010.  All matters between Mr. Brandt and us have either been
dismissed or adjudicated in our favor.  General administrative and
occupancy costs increased by $51,500, in part due to increases in computer and
telecommunications costs.  Patent costs declined by $135,800 due to
the timing of patent applications as expenses were primarily associated with
patent maintenance.  Marketing and Investor relations expenses
increased by $9,900 due to attendance and presentations at more investor
conferences with a view to raising capital.  Conference and travel
costs increased by $36,600 as a result of increased travel associated with
raising capital and the litigation activities.




33


General
and administrative expenses for our Clinical Services business includes all
costs associated with operating NTC.  This includes payroll costs,
medical supplies, occupancy costs and other general and administrative
costs.  These costs increased by $59,550 to $754,100 in the year
ending September 30, 2010 from $669,600 in the fiscal year
2009.  This increase is largely due to the recruiting fees, moving
costs, sign-on bonus and salary of our new psychiatrist who joined NTC in August
2010.  Other contributing cost increases for NTC were due to Clinical
Services staff, who had worked on the clinical study, no longer being reimbursed
by the Neurometric Information Services for their time spent on the
study.  These increases in cost for NTC were partially offset by a
reduction in rent as a less expensive lease extension was negotiated with a
reduction in sub-leased space as a cost saving measure.




Goodwill
impairment charges




During
the fiscal year 2009, we conducted a goodwill impairment test and determined
that all of the goodwill related to the NTC acquisition was impaired.
Accordingly, we recorded a goodwill impairment charge of $320,200 for the year
ended September 30, 2009.




Other income (expense)




Year ended September 30,
                      
                      
                      Percent2010
                      
                      
                      2009
                      
                      
                      ChangeNeurometric Information
      Services (Expense), net
                      
                      $
                      (1,668,100
                      )
                      
                      $
                      (1,822,700
                      )
                      
                      
                      (8
                      )%Clinical
      Services (Expense)
                      
                      
                      (100
                      )
                      
                      
                      (200
                      )
                      
                      
                      50
                      %Total
      interest income (expense)
                      
                      $
                      (1,668,200
                      )
                      
                      $
                      (1,822,900
                      )
                      
                      
                      (8
                      )%* not meaningful




For the year ended September 30, 2010 Neurometric
Information Services had several major transactions which totaled net expenses
of $1,668,100.




Firstly,
we incurred a non-cash loss on the extinguishment of debt of $1,094,300, which
was due to the fact that the Bridge Notes issued to John Pappajohn on June 3 and
July 25, 2010 and the Deerwood Notes issued to the Deerwood investors on July 5
and August 20, 2010 were subsequently replaced by October Notes (please see Note
3 to the Financial Statements).  The modifications of the terms were
accounted for as a debt extinguishment, whereby the difference in the carrying
value of the original notes (i.e., the Bridge Notes and Deerwood Notes) and the
carrying value of the replacement notes (i.e., the related October Notes) were
recognized as losses within the period. Although the replacement notes were
issued after the close of the fiscal year ended September 30, 2010, i.e., on
October 1, 2010 (in the case of John Pappajohn) and November 3, 2010 (in the
case of the Deerwood investors), we considered the replacement notes to be
outstanding and effective for the fiscal year ended September 30, 2010 and
accordingly recorded the resultant loss on extinguishment of debt for the year
ended September 30, 2010.




Secondly,
we incurred interest expenses of $360,500, which is comprised of a non-cash
charge of $258,900 associated with the value of the beneficial conversion
feature of the Bridge Notes and Deerwood Notes, which were expensed to
interest.  Additionally, we incurred a non-cash charge of $77,000
related to the amortization of warrant discount associated with the warrants
issued along with the Bridge Notes and Deerwood Notes and a further interest
charge of $19,700, which had accrued on the notes themselves.  Actual
interest paid net of interest earned was only $4,900.




Lastly,
we incurred a financing premium of $213,400.  This comprised a
non-cash charge of $193,400 associated with the warrants issued to SAIL in
connection with the guaranties provided by SAIL in connection with the Deerwood
Notes (please see Note 3 to the Financial Statements).  An additional
$20,000 was paid for due diligence work to an entity in anticipation of
obtaining financing; no financing ensued as the terms were ultimately considered
to be potentially too dilutive to our shareholders.




For
fiscal 2009, Neurometric Information Services incurred a $90,000 financing
premium that was paid in connection with the bridge note issued to Mr. Pappajohn
on June 12, 2009 and a $20,900 non-cash interest charge on the bridge notes
issued to Mr. Brandt and Sail Venture Partners.  Additionally, a
$1,058,000 non-cash charge associated with the valuation of bridge warrants and
a $642,000 non-cash charge associated with the value of the beneficial
conversion feature of the bridge notes which was expensed interest upon
conversion of the bridge notes.  Furthermore, interest paid net of
interest earned was $3,800.





34


Net Loss




Year ended September 30,
                      
                      
                      Percent2010
                      
                      
                      2009
                      
                      
                      ChangeNeurometric
      Information Services net loss
                      
                      $
                      (7,904,400
                      )
                      
                      $
                      (8,451,300
                      )
                      
                      
                      (6
                      )%Clinical
      Services net loss
                      
                      
                      (269,600
                      )
                      
                      
                      (70,900
                      )
                      
                      
                      280
                      %Total
      Net Loss
                      
                      $
                      (8,174,000
                      )
                      
                      $
                      (8,522,200
                      )
                      
                      
                      (4
                      )%




The
decrease in net loss for our Neurometric Information Services business of
approximately $547 thousand for the year ended September 30, 2010 compared to
the prior fiscal year is primarily due to reductions in our Research and
Development expenditures of $804 thousand as the clinical trial had ended in
fiscal 2009; the reduction of Sales and Marketing costs of $55 thousand; the
non-recurrence of the $320 thousand goodwill write-down of NTC in fiscal 2009;
the reduction of Other Expenses of $155 thousand due to accounting for non-cash
items including the beneficial conversion features of notes and the expensing of
warrant discounts.  These decreases were partially offset by an
increase in General and Administration expenses of $832 thousand, which was
largely due to the increase in the Brandt litigation expenses and the increase
in accounting for stock option
compensation.




The
increase in the net loss for our Clinical Services business of approximately
$199 thousand was the result of having insufficient psychiatric/prescriber
resources to see a sufficient volume of new patients for the clinic to be
profitable.  This situation was exacerbated by the upfront costs of
recruiting and hiring the needed additional psychiatrist who joined Clinical
Services in August 2010, before she could have a significant impact in
increasing the clinic’s revenue.




Liquidity and Capital
Resources




Since our inception, we have incurred significant
losses.  As of September 30, 2010, we had an accumulated deficit of
approximately $33.4 million, and as of September 30, 2009, our accumulated
deficit was approximately $25.2 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, sales 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.




As of
September 30, 2010, we had approximately $62,000 in cash and cash equivalents
and a working capital deficit of approximately $4.2 million compared to
approximately $0.99 million in cash and cash equivalents and a working capital
balance of approximately $1.1 million at September 30, 2009.  The
working capital deficit as of September 30, 2010 includes the $1.0 million of
secured convertible promissory notes (Bridge Notes and Deerwood Notes)
outstanding as of that date.




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, and we need to raise substantial
additional funds in the next 12 months in order to continue to conduct our
business.  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 immediately to continue our operations and will need
substantial additional funds before we can increase demand for our rEEG
services.  We are currently exploring 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 and to make capital
expenditures to expand our research and development programs (including
upgrading our CNS Database) and to scale up our commercial operations and
marketing efforts.   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 ultimately cause us to have to cease
operations.




Sources
of Liquidity




Since our
inception substantially all of our operations have been financed primarily from
equity and debt financings.  Through September 30, 2010, we had
received proceeds of approximately $13.7 million from the sale of stock,
$7.7 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 and warrants.  Of such amount, $1.75 million
was purchased by members of our Board of Directors or their affiliate companies.
See Note 3 of the financial
statements,  “Item 5. Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities” and “Item 13.
Certain Relationships and Related Transactions, and Director
Independence.”




35


Cash Flows




Net cash used in operating activities was $4.9
million for the fiscal year ended September 30, 2010 compared to $4.6 million
for the fiscal year ended September 30, 2009.  The increase in cash
used of $0.3 million was primarily attributable to increases in legal fees
associated with the Brandt litigation, our private placement and bridge
financings and investigation of FDA licensure issues.




Net cash
used in investing activities increased to $14,900 for the fiscal year ended
September 30, 2010 as compared to $2,000 for the year ended September 30,
2009.  Our investing activities related to the purchase of computer
equipment and some furniture for our new leased offices in Aliso Viejo,
California.




Net cash
proceeds from financing activities for the fiscal year ended September 30, 2010
were approximately $3.0 million, net of offering costs, raised on December 24
and 31, 2009 and January 4, 2009 in connection with the second, third and fourth
closings respectively of our private placement transaction; $1.0 million raised
in bridge financing transactions, and $100,000 as an advance from Mr. Pappajohn
prior to these funds becoming part of a secured promissory note on October 1,
2010.  These proceeds were partly offset by the repayment of $94,100
on a promissory note issued to Daniel Hoffman in connection with our acquisition
of NTC.





For
the fiscal year ended September 30, 2009 proceeds from financing activities were
approximately $1.8 million, net of offering costs, raised on August 26, 2009, in
connection with the first closing of our private placement transaction; $1.7
million raised in bridge financing transactions (which ultimately converted into
equity as further described in Note 3 of the financial statements), and $295,500
due to the exercise of options and warrants.  These proceeds were
partly offset by the repayment of a convertible promissory note, with accrued
interest, totaling $92,600 and the repayment of $86,700 on a promissory note
issued to Daniel Hoffman in connection with our acquisition of NTC.




Contractual Obligations and Commercial
Commitments





As of September 30, 2010, we have a contractual
obligation to pay the remaining balance on a promissory note of $24,700 issued
in connection with our acquisition of NTC, which bears interest at a rate of 8%
per annum.  Our combined lease obligations are $ 274,400; our
remaining lease obligation on our Aliso Viejo office, which expires of January
30, 2013, is $112,100 in total: being $46,500, $49,000 and 16,600 for fiscal
years 2011, 2012 and 2013 respectively, with an average monthly rental of $3,600
over the entire lease period.  Our remaining lease obligation on our
Greenwood Village, CO, clinic office, which expires of April 30, 2013, is
$162,300 in total:$58,200, $65,400 and $38,700 for fiscal years 2011, 2012 and
2013 respectively, with an average monthly rental of $5,100 over the entire
lease period.  As of September 30, 2009, the balance outstanding on
the aforementioned promissory note was $118,600; our obligations for leased
space were immaterial as the leases were expired or were close to
expiring.  Please see Note 10 to our Consolidated Financial Statements
included elsewhere in this report for further details.




Payments due by periodContractual
      Obligations
              
              Total
              
              
              Less than 1
      year
              
              
              1 to 3 years
              
              
              3-5 years
              
              
              More than 5 yearsLong-Term
      Debt Obligations
              
              
              24,700
              
              
              
              24,799
              
              
              
              -
              
              
              
              -
              
              
              
              -Capital
      Lease Obligations
              
              
              5,600
              
              
              
              2,200
              
              
              
              3,400
              
              
              
              -
              
              
              
              -Operating
      Lease Obligations
              
              
              274,500
              
              
              
              104,700
              
              
              
              169,800
              
              
              
              -
              
              
              
              -Total
              
              
              304,800
              
              
              
              131,600
              
              
              
              173,200
              
              
              
              -
              
              
              
              -





Derivative
Liability





Current liabilities include $2.1
million of derivative liability. This amount includes:





1.
            $0.9
      million, which represents the fair value liability associated with the
      warrants issued in conjunction with the October
  Notes.





2.
            $1.2
      million, which represent the fair value liability associated with the
      conversion option of the October
Notes.


(Please
      see “Item 5. Market For Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity
  Securities”.)





The
carrying value of these derivative liabilities will be reassessed each quarter
and any change in the carrying value will be booked to other income (expense) in
the income statement.





Operating Capital and Capital Expenditure
Requirements




We expect to continue to incur operating losses in
the future and to make capital expenditures to expand our research and
development programs (including upgrading our CNS Database) and to scale up our
commercial operations and marketing efforts. We expect that our existing cash
will be used to fund working capital and for capital expenditures and other
general corporate purposes, including the repayment of debt incurred as a result
of our litigation with Brandt.Although
since September 30, 2010 we have raised gross proceeds of $2.0 million
through the sale of convertible promissory notes, we anticipate that our cash on
hand (including the proceeds from these promissory notes) and cash generated
through our operations will not be sufficient to fund our operations the next 12
months.  In addition we will have to repay the outstanding notes plus
interest.  We therefore anticipate raising additional funds in the
near future.




36


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 research and
      product development activities, including enhancements to our CNS Database
      and costs we incur to further validate the efficacy of our rEEG
      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 obtain
      510(k) clearance from the FDA.





·
            if
      we expand our business by acquiring or investing in complimentary
      businesses.





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 economic 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, 2010, we had net operating
loss carryforwards for federal income tax purposes of $24.7 million. If not
utilized, the federal net operating loss carryforwards will begin expiring in
2029. 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.


37


ITEM
8.           
  Financial Statements and Supplementary Data





Index to financial statements


PageReport
      of Independent Registered Public Accounting Firm
                
                39Consolidated
      Balance Sheets as of September 30, 2010 and 2009
                
                40Consolidated
      Statements of Operations for the Years Ended September 30, 2010 and
      2009
                
                41Consolidated
      Statements of Changes in Stockholders’ Equity (Deficit) for the Years
      Ended September 30, 2010 and 2009
                
                42Consolidated
      Statements of Cash Flows for the Years Ended September 30, 2010 and
      2009
                
                43Notes
      to Consolidated Financial Statements for the Years
      Ended  September 30, 2010 and 2009
                
                44


38




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors


CNS
Response, Inc.


85
Enterprise, Suite 410


Aliso
Viejo, CA 92656





We have
audited the accompanying consolidated balance sheets of CNS Response, Inc. (the
“Company”) and its subsidiaries as of September 30, 2010 and 2009, and the
related consolidated statements of operations, changes in stockholders’ equity
(deficit), and cash flows for each of the years in the two-year period ended
September 30, 2010. CNS Response, Inc.’s management is responsible for these
financial statements. Our responsibility is to express an opinion on these
financial statements based on our audits.





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





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of September
30, 2010 and 2009, and the results of its operations and its cash flows for each
of the years in the two-year period ended September 30, 2010 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 consolidated 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 consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.





/s/
Cacciamatta Accountancy Corporation





Irvine,
California


December
20, 2010


39




CNS
RESPONSE, INC.
 
 CONSOLIDATED
BALANCE SHEETS AT SEPTEMBER 30, 2010 and 2009
 
 As
      at September 30,2010
                    
                    
                    2009ASSETSCURRENT
      ASSETS:Cash
                    
                    $
                    62,000
                    
                    
                    $
                    988,100Accounts
      receivable (net of allowance for doubtful accounts of $10,400 and $11,700
      in 2010 and 2009 respectively)
                    
                    
                    48,900
                    
                    
                    
                    61,700Prepaids
      and other
                    
                    
                    84,900
                    
                    
                    
                    89,500Total
      current assets
                    
                    
                    195,800
                    
                    
                    
                    1,139,300Furniture
      & equipment
                    
                    
                    23,000
                    
                    
                    
                    17,500Other
      assets
                    
                    
                    18,700
                    
                    
                    
                    4,100TOTAL
      ASSETS
                    
                    $
                    237,500
                    
                    
                    $
                    1,160,900LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable (including $60,800 and $7,000 to related parties in 2010 and 2009
      respectively)
                    
                    $
                    1,383,700
                    
                    
                    $
                    1,285,600Accrued
      liabilities
                    
                    
                    380,700
                    
                    
                    
                    261,400Other
      payable – related party
                    
                    
                    100,000
                    
                    
                    
                    -Deferred
      compensation (including $81,200 and $81,200 to related parties in
      2010 and 2009 respectively)
                    
                    
                    263,600
                    
                    
                    
                    220,100Accrued
      patient costs
                    
                    
                    135,000
                    
                    
                    
                    305,500Accrued
      consulting fees (including $27,000 and $18,000 to related parties in 2010
      and 2009, respectively)
                    
                    
                    86,600
                    
                    
                    
                    72,100Derivative
      liability
                    
                    
                    2,061,900
                    
                    
                    
                    -Secured
      convertible promissory notes-related party (net of discounts $1,023,900 in
      2010 and $0 in 2009)
                    
                    
                    -
                    
                    
                    
                    -Current
      portion of long-term debt
                    
                    
                    26,900
                    
                    
                    
                    95,900Total
      current liabilities
                    
                    
                    4,438,400
                    
                    
                    
                    2,240,600LONG-TERM
      LIABILITIESNote
      payable to officer
                    
                    
                    -
                    
                    
                    
                    24,800Capital
      lease
                    
                    
                    3,400
                    
                    
                    
                    5,600Total
      long-term liabilities
                    
                    
                    3,400
                    
                    
                    
                    30,400TOTAL
      LIABILITIES
                    
                    
                    4,441,800
                    
                    
                    
                    2,271,000COMMITMENTS
      AND CONTINGENCIES
                    
                    
                    -
                    
                    
                    
                    -STOCKHOLDERS'
      EQUITY:Common
      stock, $0.001 par value; authorized 750,000,000 shares; 56,023,921
      and 41,781,129 shares outstanding as of September 30, 2010 and
      2009
                    
                    
                    56,000
                    
                    
                    
                    41,800Additional
      paid-in capital
                    
                    
                    29,109,600
                    
                    
                    
                    24,044,000Accumulated
      deficit
                    
                    
                    (33,369,900
                    )
                    
                    
                    (25,195,900
                    )Total
      stockholders' equity
                    
                    
                    (4,204,300
                    )
                    
                    
                    (1,110,100
                    )TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                    
                    $
                    237,500
                    
                    
                    $
                    1,160,900
 
 See
accompanying Notes to Consolidated Financial Statements
  40
  CNS
RESPONSE, INC.
 
 CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED
 SEPTEMBER
30, 2010 AND 2009
 
 YEARS ENDED
                              SEPTEMBER 30,2010
                            
                            
                            2009REVENUESNeurometric
      Information Services
                            
                            $
                            136,100
                            
                            
                            $
                            120,400Clinical
      Services
                            
                            
                            502,400
                            
                            
                            
                            579,700638,500
                            
                            
                            
                            700,100OPERATING
      EXPENSES:Cost
      of Neurometric Service revenues
                            
                            
                            135,100
                            
                            
                            
                            131,600Research
      and development
                            
                            
                            1,120,500
                            
                            
                            
                            1,924,100Sales
      and marketing
                            
                            
                            870,900
                            
                            
                            
                            915,800General
      and administrative
                            
                            
                            5,017,000
                            
                            
                            
                            4,100,500Goodwill
      impairment charges
                            
                            
                            -
                            
                            
                            
                            320,200Total
      operating expenses
                            
                            
                            7,143,500
                            
                            
                            
                            7,392,200OPERATING
      LOSS
                            
                            
                            (6,505,000
                            )
                            
                            
                            (6,692,100
                            )OTHER
      INCOME (EXPENSE):Interest
      income (expense), net
                            
                            
                            (360,500
                            )
                            
                            
                            (1,732,900
                            )Loss
      on extinguishment of debt
                            
                            
                            (1,094,300
                            )
                            
                            
                            -Financing
      fees
                            
                            
                            (213,400
                            )
                            
                            
                            (90,000
                            )Total
      other income (expense)
                            
                            
                            (1,668,200
                            )
                            
                            
                            (1,822,900
                            )LOSS
      BEFORE PROVISION FOR INCOME TAXES
                            
                            
                            (8,173,200
                            )
                            
                            
                            (8,515,000
                            )PROVISION
      FOR INCOME TAXES
                            
                            
                            800
                            
                            
                            
                            7,200NET
      LOSS
                            
                            $
                            (8,174,000
                            )
                            
                            $
                            (8,522,200
                            )BASIC
      NET LOSS PER SHARE
                            
                            $
                            (0.16
                            )
                            
                            $
                            (0.31
                            )DILUTED
      NET LOSS PER SHARE
                            
                            $
                            (0.16
                            )
                            
                            $
                            (0.31
                            )WEIGHTED
      AVERAGE SHARES OUTSTANDING:Basic
                            
                            
                            52,277,119
                            
                            
                            
                            27,778,171Diluted
                            
                            
                            52,277,119
                            
                            
                            
                            27,778,171
 
 See
accompanying Notes to Consolidated Financial Statements
  41
  CNS
RESPONSE, INC.
 
 CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY (DEFICIT) FOR THE YEARS ENDED SEPTEMBER 30, 2010 AND
2009
 
 AdditionalCommon Stock
                    
                    
                    Paid-in
                    
                    
                    AccumulatedShares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Deficit
                    
                    
                    TotalBalance
      at October 1, 2008
                    
                    
                    25,299,547
                    
                    
                    $
                    25,300
                    
                    
                    $
                    17,701,300
                    
                    
                    $
                    (16,673,700
                    )
                    
                    $
                    1,052,900Stock-
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    850,500
                    
                    
                    
                    -
                    
                    
                    
                    850,500Issuance
      of 3,433,333 bridge warrants
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,058,000
                    
                    
                    
                    -
                    
                    
                    
                    1,058,000Exercise
      of 1,498,986 $0.01 warrants
                    
                    
                    1,498,986
                    
                    
                    
                    1,500
                    
                    
                    
                    13,500
                    
                    
                    
                    -
                    
                    
                    
                    15,000Exercise
      of 2,124,740 $0.132 options
                    
                    
                    2,124,740
                    
                    
                    
                    2,100
                    
                    
                    
                    278,400
                    
                    
                    
                    -
                    
                    
                    
                    280,500Issuance
      of stock in connection with the Maxim PIPE net of offering costs of
      $250,700
                    
                    
                    6,810,002
                    
                    
                    
                    6,800
                    
                    
                    
                    1,785,500
                    
                    
                    
                    -
                    
                    
                    
                    1,792,300Value
      of beneficial conversion feature of bridge notes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    642,000
                    
                    
                    
                    -
                    
                    
                    
                    642,000Issuance
      of stock on conversion $1,720,900 of bridge notes and accrued
      interest
                    
                    
                    6,047,854
                    
                    
                    
                    6,100
                    
                    
                    
                    1,714,800
                    
                    
                    
                    -
                    
                    
                    
                    1,720,900Warrants
      issued in association with the Maxim PIPE
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,607,000
                    
                    
                    
                    -
                    
                    
                    
                    1,607,000Offering
      cost pertaining to the Maxim PIPE
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,607,000
                    )
                    
                    
                    -
                    
                    
                    
                    (1,607,000
                    )Net
      loss for the year ended September 30, 2009
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    
                    
                    
                    
                    (8,522,200
                    )
                    
                    
                    (8,522,200
                    )Balance
      at September 30, 2009
                    
                    
                    41,781,129
                    
                    
                    $
                    41,800
                    
                    
                    $
                    24,044,000
                    
                    
                    $
                    (25,195,900
                    )
                    
                    $
                    (1,110,100
                    )Stock-
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,302,100
                    
                    
                    
                    -
                    
                    
                    
                    1,302,100Issuance
      of stock in connection with the Maxim PIPE net of offering costs of
      $540,600
                    
                    
                    11,786,666
                    
                    
                    
                    11,800
                    
                    
                    
                    2,983,600
                    
                    
                    
                    -
                    
                    
                    
                    2,995,400Warrants
      issued in association with the Maxim PIPE
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    7,615,100
                    
                    
                    
                    -
                    
                    
                    
                    7,615,100Offering
      cost pertaining to the Maxim PIPE
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (7,615,100
                    )
                    
                    
                    -
                    
                    
                    
                    (7,615,100
                    )Value
      of warrants surrendered for cashless exercise
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (415,800
                    )
                    
                    
                    -
                    
                    
                    
                    (415,800
                    )Stock
      issued for cashless exercise
                    
                    
                    2,456,126
                    
                    
                    
                    2,400
                    
                    
                    
                    413,400
                    
                    
                    
                    -
                    
                    
                    
                    415,800Warrants
      issued for consulting services
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    199,000
                    
                    
                    
                    -
                    
                    
                    
                    199,000Value
      of beneficial conversion feature of bridge notes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    430,700
                    
                    
                    
                    -
                    
                    
                    
                    430,700Issuance
      of bridge warrants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    152,600
                    
                    
                    
                    
                    
                    
                    
                    152,600Net
      loss for the year ended September 30, 2010
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (8,174,000
                    )
                    
                    
                    (8,174,000
                    )Balance
      at September 30, 2010
                    
                    
                    56,023,921
                    
                    
                    $
                    56,000
                    
                    
                    $
                    29,109,600
                    
                    
                    $
                    (33,369,900
                    )
                    
                    $
                    (4,204,300
                    )
 
 See
accompanying Notes to Consolidated Financial Statements
  42
  CNS
RESPONSE, INC.
  CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR YEARS ENDED
 SEPTEMBER
30, 2010 AND 2009
 
 YEAR ENDED SEPTEMBER 30,2010
                              
                              
                              2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                              
                              $
                              (8,174,000
                              )
                              
                              $
                              (8,522,200
                              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      & amortization
                              
                              
                              9,400
                              
                              
                              
                              9,100Amortization
      of discount on bridge notes issued
                              
                              
                              335,900
                              
                              
                              
                              1,058,000Value
      of beneficial conversion feature of bridge notes
                              
                              
                              -
                              
                              
                              
                              642,000Stock
      based compensation
                              
                              
                              1,302,100
                              
                              
                              
                              850,500Extinguishment
      of debt
                              
                              
                              1,094,300
                              
                              
                              
                              -Issuance
      of warrants for consulting services
                              
                              
                              199,000
                              
                              
                              
                              -Issuance
      of warrants for financing services
                              
                              
                              193,400
                              
                              
                              
                              -Non-cash
      interest expense
                              
                              
                              21,600
                              
                              
                              
                              20,900Goodwill
      impairment
                              
                              
                              -
                              
                              
                              
                              320,200Write-off
      of doubtful accounts
                              
                              
                              12,950
                              
                              
                              
                              22,700Changes
      in operating assets and liabilities:Accounts
      receivable
                              
                              
                              (150
                              )
                              
                              
                              13,800Prepaids
      and other
                              
                              
                              4,600
                              
                              
                              
                              99,900Accounts
      payable and accrued liabilities
                              
                              
                              231,900
                              
                              
                              
                              1,003,800Deferred
      compensation and others
                              
                              
                              43,500
                              
                              
                              
                              (40,300
                              )Accrued
      patient costs
                              
                              
                              (170,500
                              )
                              
                              
                              (92,000
                              )Security
      Deposit on new lease
                              
                              
                              (14,600
                              )
                              
                              
                              -Net
      cash used in operating activities
                              
                              
                              (4,910,600
                              )
                              
                              
                              (4,613,600
                              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisition
      of Furniture & Equipment
                              
                              
                              (14,900
                              )
                              
                              
                              (2,000
                              )Net
      cash used in investing activities
                              
                              
                              (14,900
                              )
                              
                              
                              (2,000
                              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Repayment
      of  convertible debt with accrued interest
                              
                              
                              -
                              
                              
                              
                              (92,600
                              )Repayment
      of  debt
                              
                              
                              (94,100
                              )
                              
                              
                              (86,700
                              )Repayment
      of lease payable
                              
                              
                              (1,900
                              )
                              
                              
                              (1,800
                              )Proceeds
      from the sale of common stock, net of offering costs
                              
                              
                              2,995,400
                              
                              
                              
                              1,792,300Proceeds
      from bridge notes
                              
                              
                              1,000,000
                              
                              
                              
                              1,700,000Proceeds
      from related party loan
                              
                              
                              100,000
                              
                              
                              
                              -Proceeds
      from exercise of warrants and options
                              
                              
                              -
                              
                              
                              
                              295,500Net
      cash provided by financing activities
                              
                              
                              3,999,400
                              
                              
                              
                              3,606,700NET
      DECREASE IN CASH
                              
                              
                              (926,100
                              )
                              
                              
                              (1,008,900
                              )CASH-
      BEGINNING OF YEAR
                              
                              
                              988,100
                              
                              
                              
                              1,997,000CASH-
      END OF YEAR
                              
                              $
                              62,000
                              
                              
                              $
                              988,100SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash  paid
      during the period for:Interest
                              
                              $
                              7,900
                              
                              
                              $
                              64,100Income
      taxes
                              
                              $
                              800
                              
                              
                              $
                              7,200Fair
      value of note payable to officer issued for acquisition
                              
                              $
                              24,700
                              
                              
                              $
                              118,600Fair
      value of equipment acquired through lease
                              
                              $
                              6,600
                              
                              
                              $
                              7,600Conversion
      of bridge notes and related accrued interest into common
    stock
                              
                              $
                              -
                              
                              
                              $
                              1,720,900
  See
accompanying Notes to Consolidated Financial Statements


43


CNS
RESPONSE, INC.





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED


SEPTEMBER
30, 2010 AND 2009




1.
              NATURE OF
      OPERATIONS


Organization
and Nature of Operations





CNS
Response, Inc. (the “Company”) was incorporated in Delaware on March 16, 1987,
under the name Age Research, Inc.   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, the Company entered into an Agreement and Plan of Merger (the
“Merger Agreement”) with CNS Response, Inc., a California corporation formed on
January 11, 2000 (“CNS California”), and CNS Merger Corporation, a California
corporation and the Company’s  wholly-owned subsidiary (“MergerCo”)
pursuant to which the Company 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 a wholly-owned subsidiary of the Company,
and on the same date the corporate name was changed from Strativation, Inc. to
CNS Response, Inc.




The
Company is a web-based neuroinformatic company that utilizes a patented system
that provides data to psychiatrists and other physicians/prescribers to enable
them to make a more informed decision when treating a specific patient 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, Inc. (“NTC”)
on January 15, 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 problems, expenses, difficulties, delays, complications, risks and
uncertainties frequently encountered in the operation of a new business. These
risks include the failure to develop or supply technology or services to meet
the demands of the marketplace, the ability to obtain adequate financing on a
timely basis, the failure to attract and retain qualified personnel, competition
within the industry, government regulation and the general strength of regional
and national economies.




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
future profitability of the Company, the rate of growth of the Company’s
business and other factors described elsewhere in this Annual
Report.  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.
              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.




44




Cash




The
Company deposits its cash with major financial institutions and may at times
exceed federally insured limit of $250,000.  At September 30, 2010
cash did not exceed the federally insured limit.  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.





Derivative
Liabilities





The
Company applies ASC Topic 815-40, “Derivatives and Hedging,” which provides a
two-step model to determine whether a financial instrument or an embedded
feature is indexed to an issuer’s own stock and thus able to qualify for the
scope exception in ASC 815-10-15-74. This standard triggers liability accounting
on all instruments and embedded features exercisable at strike prices based on
future equity-linked instruments issued at a lower rate.  Using the
criteria in ASC 815, the Company determines which instruments or embedded
features that require liability accounting and records the fair values as a
derivative liability. The changes in the values of the derivative liabilities
are shown in the accompanying consolidated statements of operations as “gain
(loss) on change in fair value of derivative liabilities.”





On
September 26, 2010, the Company’s board of directors approved a term sheet to
modify the terms of six convertible notes outstanding at that date in order to
induce additional investment in the form of convertible debt. The original
convertible notes were due in December 2010 with accrued interest at 9%,
convertible into common shares at $0.50 per share and had warrants exercisable
at strike price between $0.50 and $0.56. The Company modified the terms of these
notes to be due 12 months from the modification date with accrued interest at
9%, convertible into common shares at $0.30 per share, 50% warrant coverage
exercisable at $0.30 per share and increased the principal for accrued interest
through the modification date. Both the convertible note and warrants contained
ratchet provisions, which under ASC 815 required bifurcation of the conversion
feature and warrants for derivative liability treatment. As of September 30,
2010 the derivative liability was $2,061,900, which was comprised of the warrant
liability of $889,100 and the debt conversion option liability of
$1,172,800.





Fair
Value of Financial Instruments




ASC
825-10 (formerly SFAS 107, “Disclosures about Fair Value of Financial
Instruments”) defines financial instruments and requires disclosure of the fair
value of financial instruments held by the Company. The Company considers the
carrying amount of cash, accounts receivable, other receivables, accounts
payable and accrued liabilities, to approximate their fair values because of the
short period of time between the origination of such instruments and their
expected realization.





The
Company also analyzes all financial instruments with features of both
liabilities and equity under ASC 480-10 (formerly SFAS 150, “Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity”), ASC 815-10 (formerly SFAS No 133, “Accounting for Derivative
Instruments and Hedging Activities”) and ASC 815-40 (formerly EITF 00-19,
“Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company’s Own Stock”).





The
Company adopted ASC 820-10 (formerly SFAS 157, “Fair Value Measurements”) on
January 1, 2008. ASC 820-10 defines fair value, establishes a three-level
valuation hierarchy for disclosures of fair value measurement and enhances
disclosure requirements for fair value measures. The three levels are defined as
follow:




·
              Level 1   inputs
      to the valuation methodology are quoted prices (unadjusted) for identical
      assets or liabilities in active
  markets.
 
 ·
              Level 2   inputs
      to the valuation methodology include quoted prices for similar assets and
      liabilities in active markets, and inputs that are observable for the
      assets or liability, either directly or indirectly, for substantially the
      full term of the financial
instruments.
 
 ·
              Level 3   inputs
      to the valuation methodology are unobservable and significant to the fair
      value.




The
Company’s warrant liability is carried at fair value totaling $889,100 and $0,
as of September 30, 2010 and 2009, respectively.  The Company’s
conversion option liability is carried at fair value totaling $1,172,800 and $0
as of September 30, 2010 and 2009, respectively.  The Company used
Level 2 inputs for its valuation methodology for the warrant liability and
conversion option liability as their fair values were determined by using the
Black-Scholes option pricing model using the following assumptions:




45




September 30, 2010Annual
      dividend yield
                    
                    
                    -Expected
      life (years)
                    
                    
                    1.0-3.5Risk-free
      interest rate
                    
                    
                    1.12%-1.27
                    %Expected
      volatility
                    
                    
                    142%-274
                    %




Fair
      Value
                      
                      
                      Fair
      Value Measurements atAs
      of
                      
                      
                      September
      30, 2010September
      30,
                      
                      
                      Using Fair Value Hierarchy2010
                      
                      
                      Level 1
                      
                      
                      Level 2
                      
                      
                      Level 3LiabilitiesWarrant
      liability
                      
                      $
                      889,100
                      
                      
                      $
                      -
                      
                      
                      $
                      889,100
                      
                      
                      $
                      -Secured
      convertible promissory note
                      
                      
                      1,023,900
                      
                      
                      
                      
                      
                      
                      
                      1,023,900Conversion
      option liability
                      
                      
                      1,172,800
                      
                      
                      
                      -
                      
                      
                      
                      1,172,800
                      
                      
                      
                      -Total
      accrued derivative liabilities
                      
                      $
                      3,085,800
                      
                      
                      $
                      -
                      
                      
                      $
                      3,085,800
                      
                      
                      $
                      -


As of
September 30, 2010 the Company recognized no gain or loss on change in the fair
value of accrued derivative liabilities and did not identify any other assets or
liabilities that are required to be presented on the balance sheet at fair value
in accordance with ASC 825-10.





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 for the years ended September 2010 and 2009 is
$9,400 and $9,100 respectively.  Accumulated depreciation at September
30, 2010 and 2009 was $21,800 and $15,400 respectively.




Goodwill




In
accordance with ASC 350-20 (formerly Statement of Financial Accounting Standards
(“ SFAS” ) No. 142, Goodwill
and Other Intangible Assets ) (“ASC 350-10”) , goodwill is not amortized
but instead is measured for impairment at least annually, or more
frequently if certain indicators are present.




The
Company measures for impairment by applying fair value-based tests at the
reporting unit level. If the fair value of the reporting unit exceeds the
carrying value of the net assets assigned to that unit, then goodwill is not
impaired and no further testing is performed. The Company, if necessary,
measures the amount of impairment by applying fair value-based tests to
individual assets and liabilities within each reporting unit. If the carrying
value of a reporting unit’s goodwill exceeds its implied fair value, the Company
records an impairment loss equal to the difference.




To
determine the reporting unit’s fair values, the Company uses the income
approach. The income approach provides an estimate of fair value based on
discounted expected future cash flows (“DCF”). Estimates and assumptions with
respect to the determination of the fair value of the Company’s reporting units
using the income approach include the Company’s operating forecasts, revenue
growth rates and risk-commensurate discount rates.




The
Company’s estimates of revenues and costs are based on historical data, various
internal estimates and a variety of external sources, and are developed by the
Company’s regular long-range planning process.





During
the fourth quarter of fiscal year 2009, the Company conducted a goodwill
impairment test and determined that the amount of the recorded goodwill related
to the NTC acquisition was fully impaired. Accordingly, the Company
recorded a goodwill impairment charge of $320,200 for the year ended September
30, 2009.




46




Long-Lived
Assets




As
required by ASC 350-30 (formerly SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets ) (“ASC 350-30”), 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, apart from the abovementioned goodwill impairment, was recorded
for the years ended September 30, 2010 and 2009.





Revenues




The
Company recognizes revenue as the related services are delivered.




Research
and Development Expenses




The
Company charges all research and development expenses to operations as
incurred.




Advertising
Expenses




The
Company charges all advertising expenses to operations as incurred.




Stock-Based
Compensation




The
Company has adopted ASC 718-20 (formerly SFAS No. 123R, Share-Based Payment -revised
2004) (“ASC718-20”) and related interpretations which establish the accounting
for equity instruments exchanged for employee services. Under ASC 718-20,
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 ASC 740-20
(formerly SFAS No. 109, Accounting for Income Taxes)
(“ASC 740-20”). Under the provisions of ASC 740-20, 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)




ASC
220-10 (formerly, SFAS No. 130, Reporting Comprehensive
Income) (“ASC 220-10”), 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, 2010 and 2009.




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 Neurometric
Information Service (formerly called Laboratory Information Services) provides
reports (“rEEG Reports”) enable psychiatrist or other physicians/prescribers to
make more informed decisions with a treatment strategy for a specific patient
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 previously reported have been reclassified to conform to the current
period presentation. The reclassifications were made to change the income
statement presentation to provide the users of the financial statements
additional information related to the operating results of the Company. These
reclassifications include reclassifying the Company’s patent costs to
General and Administrative costs as patent costs were previously included in
Research and Development costs.  The reclassifications had no effect
on consolidated net income or consolidated assets and liabilities.




47




Recent
Accounting Pronouncements





In June
2009, the FASB approved its Accounting Standards Codification, or Codification,
as the single source of authoritative United States accounting and reporting
standards applicable for all non-governmental entities, with the exception of
the SEC and its staff. The Codification, which changes the referencing of
financial standards, is effective for interim or annual financial periods ending
after September 15, 2009. Therefore, starting from fiscal year end 2009, all
references made to US GAAP will use the new Codification numbering system
prescribed by the FASB. As the Codification is not intended to change or alter
existing US GAAP, it did not have any impact on the Company’s audited
consolidated financial statements.





As a
result of the Company’s implementation of the Codification during the year ended
September 30, 2009, previous references to new accounting standards and
literature are no longer applicable. In the current interim financial
statements, the Company will provide reference to both new and old guidance to
assist in understanding the impact of recently adopted accounting literature,
particularly for guidance adopted since the beginning of the current fiscal year
but prior to the Codification.





In
January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU
2010-06), “Fair Value Measurements and Disclosures (Topic 820) – Improving
Disclosures About Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10
that requires new disclosures and provides clarification of existing
disclosures. ASU 2010-06 also includes conforming amendments to the guidance on
employers’ disclosures about postretirement benefit plans assets (Subtopic
715-20). ASU 2010-06 is effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. Those disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is evaluating the impact of the adoption of ASU 2010-06 on
its audited consolidated financial statements.




In
February 2010, the FASB issued Accounting Standards Update No. 2010-09 (“ASU
2010-09”) as amendments to certain recognition and disclosure requirements. The
amendments remove the requirement for an SEC filer to disclose a date in both
issued and revised financial statements. Revised financial statements include
financial statements revised as a result of either correction of an error or
retrospective application of U.S. GAAP. Those amendments remove potential
conflicts with the SEC’s literature. All of the amendments in ASU 2010-09 were
effective upon issuance for interim and annual periods. The adoption of ASU
2010-09 did not have a material impact on the Company’s audited
consolidated financial statements.





In April
2010, the FASB issued Accounting Standards Update 2010-12 (“ASU 2010-12”),
“Income Taxes (Topic 740): Accounting for Certain Tax Effects of the 2010 Health
Care Reform Acts”.  After consultation with the FASB, the SEC stated
that it “would not object to a registrant incorporating the effects of the
Health Care and Education Reconciliation Act of 2010 when accounting for the
Patient Protection and Affordable Care Act.” The Company does not expect the
provisions of ASU 2010-12 to have a material impact on the Company’s audited
consolidated financial statements.





In April
2010, the FASB issued Accounting Standards Update 2010-13 (“ASU 2010-13”),
Compensation-Stock Compensation (Topic 718): Effect of Denominating the Exercise
Price of a Share-Based Payment Award in the Currency of the Market in Which the
Underlying Equity Security Trades - a consensus of the FASB Emerging Issues Task
Force.  The amendments in this Update are effective for fiscal years,
and interim periods within those fiscal years, beginning on or after December
15, 2010.  Earlier application is permitted.  The Company
does not expect the provisions of ASU 2010-13 to have a material impact on the
Company’s audited consolidated financial statements.




3.
              CONVERTIBLE DEBT AND EQUITY
      FINANCINGS




As of
October 1, 2008, one convertible promissory note, originally issued by CNS
California prior to September 30, 2006, with a principal balance of $49,950
remained outstanding.  In May 2009, the Company entered into a settlement
and release agreement with this note holder and fully repaid the promissory note
with accrued interest on June 30, 2009.





Between
March 30 and June 12, 2009 the Company entered into three rounds of bridge
financings in the form of secured convertible promissory notes.  These
three rounds are referred to as:




(a)
              the
      March 30, 2009 SAIL/Brandt Notes
 (b)
              the
      May 14, 2009 SAIL Note
 (c)
              the
      June 12, 2009 Pappajohn Note




48




All of
these notes were converted to equity as a result of a private placement
transaction  closed on August 26, 2009, which is fully described in
the section below.





The
Private Placement Transactions





Completion
of First Closing of 2009 Private Placement Transaction





On
August 26, 2009, the Company received gross proceeds of approximately $2,043,000
in a private placement transaction (the “Private Placement”) with six
investors.  Pursuant to Subscription Agreements entered into with the
investors, the Company sold approximately 38 Investment Units at $54,000 per
Investment Unit.  Each “Investment Unit” consists of 180,000 shares of
the Company’s common stock and a five year non-callable warrant to purchase
90,000 shares of the Company’s common stock at an exercise price of $0.30 per
share.  After commissions and expenses, the Company received net
proceeds of approximately $1,792,300 in the Private Placement.  These
funds were used to repay outstanding liabilities, fund the Company’s recent
clinical trial and for general working capital purposes.





A
FINRA member firm, the Maxim Group LLC (“Maxim Group”), acted as lead placement
agent in connection with the Private Placement.  For its services in
connection with the first closing of the offering, Maxim Group received (i) a
cash fee of $ 55,980, (ii) a cash expense allowance of $40,860, and (iii) a five
year non-callable warrant to purchase 274,867 shares of the Company’s common
stock at an exercise price of $0.33 per share. By agreement dated July 23, 2010,
the Company and Maxim Group agreed, among other things, to amend the five year
exercise period to begin on the date that the registration statement covering
the resale of the shares of common stock issuable upon exercise of the placement
agent warrants (among other securities) is declared effective.




A
secondary placement agent who participated in the first closing of the private
placement received cash fees of $29,200 and five year non-callable warrants to
purchase 97,200 shares of the Company’s common stock at an exercise price
of $ 0.33 per share. The Company has agreed to amend the five year exercise
period applicable to these warrants to begin on the effective date of the
registration statement, as described above.




Pursuant to a Registration Rights agreement entered into with each investor, the
Company agreed to file a registration statement covering the resale of the
common stock and the common stock underlying the warrants sold in the Private
Placement, as well as the common stock underlying the warrants issued to Maxim
Group by the later of October 26, 2009 or the 20th calendar day after the
termination of the offering.  The Registration Rights agreement was
subsequently amended to permit the filing of the registration statement no
later than 10 business days following the Company’s filing of its Annual Report
on Form 10-K for its September 30, 2009 year end, or the 20th calendar day
after termination of the private offering.  The Registration Statement
was filed with the Securities and Exchange Commission (SEC) on February 1,
2010.  Amendment No. 3 to the Registration Statement was filed with
the SEC on November 8, 2010.





In
addition, the Company agreed to use its best efforts to have the registration
statement declared effective no later than 180 days following the final closing
of the offering, or July 3, 2010, and maintain such effectiveness until the
earlier of the second anniversary of the date of such effectiveness or the date
that all of the securities covered by the registration statement may be sold
without restriction.  The registration statement has not yet been
declared effective.





Events
Relating to 2009 Private Placement Transaction




(a)
            Conversion
      of the March 30, 2009 SAIL/Brandt
Notes




On March
30, 2009, the Company entered into two Senior Secured Convertible Promissory
Notes, each in the principal amount of $250,000 (each a “March Note” and,
collectively, the “March Notes”), with Brandt Ventures, GP (“Brandt”) and SAIL
Venture Partners, LP (“SAIL”). Leonard Brandt, a former member of the Company’s
board of directors, is the general partner of Brandt and David B. Jones, a
current member of the Company’s board of directors, is a managing member of SAIL
Venture Partners, LLC, which is the general partner of SAIL. The terms of the
March Notes provided that in the event the Company consummates an equity
financing transaction of at least $1,500,000 (excluding any and all other debt
that is converted), then the principal and all accrued, but unpaid interest
outstanding under the notes shall be automatically converted into the securities
issued in the equity financing by dividing such amount by 90% of the per share
price paid by the investors in such financing.  In accordance with the
terms of the March Notes, at the closing of the Private Placement, the Company
issued to each of Brandt and SAIL 956,164 shares of common stock and a five year
non-callable warrant to purchase 478,082 shares of its common stock at an
exercise price of $0.30 per share.





(b)
            Conversion
      of the May 14, 2009 SAIL Note





On May
14, 2009, the Company entered into a Bridge Note and Warrant Purchase Agreement
(the “SAIL Purchase Agreement”) with SAIL. Pursuant to the SAIL Purchase
Agreement, on May 14, 2009, SAIL purchased a Secured Promissory Note in the
principal amount of $200,000 from the Company (the “May SAIL
Note”).  In order to induce SAIL to purchase the note, the Company
issued to SAIL a warrant to purchase up to 100,000 shares of the Company’s
common stock at a purchase price equal to $0.25 per share.  The
warrant expires on May 31, 2016.




49




The terms
of the May SAIL Note provided that in the event the Company consummates an
equity financing transaction of at least $1,500,000 (excluding any and all other
debt that is converted), then the principal and all accrued, but unpaid interest
outstanding under the note shall be automatically converted into the securities
issued in the equity financing by dividing such amount by 85% of the per share
price paid by the investors in such financing.  In accordance with the
terms of the May SAIL Note, at the first closing of the Private Placement on
August 26, 2009, the Company issued to SAIL 802,192 shares of its common stock
and a five year non-callable warrant to purchase 401,096 shares of its common
stock at an exercise price of $0.30 per share.





(c)
            Conversion of
      the June 12, 2009 Pappajohn Note





On June
12, 2009, John Pappajohn entered into a Bridge Note and Warrant Purchase
Agreement (the “Pappajohn Purchase Agreement”) with the
Company.  Pursuant to the Pappajohn Purchase Agreement, Mr. Pappajohn
purchased a Secured Convertible Promissory Note in the principal amount of
$1,000,000 from the Company.  In order to induce Mr. Pappajohn to
purchase the note, the Company issued to Mr. Pappajohn a warrant to
purchase up to 3,333,333 shares of the Company’s common stock at a purchase
price equal to $0.30 per share.  The warrant expires on June 30,
2016.





The
note issued pursuant to the Pappajohn Purchase Agreement provided that the
principal amount of $1,000,000 together with a single payment of $90,000 (the
“Premium Payment”) would be due and payable, unless sooner converted into shares
of the Company’s common stock (as described below), upon the earlier to occur
of: (i) a declaration by Mr. Pappajohn on or after June 30, 2010 or (ii) an
Event of Default (as defined in the note).  The note was secured by a
lien on substantially all of the assets (including all intellectual property) of
the Company.  In the event of a liquidation, dissolution or
winding up of the Company, unless Mr. Pappajohn informed the Company otherwise,
the Company was required to pay Mr. Pappajohn an amount equal to the product of
250% multiplied by the then outstanding principal amount of the note and the
Premium Payment.




The
Pappajohn Purchase Agreement also provided that in the event the Company
consummated an equity financing transaction of at least $1,500,000 (excluding
any and all other debt that is converted), the then outstanding principal amount
of the note (but excluding the Premium Payment, which would be repaid in cash at
the time of such equity financing) would be automatically converted into the
securities issued in the equity financing by dividing such amount by the per
share price paid by the investors in such financing.  The note also
provided that the securities issued upon conversion of the note would be
otherwise issued on the same terms as such shares are issued to the lead
investor that purchases shares of the Company in the qualified
financing.




On August
26, 2009, at the closing of the Private Placement, the Company paid the Premium
Payment to Mr. Pappajohn, and the outstanding principal amount of Mr.
Pappajohn’s note ($1,000,000 as of August 26, 2009) converted into 3,333,334
shares of the Company’s common stock. In addition, in accordance with the terms
of his note, Mr. Pappajohn was issued a five-year non-callable warrant to
purchase 1,666,667 shares of the Company’s common stock at an exercise price of
$0.30 per share.





Upon the
abovementioned conversions, the Company evaluated the terms and calculated the
fair value of the common stock (by using the closing market price on the
respective original issuance dates of the convertible notes) and warrants
(through the use of the Black-Scholes Model) issued upon the conversions and
determined that the notes were converted with a beneficial conversion feature
amounting to $642,000. As a result, for the year ended September 30, 2009, the
Company recorded $642,000 as interest expense.





Completion
of Second, Third and Fourth Closings of the 2009 Private Placement
Transaction




On
December 24 and 31, 2009 and January 4, 2010, the Company completed a second,
third and fourth and final closing of its private placement (the first closing
having occurred on August 26, 2009), resulting in additional gross proceeds to
the Company of $2,996,000, $432,000 and $108,000 respectively from accredited
investors.





Pursuant
to Subscription Agreements entered into with the investors, the Company sold
approximately 65 Investment Units in the three closings at $54,000 per
Investment Unit. Each “Investment Unit” consists of 180,000 shares of the
Company’s common stock and a five-year non-callable warrant to purchase 90,000
shares of the Company’s common stock at an exercise price of $0.30 per
share.





After
commissions and expenses, the Company received net proceeds of approximately
$2,650,400 million at the second closing, $380,200 at the third and $95,000 at
the fourth and final closing.  The Company intends to use the proceeds
from these closings of its private placement for general corporate purposes,
including clinical trial expenses, research and development expenses, and
general and administrative expenses, including the payment of accrued legal
expenses incurred in connection with the Company’s litigation with Mr.
Brandt.




50




A FINRA
member firm, the Maxim Group acted as lead placement agent in connection with
the second, third and fourth closings of the private placement.  For
its services in connection with the second closing, the Maxim Group received (i)
a cash fee of $195,200, (ii) a cash expense allowance of $59,920, and (iii) a
five year non-callable warrant to purchase 672,267 shares of the Company’s
common stock at an exercise price of $ 0.33 per share. For the third
closing the Maxim Group received (i) a cash fee of $4,300, (ii) a cash expense
allowance of $8,600, and (iii) a five year non-callable warrant to
purchase 14,400 shares of the Company’s common stock at an exercise price
of $ 0.33 per share. For the fourth closing the Maxim Group received (i) a cash
fee of $1,100, (ii) a cash expense allowance of $2,100, and (iii) a five year
non-callable warrant to purchase 3,600 shares of the Company’s common stock at
an exercise price of $ 0.33 per share. By agreement dated July 23, 2010, the
Company and Maxim Group agreed, among other things, to amend the five year
exercise period applicable to the placement agent warrants in the second, third
and fourth closings of the private placement to begin on the date that the
registration statement covering the resale of the shares of common stock
issuable upon exercise of the placement agent warrants (among other securities)
is declared effective.




Secondary
placement agents who participated in the second closing of the private placement
received cash fees of $75,200 and five-year non-callable warrants to
purchase 250,800 shares of the Company’s common stock at an exercise price
of $ 0.33 per share.  For the third closing, the secondary placement
agents received cash fees of $38,900 and five year non-callable warrants to
purchase 129,600 shares of the Company’s common stock at an exercise price
of $ 0.33 per share.  For the fourth closing, the secondary placement
agents received cash fees of $9,700 and five-year non-callable warrants to
purchase 32,400 shares of the Company’s common stock at an exercise price
of $ 0.33 per share. The Company has agreed to amend the five-year exercise
period applicable to these warrants to begin on the effective date of the
registration statement, as described above.




In
connection with the second, third and fourth closing of the Company’s private
placement, each investor who participated in the financing became party to the
abovementioned Registration Rights agreement, which was filed with the
Securities and Exchange Commission on February 1, 2010, and received the same
rights and benefits as the investors in the first closing of the Company’s
Private Placement on August 26, 2009.





2010
Promissory Note Transactions





On June
3, 2010, the Company entered into a Bridge Note and Warrant Purchase Agreement
with John Pappajohn to purchase two secured promissory notes (each, a “Bridge
Note”) in the aggregate principal amount of $500,000, with each Bridge Note in
the principal amount of $250,000 maturing on December 2, 2010.  On
June 3, 2010, Mr. Pappajohn loaned the Company $250,000 in exchange for the
first Bridge Note (there were no warrants issued in connection with this first
note) and on July 25, 2010, Mr. Pappajohn loaned the Company $250,000 in
exchange for the second Bridge Note.  In connection with his purchase
of the second Bridge Note, Mr. Pappajohn received a warrant to purchase up to
250,000 shares of the Company’s common stock.  The exercise price of
the warrant (subject to anti-dilution adjustments, including for issuances of
securities at prices below the then-effective exercise price) was $0.50 per
share.





Pursuant to a separate agreement that
the Company entered into with Mr. Pappajohn on July 25, 2010, the Company
granted him a right to convert his Bridge Notes into shares of it’s common stock
at a conversion price of $0.50.  The conversion price was subject to
customary anti-dilution adjustments, but would never be less than
$0.30.  Each Bridge Note accrued interest at a rate of 9% per
annum.





On July 5, 2010 and August 20, 2010,
the Company issued unsecured promissory notes (each, a “Deerwood Note”) in the
aggregate principal amount of $500,000 to Deerwood Partners LLC and Deerwood
Holdings LLC, with each investor purchasing two notes in the aggregate principal
amount of $250,000.  The Company’s director George Kallins and his
spouse are the managing members of these investors.  The Deerwood Notes
mature on December 15, 2010.  The Company received $250,000 in gross
proceeds from the issuance of the first two notes on July 5, 2010 and another
$250,000 in gross proceeds from the issuance of the second two notes on August
20, 2010.   In connection with the August 20, 2010 transaction,
each of the two investors also received a warrant to purchase up to 75,000
shares of the Company’s common stock at an exercise price (subject to
anti-dilution adjustments, including for issuances of securities at prices below
the then-effective exercise price) of $0.56 per share.




SAIL Venture Partners L.P. (“SAIL”), of
which the Company’s director David Jones is a managing partner, issued
unconditional guaranties to each of the Deerwood investors, guaranteeing the
prompt and complete payment when due of all principal, interest and other
amounts under each Deerwood Note.  The obligations under each guaranty
were independent of the Company’s obligations under the Deerwood Notes and
separate actions could be brought against the guarantor.  The Company
entered into an oral agreement to indemnify SAIL and grant to SAIL a security
interest in the Company’s assets in connection with the guaranties. In addition,
on August 20, 2010, the Company granted SAIL warrants to purchase up to an
aggregate of 100,000 shares of common stock at an exercise price (subject to
anti-dilution adjustments, including for issuances of securities at prices below
the then-effective exercise price) of $0.56 per share.




Each Deerwood Note accrued interest at
a rate of 9% per annum and was convertible into shares of the Company’s common
stock at a conversion price of $0.50.  The conversion price was
subject to customary anti-dilution adjustments, but would never be less than
$0.30.




51




On
October 1, 2010, the Company entered into a Note and Warrant Purchase Agreement
(the “Purchase Agreement”) with John Pappajohn and SAIL as investors, pursuant
to which the Company issued to the investors secured convertible promissory
notes (the “October Notes”) in the aggregate principal amount of $1,011,688 and
warrants to purchase up to 1,686,144 shares of common stock, as
follows:   (a) The Company received $500,000 in gross proceeds
from the issuance to these investors of October Notes in the aggregate principal
amount of $500,000 and related warrants to purchase up to 833,332
shares.  (b) The Company also issued October Notes in the aggregate
principal amount of $511,688, and related warrants to purchase up to 852,812
shares, to Mr. Pappajohn in exchange for the cancellation of the two Bridge
Notes originally issued to him on June 3, 2010 and July 25, 2010 in the
aggregate principal amount of $500,000 (and accrued and unpaid interest on those
notes) and a warrant to purchase up to 250,000 shares originally issued to him
on July 25, 2010.  The transaction closed on October 1,
2010.




On
November 3, 2010, three affiliated entities, identified below, executed the
Purchase Agreement.  In connection therewith, the Company issued
October Notes in the aggregate principal amount of $762,250 and warrants to
purchase up to 1,270,414 shares of common stock, as follows:  (a) The
Company received $250,000 in gross proceeds from the issuance to BGN Acquisition
Ltd., LP, an entity controlled by the Company’s director George Kallins, of
October Notes in the aggregate principal amount of $250,000 and related warrants
to purchase up to 416,666 shares.  (b)  The Company also
issued October Notes in the aggregate principal amount of $512,250, and related
warrants to purchase up to 512,250 shares, to Deerwood Holdings LLC and Deerwood
Partners LLC, two entities controlled by Mr. Kallins, in exchange for the
cancellation of the Deerwood Notes originally issued on July 5, 2010 and August
20, 2010 in the aggregate principal amount of $500,000 (and accrued and unpaid
interest on those notes) and warrants to purchase an aggregate of up to 150,000
shares originally issued on August 20, 2010.  The related guaranties
and oral indemnification and security agreement that had been entered into in
connection with the Deerwood Notes were likewise
terminated.   SAIL, of which the Company’s director David Jones
is a managing partner, issued unconditional guaranties to each of the Deerwood
investors, guaranteeing the prompt and complete payment when due of all
principal, interest and other amounts under the October Notes issued to such
investors.  The obligations under each guaranty are independent of the
Company’s obligations under the October Notes and separate actions may be
brought against the guarantor.  In connection with its serving as
guarantor, the Company granted SAIL warrants to purchase up to an aggregate of
341,498 shares of common stock.  The warrants to purchase 100,000
shares of common stock previously granted to SAIL on August 20, 2010 were
canceled.




The
Purchase Agreement provides for the issuance and sale of October Notes, for cash
or in exchange for outstanding convertible notes, in the aggregate principal
amount of up to $3,000,000 plus an amount corresponding to accrued and unpaid
interest on any exchanged notes, and warrants to purchase a number of shares
corresponding to 50% of the number of shares issuable on conversion of the
October Notes.  The agreement provides for multiple closings, but
mandates that no closings may occur after January 31, 2011.  The
Purchase Agreement also provides that the Company and the holders of the October
Notes will enter into a registration rights agreement covering the registration
of the resale of the shares underlying the October Notes and the related
warrants.




The
October Notes mature one year from the date of issuance (subject to earlier
conversion or prepayment), earn interest equal to 9% per year with interest
payable at maturity, and are convertible into shares of common stock of the
Company at a conversion price of $0.30.  The conversion price is
subject to adjustment upon (1) the subdivision or combination of, or stock
dividends paid on, the common stock; (2) the issuance of cash dividends and
distributions on the common stock; (3) the distribution of other capital stock,
indebtedness or other non-cash assets; and (4) the completion of a financing at
a price below the conversion price then in effect.  The October Notes
are furthermore convertible, at the option of the holder, into securities to be
issued in subsequent financings at the lower of the then-applicable conversion
price or price per share payable by purchasers of such
securities.  The October Notes can be declared due and payable upon an
event of default, defined in the October Notes to occur, among other things, if
the Company fails to pay principal and interest when due, in the case of
voluntary or involuntary bankruptcy or if the Company fails to perform any
covenant or agreement as required by the October Note. The
aggregate number of shares of common stock underlying the principal amount of
the October Notes, which were accounted for as being outstanding at September
30, 2010, is 3,413,126 at a conversion price of $0.30 per
share.




The
Company’s obligations under the terms of the October Notes are secured by a
security interest in the tangible and intangible assets of the Company, pursuant
to a Security Agreement, dated as of October 1, 2010, by and between the Company
and John Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.




The
warrants related to the October Notes expire seven years from the date of
issuance and are exercisable for shares of common stock of the Company at an
exercise price of $0.30.  Exercise price and number of shares issuable
upon exercise are subject to adjustment (1) upon the subdivision or combination
of, or stock dividends paid on, the common stock; (2) in case of any
reclassification, capital reorganization or change in capital stock and (3) upon
the completion of a financing at a price below the exercise price then in
effect.  Any provision of the October Notes or related warrants can be
amended, waived or modified upon the written consent of the Company and holders
of a majority of the aggregate principal amount of such notes
outstanding.  Any such consent will affect all October Notes or
warrants, as the case may be, and will be binding on all holders
thereof.




ASC
470-50-40 “Extinguishments of
Debt” requires modifications to debt instruments to be evaluated to
assess whether the modifications are considered “substantial modifications”. A
substantial modification of terms shall be accounted for like an extinguishment.
For extinguished debt, a difference between the re-acquisition price and the net
carrying amount of the extinguished debt shall be recognized currently in income
of the period of extinguishment as losses or gains. The Company evaluated the
change in terms between the Bridge Notes and Deerwood Notes, on the one hand,
and the October Notes, on the other hand, under ASC 470, noting that they met
the criteria for substantial modification and accordingly treated the
modification as extinguishment of the original convertible notes (i.e., the
Bridge Notes and Deerwood Notes), replaced by the new convertible notes (i.e.,
the October Notes) with modified terms. Although the replacement notes were
issued after the close of the fiscal year ended September 30, 2010, i.e., in
October and November 2010, the Company considered the replacement notes to
be  outstanding and effective for the fiscal year ended September 30,
2010 and accordingly recorded a loss on extinguishment of debt of $1,094,300 for
the year ended September 30, 2010.




52




4.
              STOCKHOLDERS’
      EQUITY




Common
and Preferred Stock




As of
September 30, 2009 the Company is authorized to issue 750,000,000 shares of
common stock.




As of
September 30, 2009, 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, 2009, Colorado CNS Response, Inc. is authorized to issue 1,000,000
shares of common stock.




As of
September 30, 2009, Neuro-Therapy Clinic, Inc., a wholly-owned subsidiary of
Colorado CNS Response, Inc., is authorized to issue ten thousand (10,000) shares
of common stock, no par value per share.




Stock-Option
Plan




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
were initially reserved for issuance under the 2006
Plan.




The 2006
Plan initially provided that in any calendar year, no eligible employee or
director shall be granted an award to purchase more than 3 million shares of
stock. The option price for each share of stock subject to an option shall be
(i) no less than the fair market value of a share of stock on the date the
option is granted, if the option is an ISO, or (ii) no less than 85% of the fair
market value of the stock on the date the option is granted, if the option is a
NSO; provided, however, if the option is an ISO granted to an eligible employee
who is a 10% shareholder, the option price for each share of stock subject to
such ISO shall be no less than 110% of the fair market value of a share of stock
on the date such ISO is granted. Stock options have a maximum term of ten years
from the date of grant, except for ISOs granted to an eligible employee who is a
10% shareholder, in which case the maximum term is five years from the date of
grant. ISOs may be granted only to eligible employees.




On March
3, 2010, the Board of Directors approved an amendment to the 2006 Plan which
increased the number of shares reserved for issuance under the 2006 Plan from 10
million to 20 million shares of stock.  The amendment also increased
the limit on shares issued within a calendar year to any eligible employee or
director from 3 million to 4 million shares of stock.  The amendment
was approved by shareholders at the annual meeting held on April 27,
2010.




On March
3, 2010, the Board of Directors also approved the grant of 9,150,000 options to
staff members, directors, advisors and consultants, of which 8,650,000 were in
fact granted.  For staff members the options will vest equally over a
48 month period while for directors, advisors and consultants the options will
vest equally over a 36 month period.  The effective grant date for
accredited investors was March 3, 2010 and the exercise price of $0.55 per share
was based on the quoted closing share price of the Company’s stock at the time
of grant.  For non-accredited investors the grant date will be
determined at some time after obtaining a permit from the State of California
allowing the granting of options to non-accredited investors.  This
permit was granted by the State of California in July 2010.  No
options have been granted to non-accredited investors at this time.





On July
5, 2010, the Board of Directors also approved an additional grant of 800,000
options to a new member of the executive management team, a new member of the
board of directors and a new advisor to the Company.  The respective
vesting periods are the same as those for the abovementioned March 3, 2010
grants.  The effective grant date for these accredited investors was
July 5, 2010 and the exercise price of $0.40 per share was based on the quoted
closing share price of the Company’s stock on July 2, 2010 as markets were
closed for the 4th of July
holiday weekend.





As of
September 30, 2010, 2,124,740 options were exercised and there were 15,670,973
options and 183,937 restricted shares outstanding under the amended 2006 Plan
leaving 2,020,350 shares available for issuance of future awards.




The
Company has adopted ASC 718-20 (formerly, SFAS No. 123R -revised 2004,
“Share-Based Payment”), and related interpretations. Under ASC 718-10,
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:




53




Options 
      granted  in:
                          
                          Dividend
                            Yield
                          
                          
                          Risk-free
                            interest 
      rate
                          
                          
                          Expected
                            volatility
                          
                          Expected lifeFiscal
      2006
                          
                          
                          0
                          %
                          
                          
                          5.46
                          %
                          
                          
                          100
                          %
                          5
      yearsNovember
      2006
                          
                          
                          0
                          %
                          
                          
                          5.00
                          %
                          
                          
                          100
                          %
                          10
      yearsAugust
      2007
                          
                          
                          0
                          %
                          
                          
                          4.72
                          %
                          
                          
                          91
                          %
                          5
      yearsOctober
      2007
                          
                          
                          0
                          %
                          
                          
                          4.60
                          %
                          
                          
                          105
                          %
                          5
      yearsDecember
      2007
                          
                          
                          0
                          %
                          
                          
                          4.00
                          %
                          
                          
                          113
                          %
                          5
      yearsApril
      2008
                          
                          
                          0
                          %
                          
                          
                          3.78
                          %
                          
                          
                          172
                          %
                          5
      yearsSeptember
      2008
                          
                          
                          0
                          %
                          
                          
                          3.41
                          %
                          
                          
                          211
                          %
                          5
      yearsOctober
      2008
                          
                          
                          0
                          %
                          
                          
                          3.77
                          %
                          
                          
                          211
                          %
                          5
      yearsMarch
      2009
                          
                          
                          0
                          %
                          
                          
                          3.00
                          %
                          
                          
                          385
                          %
                          5
      yearsMarch
      2010
                          
                          
                          0
                          %
                          
                          
                          3.62
                          %
                          
                          
                          215
                          %
                          5
      yearsJuly
      2010
                          
                          
                          0
                          %
                          
                          
                          1.81
                          %
                          
                          
                          536
                          %
                          5
      years




Stock-based
compensation expense is recognized over the employees’ or service provider’s
requisite service period, generally the vesting period of the award. Stock-based
compensation expense included in the accompanying statements of operations for
the periods ended September 30, 2010 and 2009 is as follows:





For the fiscal year ended September 30,2010
                        
                        
                        2009Operations
                        
                        $
                        18,000
                        
                        
                        $
                        16,100Research
      and development
                        
                        
                        341,600
                        
                        
                        
                        260,800Sales
      and marketing
                        
                        
                        197,200
                        
                        
                        
                        137,500General
      and administrative
                        
                        
                        745,300
                        
                        
                        
                        436,100Total
                        
                        $
                        1,302,100
                        
                        
                        $
                        850,500




Total
unrecognized compensation as of September 30, 2010 amounted to
$4,549,700.




A summary
of stock option activity is as follows:





Number of
                                  Shares
                                
                                Weighted Average
                                  Exercise PriceOutstanding
      at October 1, 2008
                                
                                
                                8,964,567
                                
                                
                                $
                                0.60Granted
                                
                                
                                80,000
                                
                                
                                $
                                0.43Exercised
                                
                                
                                (2,124,740
                                )
                                
                                $
                                0.132Forfeited
                                
                                
                                (257,813
                                )
                                
                                $
                                0.51Outstanding
      at September 30, 2009
                                
                                
                                6,662,014
                                
                                
                                $
                                0.76Granted
                                
                                
                                9,450,000
                                
                                
                                $
                                0.54Exercised
                                
                                
                                -
                                
                                
                                $Forfeited
                                
                                
                                (441,041
                                )
                                
                                $
                                0.81Outstanding
      at September 30, 2010
                                
                                
                                15,670,973
                                
                                
                                $
                                0.62Weighted
      average fair value of options granted during:Year
      ended September 30, 2009
                                
                                
                                
                                
                                
                                $
                                0.43Year
      ended September 30, 2010
                                
                                
                                
                                
                                
                                $
                                0.54




54




Following
is a summary of the status of options outstanding at September 30,
2010:





Exercise
      Price
                            
                            Number
      of Shares
                            
                            Weighted
      Average
                              Contractual
      Life
                            
                            Weighted
      Average
                              Exercise
      Price$0.12
                            
                            
                            859,270
                            
                            10
      years
                            
                            $
                            0.12$0.132
                            
                            
                            987,805
                            
                            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
                            
                            
                            2,513,549
                            
                            10
      years
                            
                            $
                            1.09$1.20
                            
                            
                            243,253
                            
                            5
      years
                            
                            $
                            1.20$0.51
                            
                            
                            41,187
                            
                            10
      years
                            
                            $
                            0.51$0.40
                            
                            
                            856,000
                            
                            10
      years
                            
                            $
                            0.40$0.55
                            
                            
                            8,400,000
                            
                            10
      years
                            
                            $
                            0.55Total
                            
                            
                            15,670,973
                            
                            
                            
                            $
                            0.62





Warrants
to Purchase Common Stock




At
October 1, 2008, 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.




During
the year ended September 30, 2009, 1,498,986 warrants with an exercise price of
$0.01 were exercised.




During
the year ended September 30, 2009, the following additional 10,137,118 warrants
were granted as follows:





Warrants
      to Purchase
                    
                    Exercise
                      Price
                    
                    Issued
      in Connection With:100,000
      shares
                    
                    $
                    0.25
                    
                    A
      $200,000 bridge note with SAIL on May 14, 2009 as described in Note
      33,333,333
      shares
                    
                    $
                    0.30
                    
                    A
      $1,000,000 bridge note with Pappajohn on June 12, 2009 as described
      in Note 33,404,991
      shares
                    
                    $
                    0.30
                    
                    Associated
      with the August 26, 2009 private placement transaction of 6,810,002 shares
      at $0.30 with 50% warrant coverage as described in Note
  33,023,927
      shares
                    
                    $
                    0.30
                    
                    Associated
      with the automatic conversion of $1,700,000 of convertible promissory
      notes and $20,900 accrued interest upon completion an equity financing in
      excess of $1,500,000 as described  in Note 3274,867
      shares
                    
                    $
                    0.33
                    
                    The
      placement agent for private placement as described in Note
    3




At
September 30, 2009, there were warrants outstanding to purchase 15,537,485
shares.  During the year ended September 30, 2010, a further 9,300,161
warrants were granted, of which 500,000 were cancelled and replaced with
1,706,560 warrants pursuant to the Note and Warrant Purchase agreement dated
October 1, 2010 as described below and in note 3.  Furthermore
3,333,333 warrants were exercised.  The warrant activity is described
as follows:




55




Warrants to Purchase
                          
                          Exercise
                            Price
                          
                          Issued in Connection With:5,893,334
      shares
                          
                          $
                          0.30
                          
                          Associated
      with the second, third and fourth closing of the private placement
      transaction of 11,786,667 shares at $0.30 with 50% warrant coverage as
      described in Note 31,200,267
      shares
                          
                          $
                          0.33
                          
                          Associated
      with warrants for the lead and secondary placement agents for private
      placement as described in Note 3(3,333,333)
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were surrendered in a net issue exercise and 2,456,126 shares
      were issued in lieu of cash.500,000
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were granted to individual staff members of Equity Dynamics, Inc.
      a Company owned by Mr. Pappajohn, for their efforts in providing
      consulting services associated with the Company’s financing
      activities.852,812
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were issued to Mr. John Pappajohn, a Director of the Company,
      pursuant to the October 1, 2010 Note and Warrant Purchase agreement
      described in note 3; whereby two outstanding convertible notes of $250,000
      each, issued on June 3 and July 25, 2010 respectively, and 250,000
      outstanding warrants issued on July 25, 2010, with an exercise price of
      $0.50  were cancelled and exchanged on October 1, 2010 for two
      new notes of $250,000 each plus unpaid interest and warrants to purchase
      852,812 shares of common stock.256,125
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were issued to Deerwood Partners, LLC which is controlled by Dr.
      George Kallins, a Director of the Company, pursuant to the October 1, 2010
      Note and Warrant Purchase agreement described in note 3; whereby two
      outstanding convertible notes of $125,000 each, issued on July 5 and
      August 20, 2010 respectively, and 75,000 outstanding warrants issued on
      August 20, 2010, with an exercise price of $0.56 were cancelled and
      exchanged on November 3, 2010 for two new notes of $125,000 each plus
      unpaid interest and warrants to purchase 256,125 shares of common
      stock.256,125
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were issued to Deerwood Holdings, LLC which is controlled by Dr.
      George Kallins, a Director of the Company, pursuant to the October 1, 2010
      Note and Warrant Purchase agreement described in note 3; whereby two
      outstanding convertible notes of $125,000 each, issued on July 5 and
      August 20, 2010 respectively, and 75,000 outstanding warrants issued on
      August 20, 2010, with an exercise price of $0.56 were cancelled and
      exchanged on November 3, 2010 for two new notes of $125,000 each plus
      unpaid interest and warrants to purchase 256,125 shares of common
      stock.341,498
      shares
                          
                          $
                          0.30
                          
                          These
      warrants were issued to SAIL, of which Mr. David Jones, a Director of the
      Company, is a managing partner.  SAIL had undertaken to
      guarantee the four abovementioned Deerwood notes which were issued on July
      5 and August 20, 2010.  For this guarantee SAIL was issued
      100,000 warrants on August 20, 2010 with an exercise price of
      $0.56.  Upon the cancellation and exchange of the Deerwood notes
      on November 3, 2010, SAIL undertook to guarantee the four new Deerwood
      notes in exchange for the cancellation of the SAIL’s 100,000 outstanding
      warrants which were replaced with new
341,498.




At
September 30, 2010, there were warrants outstanding to purchase 21,504,313
shares of the Company’s common stock which includes a net 1,206,560 shares which
were the result of the cancellation and reissuance of warrants in accordance
with the Note and Warrant Purchase Agreement of October 1, 2010 detailed above
and in Note 3.  The exercise price of the outstanding warrants range
from $0.01 to $1.812 with a weighted average exercise price of
$0.56.  The warrants expire at various times through
2017.




5.
              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. The Company provides a valuation allowance to reduce the
Company’s deferred tax assets to their estimated realizable value.




56




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:




2010
                  
                  
                  2009Federal
      income tax (benefit) at statutory rates
                  
                  
                  (34
                  )%
                  
                  
                  (34
                  )%Stock-based
      compensation
                  
                  
                  0
                  %
                  
                  
                  0
                  %Non
      deductible interest expense
                  
                  
                  5
                  %
                  
                  
                  0
                  %Extinguishment
      of debt
                  
                  
                  5
                  %
                  
                  
                  0
                  %Change
      in valuation allowance
                  
                  
                  30
                  %
                  
                  
                  37
                  %Goodwill
      write off
                  
                  
                  0
                  %
                  
                  
                  (3
                  )%State
      tax benefit
                  
                  
                  (6
                  )%
                  
                  
                  0
                  %




Temporary
differences between the financial statement carrying amounts and bases of assets
and liabilities that give rise to significant portions of deferred taxes relate
to the following at September 30, 2010 and 2009:




2010
                          
                          
                          2009Deferred
      income tax assets:Net
      operating loss carryforward
                          
                          $
                          10,451,700
                          
                          
                          $
                          8,765,900Deferred
      interest, consulting and compensation liabilities
                          
                          
                          1,776,800
                          
                          
                          
                          987,500Amortization
                          
                          
                          (34,400
                          )
                          
                          
                          (24,300
                          )Deferred
      income tax assets – other
                          
                          
                          15,000
                          
                          
                          
                          7,80012,209,100
                          
                          
                          
                          9,736,900Deferred
      income tax liabilities—other
                          
                          
                          -
                          
                          
                          
                          -Deferred
      income tax asset—net before valuation allowance
                          
                          
                          12,209,100
                          
                          
                          
                          9,736,900Valuation
      allowance
                          
                          
                          (12,209,100
                          )
                          
                          
                          (9,736,900
                          )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, 2010, the Company has net
operating loss carryforwards of approximately $24.7 million. The net operating
loss carryforwards expire by 2029. 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.





6.
              ACQUISITION OF NEURO THERAPY
      CLINIC, PC





On
January 15, 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 15, 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
                          
                          $
                          265,900Direct
      transaction costs
                          
                          
                          43,700Purchase
      price
                          
                          
                          309,600Allocated
      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.  As of September 30, 2009, goodwill was measured and
determined to be fully impaired and consequently written off.




57




7.
            LONG-TERM
      DEBT





As
described in Note 6 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, 2010 and September 30, 2009 the note has an outstanding principal
balance in the amount of $24,700 and $118,600 respectively.  The
entire balance is current as of September 30, 2010.





8.
            RELATED
      PARTY TRANSACTIONS





As at
September 30, 2010 accrued consulting fees included the $27,000 due to a
director in accordance with a 12 month consulting agreement, the term of which
ends on December 31, 2010.  In January, 2010 a payment of $24,000 was
made to that same director for the 12 month consulting agreement, the term of
which ended on December 31, 2009 and $36,000 was paid, with board approval, to
the spouse of the Company’s Chief Executive Officer, who provided data discovery
consulting services in support of the Company’s litigation with Mr.
Brandt.





On June
3, 2010, the Company entered into a Bridge Note and Warrant Purchase Agreement
with John Pappajohn to purchase two secured promissory notes in the aggregate
principal amount of $500,000. For further detail, please refer to the section
2010 Promissory Note
Transactionsin Note 3 above.





On July
5, 2010 and August 20, 2010, the Company issued unsecured promissory notes
(each, a “Deerwood Note”) in the aggregate principal amount of $500,000 to
Deerwood Partners LLC and Deerwood Holdings LLC, which are entities controlled
by Dr George Kallins.  For further detail, please refer to the section
2010 Promissory Note
Transactionsin Note 3 above.





On July
5, 2010 the Board granted warrants to purchase 500,000 shares of common stock to
members of staff of Equity Dynamics, Inc, a company owned by Mr. Pappajohn, for
consulting services they had rendered to the Company, advising on and assisting
with fund raising activities.  Using the Black-Scholes model, these
warrants were valued at $199,000 and expensed to consulting
fees.   These warrants have an exercise price of $0.30 cents per
share, are exercisable from the date of grant and have a term of 10 years from
the date of grant.




On
November 24, 2010 the Board of Directors, excluding Mr. Pappajohn, resolved to
ratify an engagement agreement with Equity Dynamics, Inc. a company owned by Mr.
Pappajohn, to provide financial advisory serviced to assist the Company with the
Company’s fund raising efforts.  These efforts have included advice
and assistance with the preparation of Private Placement Memoranda, investor
presentations, financing strategies, identification of potential and actual
investors, and introductions to placement agents and investment bankers. The
engagement letter calls for a retainer fee of $10,000 per month starting
February, 1, 2010.  As of September 30, 2010 the Company has accrued
$80,000 for the services provided by Equity Dynamics.  The term of the
agreement is for 12 months from its initiation and can be cancelled by either
party, with or without cause, with 30 days written notice.





9.
            REPORTABLE
      SEGMENTS





The
Company operates in two business segments:  reference neurometric and
clinic.  Neurometric Information Services (formerly called Laboratory
Information Services) provides data to psychiatrists and other
physicians/prescribers to enable them to make a more informed decision when
treating a specific patient with mental, behavioral and/or addictive disorders
provides reports (“rEEG Reports”).  Clinic operates NTC, a full
service psychiatric practice.





The
following tables show operating results for the Company’s 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,
      2010Reference
                                          Neurometric
                                        
                                        
                                        Clinic
                                        
                                        
                                        Eliminations
                                        
                                        
                                        TotalRevenues
                                        
                                        
                                        156,000
                                        
                                        
                                        
                                        535,700
                                        
                                        
                                        
                                        (53,200
                                        )
                                        
                                        
                                        638,500Operating
      expenses:Cost
      of revenues
                                        
                                        
                                        135,100
                                        
                                        
                                        
                                        19,900
                                        
                                        
                                        
                                        (19,900
                                        )
                                        
                                        
                                        135,100Research
      and development
                                        
                                        
                                        1,120,500
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,120,500Sales
      and marketing
                                        
                                        
                                        853,100
                                        
                                        
                                        
                                        17,800
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        870,900General
      and administrative
                                        
                                        
                                        4,296,200
                                        
                                        
                                        
                                        754,100
                                        
                                        
                                        
                                        (33,300
                                        )
                                        
                                        
                                        5,017,000Goodwill
      impairment charges
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Total
      operating expenses
                                        
                                        
                                        6,404,900
                                        
                                        
                                        
                                        791,800
                                        
                                        
                                        
                                        (53,200
                                        )
                                        
                                        
                                        7,143,500Loss
      from operations
                                        
                                        $
                                        (6,248,900
                                        )
                                        
                                        $
                                        (256,100
                                        )
                                        
                                        $
                                        0
                                        
                                        
                                        $
                                        (6,505,000
                                        )




58




Year ended September 30,2009Reference
                              Neurometric
                            
                            
                            Clinic
                            
                            
                            Eliminations
                            
                            
                            TotalRevenues
                            
                            
                            138,900
                            
                            
                            
                            628,200
                            
                            
                            
                            (67,000
                            )
                            
                            
                            700,100Operating
      expenses:Cost
      of revenues
                            
                            
                            131,600
                            
                            
                            
                            18,500
                            
                            
                            
                            (18,500
                            )
                            
                            
                            131,600Research
      and development
                            
                            
                            1,924,100
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            1,924,100Sales
      and marketing
                            
                            
                            908,500
                            
                            
                            
                            7,300
                            
                            
                            
                            -
                            
                            
                            
                            915,800General
      and administrative
                            
                            
                            3,479,400
                            
                            
                            
                            669,600
                            
                            
                            
                            (48,500
                            )
                            
                            
                            4,100,500Goodwill
      impairment charges
                            
                            
                            320,200
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            320,200Total
      operating expenses
                            
                            
                            6,763,800
                            
                            
                            
                            695,400
                            
                            
                            
                            (67,000
                            )
                            
                            
                            7,392,200Loss
      from operations
                            
                            $
                            (6,624,900
                            )
                            
                            $
                            (67,200
                            )
                            
                            $
                            0
                            
                            
                            $
                            (6,692,100
                            )





The
following table includes selected segment financial information as of September
30, 2010, related to total assets:





Reference
                    Neurometric
                  
                  
                  Clinic
                  
                  
                  TotalTotal
      assets
                  
                  $
                  203,900
                  
                  
                  $
                  33,600
                  
                  
                  $
                  237,500




10.
              EARNINGS
      PER SHARE




In
accordance with ASC 260-10 (formerly 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, 2010
and 2009, 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, 2010 and 2009 is as follows:




2010
                                
                                
                                2009Net
      loss for computation of basic net income (loss) per share
                                
                                $
                                (8,174,000
                                )
                                
                                $
                                (8,522,200
                                )Net
      income (loss) for computation of dilutive net income (loss) per
      share
                                
                                $
                                (8,174,000
                                )
                                
                                $
                                (8,522,200
                                )Basic
      net income (loss) per share
                                
                                $
                                (0.16
                                )
                                
                                $
                                (0.31
                                )Diluted
      net income (loss) per share
                                
                                $
                                (0.16
                                )
                                
                                $
                                (0.31
                                )Basic
      weighted average shares outstanding
                                
                                
                                52,277,119
                                
                                
                                
                                27,778,171Dilutive
      common equivalent shares
                                
                                
                                -
                                
                                
                                
                                -Diluted
      weighted average common shares
                                
                                
                                52,277,119
                                
                                
                                
                                27,778,171Anti-dilutive
      common equivalent shares not included in thecomputation
      of dilutive net loss per share:Convertible
      debt
                                
                                
                                214,561
                                
                                
                                
                                -Warrants
                                
                                
                                19,194,806
                                
                                
                                
                                8,318,310Options
                                
                                
                                11,242,729
                                
                                
                                
                                8,548,206




59




11.
              COMMITMENTS
      AND CONTINGENT
LIABILITIES


Litigation




From time
to time, the Company may be involved in litigation relating to claims arising
out of the Company’s operations in the ordinary course of business. Other than
as set forth below, the Company are not currently party to any legal
proceedings, the adverse outcome of which, in the Company’s management’s
opinion, individually or in the aggregate, would have a material adverse effect
on the Company’s results of operations or financial position.





Since
June of 2009, the Company has been involved in litigation against Leonard J.
Brandt, a stockholder, former director and the Company’s former Chief Executive
Officer (“Brandt”) in the Delaware Chancery Court and the United States District
Court for the Central District of California.  At the conclusion of a
two-day trial that commenced December 1, 2009, the Chancery
Court entered judgment for the Company and dismissed with prejudice
Brandt's action brought pursuant to Section 225 of the Delaware General
Corporation Law, which sought to oust the incumbent directors other than
Brandt.  The Chancery Court thereby found that the purported special
meeting of stockholders convened by Brandt on September 4, 2009 was not valid
and that the directors purportedly elected at that meeting are not entitled to
be seated.  On January 4, 2010, Brandt filed an appeal with the
Supreme Court of the State of Delaware in relation to the case.  On
April 20, 2010, the Delaware Supreme Court affirmed the ruling of the Chancery
Court.




The Chancery
Court also denied an injunction sought by Mr. Brandt to prevent the voting
of shares issued by the Company in connection with the Company’s bridge
financing in June 2009, and securities offering in August 2009, and dismissed
Brandt's claims regarding those financings and stock issuances. 
On January 4, 2010, Brandt also filed an appeal in relation to this ruling with
the Delaware Supreme Court which, on April 20, 2010, affirmed the ruling of the
Chancery Court.




The
Chancery Court also dismissed with prejudice another action brought by Mr.
Brandt, in which he claimed he had not been provided with information owed to
him.




In July
2009, the Company filed an action in the United States District Court for the
Central District of California against Mr. Brandt and certain
others.  The Company’s complaint alleged a variety of violations of
federal securities laws, including anti-fraud based claims under
Rule 14a-9, solicitation of proxies in violation of the filing and
disclosure dissemination requirements of Regulation 14A, and material
misstatements and omissions in and failures to promptly file amendments to
Schedule 13D.  Mr. Brandt and the other defendants filed
counterclaims against us, alleging violations of federal securities laws
relating to alleged actions and statements taken or made by the Company or the
Company’s officers and directors in connection with Mr. Brandt’s proxy and
consent solicitations.  On March 10, 2010, the Company dismissed the
Company’s claims against EAC, and EAC dismissed its claims against the Company
and Mr. Carpenter.  On April 10, 2010, Mr. Brandt's attorneys moved to
withdraw from representing Mr. Brandt in the case.  On July 7, 2010,
Mr. Brandt moved to dismiss his counterclaims against the Company and the
Company consented to dismiss its complaint against Mr. Brandt.  On
July 13, 2010, all of the Company’s claims and Mr. Brandt’s counterclaims in
such action were dismissed.  This resolved all pending actions between
the Company and Mr. Brandt.




The
Company has expended substantial resources to pursue the defense of legal
proceedings initiated by Mr. Brandt.  The Company does not know
whether Mr. Brandt will institute new claims against the Company and the
defense of any such claims could involve the expenditure of additional resources
by the Company.




Lease
Commitments




The
Company leased its headquarters and Neurometric Information Services space under
an operating lease which terminated on November 30, 2009. The Company continued
to lease the space on a month-to-month basis through January 22, 2010 at which
time the Company moved to its new premises.




On
December 30, 2009 the Company entered a three year lease, commencing February 1,
2010 and terminating on January 30, 2013 for its new Headquarters and
Neurometric Information Services business premises located at 85 Enterprise,
Aliso Viejo, California 92656.  The 2,023 square foot facility has an
average cost for the lease term of $3,600 per month.  The remaining
lease obligation totals $112,200: being $46,500, $49,000 and $16,600 for fiscal
years 2011, 2012 and 2013 respectively.




60




The
Company leases space for its Clinical Services operations under an operating
lease. The base rental as of September 30, 2009 was $6,000 per
month.  This lease terminated on February 28, 2010 and a 37 month
extension to the lease was negotiated commencing April 1, 2010 and terminating
April 30, 2013. The 3,542 square foot facility has an average cost for the lease
term of $5,100 per month. The remaining lease obligation totals $162,300: being
$58,200, $65,400 and $38,700 for fiscal years 2011, 2012 and 2013
respectively.




The
Company also sub-leased space for its Clinical Services operations on a
month-to-month basis for $1,000 per month up until March 2010 when it terminated
this sub-lease and gave up the space.




The
Company leases a copier for $200 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.





The
Company incurred rent expense of $121,100 and $141,700 for the year ended
September 30, 2010 and 2009.




12.
              SIGNIFICANT
      CUSTOMERS




For the
year ended September 30, 2010, four customers accounted for 48% of Neurometric
Information Services revenue and two customers 27% of accounts receivable at
September 30, 2010





For the
year ended September 30, 2009, three customers accounted for 39% of Neurometric
Information Services revenue and 45% of accounts receivable at September 30,
2009.





13.
              SUBSEQUENT
      EVENTS




Events
subsequent to September 30, 2010 have been evaluated through the date these
financial statements were issued, to determine whether they should be disclosed
to keep the financial statements from being misleading.  The following
events have occurred since September 30, 2010.




Subsequent
to September 30, 2010 and through December 17, 2010 the company had raised an
additional $2,000,000 through the sale of secured convertible promissory notes
and warrants. At the December 17, 2010 the Company had a cash balance of
$930,000.




On
October 1, 2010, the Company entered into a Note and Warrant Purchase Agreement
(the “Purchase Agreement”) with John Pappajohn and SAIL as investors, pursuant
to which the Company issued to the investors secured convertible promissory
notes (the “October Notes”) in the aggregate principal amount of $1,011,688 and
warrants to purchase up to 1,686,144 shares of common stock, as
follows:   (a) The Company received $500,000 in gross proceeds
from the issuance to these investors of October Notes in the aggregate principal
amount of $500,000 and related warrants to purchase up to 833,332
shares.  (b) The Company also issued October Notes in the aggregate
principal amount of $511,688, and related warrants to purchase up to 852,812
shares, to Mr. Pappajohn in exchange for the cancellation of the two Bridge
Notes originally issued to him on June 3, 2010 and July 25, 2010 in the
aggregate principal amount of $500,000 (and accrued and unpaid interest on those
notes) and a warrant to purchase up to 250,000 shares originally issued to him
on July 25, 2010.  The transaction closed on October 1,
2010.




On
October 7 and October 12, 2010, a third and fourth accredited investor,
respectively, executed the Purchase Agreement.  In connection
therewith, the Company issued October Notes in the aggregate principal amount of
$600,000 and warrants to purchase up to 999,999 shares of common stock of the
Company, to such investors on those dates.  The Company received
$588,000 in net proceeds from these investors, after paying $12,000 to the
placement agent as described below.  Monarch Capital Group LLC
(“Monarch”) acted as non-exclusive placement agent with respect to the October
12 placement of October Notes in the aggregate principal amount of $100,000 and
related warrants, pursuant to an engagement agreement, dated September 30, 2010,
between the Company and Monarch.  Under the engagement agreement, in
return for its services as non-exclusive placement agent, Monarch was entitled
to receive (a) a cash fee equal to 10% of the gross proceeds raised from the
sale of October Notes to investors introduced to the Company by Monarch; (b) a
cash expense allowance equal to 2% of the gross proceeds raised from the sale of
October Notes to such investors; and (c) five-year warrants (the “Placement
Agent Warrants”) to purchase common stock of the Company equal to 10% of the
shares issuable upon conversion of October Notes issued to such
investors.  In connection with the October 12, 2010 closing, Monarch
received a cash fee of $10,000 and a cash expense allowance of $2,000 and, on
October 25, 2010, received Placement Agent Warrants to purchase 33,333 shares of
the Company’s common stock at an exercise price of $0.33 per share. The terms of
the Placement Agent Warrant, except for the exercise price and period, are
identical to the terms of the Warrants.





On
October 21, 2010 and October 28, a fifth and sixth accredited investor,
respectively, executed the Purchase Agreement.  In connection
therewith, the Company issued October Notes in the aggregate principal amount of
$250,000 and warrants to purchase up to 416,666 shares of common stock to such
investors on such dates.  The Company received approximately $250,000
in net proceeds from the issuance to these investors.




61




On
November 3, 2010, three affiliated entities, identified below, executed the
Purchase Agreement.  In connection therewith, the Company issued
October Notes in the aggregate principal amount of $762,250 and warrants to
purchase up to 1,270,414 shares of common stock, as follows:  (a) The
Company received $250,000 in gross proceeds from the issuance to BGN Acquisition
Ltd., LP, an entity controlled by the Company’s director George Kallins, of
October Notes in the aggregate principal amount of $250,000 and related warrants
to purchase up to 416,666 shares.  (b)  The Company also
issued October Notes in the aggregate principal amount of $512,250, and related
warrants to purchase up to 512,250 shares, to Deerwood Holdings LLC and Deerwood
Partners LLC, two entities controlled by Mr. Kallins, in exchange for the
cancellation of the Deerwood Notes originally issued on July 5, 2010 and August
20, 2010 (see note 3) in the aggregate principal amount of $500,000 (and accrued
and unpaid interest on those notes) and warrants to purchase an aggregate of up
to 150,000 shares originally issued on August 20, 2010.  The related
guaranties and oral indemnification and security agreement that had been entered
into in connection with the Deerwood Notes were likewise
terminated.   SAIL, of which the Company’s director David Jones
is a managing partner, issued unconditional guaranties to each of the Deerwood
investors, guaranteeing the prompt and complete payment when due of all
principal, interest and other amounts under the October Notes issued to such
investors.  The obligations under each guaranty are independent of the
Company’s obligations under the October Notes and separate actions may be
brought against the guarantor.  In connection with its serving as
guarantor, the Company granted SAIL warrants to purchase up to an aggregate of
341,498 shares of common stock.  The warrants to purchase 100,000
shares of common stock previously granted to SAIL on August 20, 2010 were
canceled.




On
November 12, a tenth accredited investor executed the Purchase
Agreement.  In connection therewith, the Company issued Notes in the
aggregate principal amount of $400,000 and Warrants to purchase up to 666,666
shares of common stock of the Company, to the investor on such
date.   The Company received $352,000 in net proceeds from the
investor.   Monarch acted as non-exclusive placement agent with
respect to the placement of the Note in the aggregate principal amount of
$400,000 and related Warrants, pursuant to the abovementioned engagement
agreement, dated September 30, 2010.  In connection with the November
12, 2010 closing, Monarch received a cash fee of $40,000 and a cash expense
allowance of $8,000 and will receive a Placement Agent Warrant to purchase
133,333 shares of the Company’s common stock at an exercise price of $0.33 per
share.





The
Purchase Agreement provides for the issuance and sale of October Notes, for cash
or in exchange for outstanding convertible notes, in the aggregate principal
amount of up to $3,000,000 plus an amount corresponding to accrued and unpaid
interest on any exchanged notes, and warrants to purchase a number of shares
corresponding to 50% of the number of shares issuable on conversion of the
October Notes.  The agreement provides for multiple closings, but
mandates that no closings may occur after January 31, 2011.  The
Purchase Agreement also provides that the Company and the holders of the October
Notes will enter into a registration rights agreement covering the registration
of the resale of the shares underlying the October Notes and the related
warrants.




The
October Notes mature one year from the date of issuance (subject to earlier
conversion or prepayment), earn interest equal to 9% per year with interest
payable at maturity, and are convertible into shares of common stock of the
Company at a conversion price of $0.30.  The conversion price is
subject to adjustment upon (1) the subdivision or combination of, or stock
dividends paid on, the common stock; (2) the issuance of cash dividends and
distributions on the common stock; (3) the distribution of other capital stock,
indebtedness or other non-cash assets; and (4) the completion of a financing at
a price below the conversion price then in effect.  The October Notes
are furthermore convertible, at the option of the holder, into securities to be
issued in subsequent financings at the lower of the then-applicable conversion
price or price per share payable by purchasers of such
securities.  The October Notes can be declared due and payable upon an
event of default, defined in the October Notes to occur, among other things, if
the Company fails to pay principal and interest when due, in the case of
voluntary or involuntary bankruptcy or if the Company fails to perform any
covenant or agreement as required by the October Note.




The
Company’s obligations under the terms of the October Notes are secured by a
security interest in the tangible and intangible assets of the Company, pursuant
to a Security Agreement, dated as of October 1, 2010, by and between the Company
and John Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.




The
warrants related to the October Notes expire seven years from the date of
issuance and are exercisable for shares of common stock of the Company at an
exercise price of $0.30.  Exercise price and number of shares issuable
upon exercise are subject to adjustment (1) upon the subdivision or combination
of, or stock dividends paid on, the common stock; (2) in case of any
reclassification, capital reorganization or change in capital stock and (3) upon
the completion of a financing at a price below the exercise price then in
effect.Any provision
of the October Notes or related warrants can be amended, waived or modified upon
the written consent of the Company and holders of a majority of the aggregate
principal amount of such notes outstanding.  Any such consent will
affect all October Notes or warrants, as the case may be, and will be binding on
all holders thereof.




ITEM
      9.
              Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure




None.


62


ITEM
9A.           Controls and
Procedures





Disclosure
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
Rule 13a-15, as of September 30, 2010, 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 effective as of September 30,
2010.




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 includes those policies 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 (Principal Executive Officer) and Chief
Financial Officer (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.




Assessment
of Internal Controls Over Financial Reporting




Members
of our management, including George Carpenter our PEO and Paul Buck our PFO,
have evaluated the effectiveness of our internal control over financial
reporting as of September 30, 2010, 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.




The
following significant deficiency (as defined below) was identified, which in
combination with other deficiencies may constitute a material weakness (as
defined below):




·
            We do not have a comprehensive
      and formalized accounting and procedures
  manual.




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.




To the
knowledge of our management, including our PEO and PFO, the aforementioned
significant deficiency has not led to a misstatement of our results of
operations for the year ended September 30, 2010, or statement of financial
position as of September 30, 2010.




63




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 rules of the Securities and
Exchange Commission that permit the Company to provide only management’s report
in this annual report.




Changes
in Internal Control Over Financial Reporting




During
the quarterly period ending September 30, 2010, there were no changes in our
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




ITEM
9B.           Other Information





None.




64


PART
III




ITEM
10.            Directors,
Executive Officers and Corporate Governance.





The
following table sets forth the name, age and position of each of our executive
officers and directors as of December 17, 2010.




Name
                    
                    Age
                    
                    PositionGeorge
      Carpenter
                    
                    52
                    
                    Chairman
      of the Board, Chief Executive Officer and SecretaryPaul
      Buck
                    
                    54
                    
                    Chief
      Financial OfficerDaniel
      Hoffman, M.D.
                    
                    62
                    
                    President,
      Chief Medical OfficerMichael
      Darkoch
                    
                    66
                    
                    Executive
      Vice President and Chief Marketing OfficerJohn
      Pappajohn
                    
                    82
                    
                    DirectorDavid
      B. Jones
                    
                    67
                    
                    DirectorJerome
      Vaccaro, M.D.
                    
                    55
                    
                    DirectorHenry
      T. Harbin, M.D
                    
                    64
                    
                    DirectorGeorge
      Kallins, M.D.
                    
                    50
                    
                    Director




George
Carpenter, Chairman of the Board, Chief Executive Officer,
Secretary




George
Carpenter joined our board of directors as Chairman on April 10,
2009.  Mr. Carpenter has been serving as our Chief Executive Officer
since April 10, 2009 and prior to that date served as our President since
October 1, 2007.  As President, Mr. Carpenter’s primary responsibility
involved developing strategy and commercializing our rEEG
technology.  From 2002 until he joined CNS in October 2007, Mr.
Carpenter was the President & CEO of WorkWell Systems, Inc., a national
physical medicine firm that manages occupational health programs for Fortune 500
employers.  Prior to his position at WorkWell Systems, Mr. Carpenter
founded and served as Chairman and CEO of Core, Inc., a company focused on
integrated disability management and work-force analytics.  He served
in those positions from 1990 until Core was acquired by Assurant, Inc. in
2001.  From 1984 to 1990, Mr. Carpenter was a Vice President of
Operations with Baxter Healthcare, served as a Director of Business Development
and as a strategic partner for Baxter’s alternate site
businesses.  Mr. Carpenter began his career at Inland Steel where he
served as a Senior Systems Consultant in manufacturing process
control.  Mr. Carpenter holds an MBA in Finance from the University of
Chicago and a BA with Distinction in International Policy & Law from
Dartmouth College.  The Board selected Mr. Carpenter to serve as a
director because of his extensive experience as chief executive officer for
several companies and his service in a variety of leadership positions in the
areas of fund raising, business development and building a management
team.  Mr. Carpenter provides critical insight into the areas of
organizational and operational management.




Paul
Buck, Chief Financial Officer




Effective
February 18, 2010, we appointed Paul Buck, 54, to the position of Chief
Financial Officer.  Mr. Buck has been working with the Company as an
independent consultant since December 2008, assisting management with finance
and accounting matters as well as the Company’s filings with the Securities and
Exchange Commission.  Prior to joining the Company, Mr. Buck worked as
an independent consultant since 2004 and has broad experience with a wide
variety of public companies.  His projects have included forensic
accounting, restatements, acquisitions, interim management and system
implementations.  Mr. Buck, a Swiss National, was raised in Southern
Africa and holds a Bachelor of Science degree in Chemistry and a Bachelor of
Commerce degree both from the University of Cape Town, South
Africa.  He started his career with Touche Ross & Co. in Cape Town
and qualified as a Chartered Accountant.  In 1985, Mr. Buck joined the
Los Angeles office of Touche Ross & Co. where he was an audit
manager.  In 1991 he joined the American Red Cross Biomedical Services
as the CFO of the Southern Californian Region.  After five years with
the organization, he returned to Deloitte & Touche as a manager in the
Solutions Consulting Group.  In 1998, Mr. Buck was recruited back to
the American Red Cross Biomedical Services as CFO and became the Director of
Operations for the Southern California Region until 2003.




65




Daniel
Hoffman, Chief Medical Officer and President




Dr.
Hoffman, 62, became our President on April 10, 2009 and our Chief Medical
Officer on January 15, 2008, upon our acquisition of Neuro-Therapy Clinic, Inc.,
which at the time of the acquisition was our largest customer and which was
owned by Dr. Hoffman.  He had served as the Medical Director of
Neuro-Therapy Clinic, Inc. since 1993, and as President of Neuro-Therapy Clinic,
Inc. since he founded it in the 1980’s.  Dr. Hoffman owned the clinic
before it was purchased by CNS Response, Inc.  Neuro-Therapy Clinic,
Inc. is focused on discovering ways to integrate technology into the creation of
better business practices.  Dr. Hoffman is a Neuropsychiatrist with
over 25 years experience treating general psychiatric conditions such as
depression, bipolar disorder and anxiety.  He provides the newest
advances in diagnosing and treating attentional and learning problems in
children and adults.  Dr. Hoffman has authored over 50 professional
articles, textbook chapters, poster presentations and letters to the editors on
various aspects of neuropsychiatry, Quantitative EEG, LORETA, Referenced EEG,
advances in medication management, national position papers and standards, Mild
Traumatic Brain Injury, neurocognitive effects of Silicone Toxicity, sexual
dysfunction and other various topics.  Dr. Hoffman has given over 58
major presentations and seminars, including Grand Rounds at Universities and
Hospitals, workshops and presentations at national society meetings (such as
American Psychiatric Association and American Neuropsychiatric Association),
national CME conferences, insurance companies, national professional
associations, panel member discussant, and presenter of poster
sessions.  He has also lectured internationally as part of a
consortium advancing Quantitative EEG in Psychiatry and done research with the
major national academic institutions on the use of Referenced EEG to help guide
treatment choices.  Dr. Hoffman has a Bachelor of Science in
Psychology from the University of Michigan, an MD from Wayne State University
School of Medicine and conducted his Residency in Psychiatry at the University
of Colorado Health Sciences Center.




Michael
Darkoch, Executive Vice President and Chief Marketing Officer




Michael
Darkoch, 66, became our Executive Vice President and Chief Marketing Officer on
July 6, 2010.  Prior to joining the Company, Mr. Darkoch worked as
Vice President of Network Management for MedImpact Health Systems in San Diego
since 2004, where he managed new business development for self-insured clients
achieving 25% growth per year, and worked in product development releasing two
major products in one year, and Specialty Pharmacy, a value-added product
generating $20 million in sales in its first year [of
commercialization.  At the Company, Mr. Darkoch is responsible for
managing and implementing various business activities associated with the launch
and the commercialization of rEEG.  This includes responsibility for
business development, revenue generation, marketing, network management and
performance and patient management.  He is also responsible for
managing sales and product placement across the various market channels the
Company addresses, including commercial payers, government agencies, employers
and direct to consumer.  Mr. Darkoch’s experience in healthcare spans
over 30 years.  He has significant business development and executive
management experience in the pharmaceutical distribution field. He started his
engineering and management career with Texas Instruments and Mobil Chemical
Company.  He moved into healthcare in 1974 and joined Baxter
International.  He progressed through product development, logistics
and distribution, business development and general manager over several business
units.  He pioneered business initiatives into home infusion, hospital
systems, and alternate site delivery systems.  He was responsible for
client acquisition and renewal on the original Baxter team that developed Mail
Order prescription fulfillment.  This business unit was eventually
spun-off and became Caremark Rx.  Mr. Darkoch managed Caremark Rx
sales and client growth from $100 million to $ 2.1 billion in a five year time
frame.  He left Caremark Rx in the late 1990’s and managed business
development and client management for two disability management companies— CORE,
Inc. and WorkWell Health Systems. Mr. Darkoch holds a Bachelor of Science of
Industrial Engineering degree from Lehigh University and Master of Science in
Business from Southern Methodist University. .




John
Pappajohn, Director




John
Pappajohn joined our board of directors on August 26, 2009.  Since
1969, Mr. Pappajohn has been the President and sole owner of Pappajohn Capital
Resources, a venture capital firm, and President and sole owner of Equity
Dynamics, Inc., a financial consulting firm, both located in Des Moines,
Iowa.  He serves as a director on the boards of the following public
companies:  American CareSource Holdings, Inc., Dallas, TX since 1994;
PharmAthene, Inc., Annapolis, MD, since 2007; ConMed Healthcare Management,
Inc., Hanover, MD, since 2005.  Mr. Pappajohn was chosen to serve as a
director of the Company because of his unparalleled experience serving as a
director of more than 40 companies and the substantial insight he has gained
into the life sciences and healthcare industries by actively investing in the
industries for more than 40 years, and by founding and supporting several public
healthcare companies.




David
B. Jones, Director




David B.
Jones has been a director of CNS California since August 2006, and became a
director of the company upon the completion of our merger with CNS California on
March 7, 2007.  Mr. Jones currently serves as a partner of SAIL
Venture Partners, L.P., a position which he has held since 2003.  SAIL
Venture Partners, L.P. engages in investing primarily in cleantech companies,
and is deemed to be the beneficial owner of approximately 17.3% of the Company’s
common stock as determined for purposes of Rule 13d-3 under the Securities
Exchange Act. Mr. Jones also served as Chairman and Chief Executive Officer of
Dartron, Inc., a computer accessories manufacturer.  From 1985 to
1997, Mr. Jones was a general partner of InterVen Partners, a venture capital
firm with offices in Southern California and Portland, Oregon.  From
1979 to 1985, Mr. Jones was President and Chief Executive Officer of First
Interstate Capital, Inc., the venture capital affiliate of First Interstate
Bancorp.  He has served on several boards of public and private
companies and has acted as Chairman and Chairman of the Audit Committee for two
public companies: Birtcher Medical Systems, Inc from 1992 to 1994 and Triquint
Semiconductor, Inc. from 1993 to 1995.  From 2005 to 2008, he was a
Director of Earthanol, Inc., and from October 2009 to present, he has served as
a director of M2 Renewables, Inc. Mr. Jones is a graduate of Dartmouth College
and holds Masters of Business Administration and law degrees from the University
of Southern California.  Mr. Jones is the longest-serving member on
our board and adds substantial expertise from his venture capital finance
background and his executive experience.  His experience provides the
Company with valuable insight with respect to financing and operational
strategies and corporate governance issues.




66




Jerome
Vaccaro, M.D., Director




Jerome
Vaccaro, M.D., joined the board of directors of CNS California in 2006 and
became a director of the Company upon the completion of our merger with CNS
California on March 7, 2007.  Dr. Vaccaro is President and Chief
Operating Officer of APS Healthcare, Inc. (APS), a privately held specialty
healthcare company, which he joined in June 2007.  From February 2001
until its acquisition by United Health Group in 2005, Dr. Vaccaro served as
President and Chief Executive Officer of PacifiCare Behavioral Health (“PBH”),
and then served as Senior Vice President with United Health Group’s Specialized
Care Services until he joined APS.  Dr. Vaccaro has also served as
Medical Director of PBH (1996-2001), Chief Executive Officer of PacifiCare
Dental and Vision (2002-2004), and Senior Vice President for the PacifiCare
Specialty Health Division (2002-2004).  Dr. Vaccaro has an extensive
background in community mental health and public sector work, including editing
the textbook, “Practicing Psychiatry in the Community,” which is hailed as the
definitive community psychiatry text.  Dr. Vaccaro completed medical
school and a Psychiatry Residency at the Albert Einstein College of Medicine in
New York City.  After his training, Dr. Vaccaro served on the
full-time faculty of the University of Hawaii (1985-1989) and UCLA (1989-1996)
Departments of Psychiatry.  Dr. Vaccaro was chosen to serve on the
Company’s board because of his experience in senior executive positions in a
diverse set of mental healthcare companies, his extensive background in
community mental health and public sector work and his valuable experience in
medical academia.




Henry
T. Harbin, M.D., Director




Henry
Harbin, M.D. joined our board of directors on October 17, 2007.  Since
2004, Dr. Harbin has worked as an independent consultant providing health care
consulting services to a number of private and public
organizations.  Dr. Harbin is a psychiatrist with over 30 years of
experience in the behavioral health field.  He has held a number of
senior positions in both public and private health care
organizations.  He worked for 10 years in the public mental health
system in Maryland serving as director of the state mental health authority for
three of those years.  He has been CEO of two national behavioral
healthcare companies — Greenspring Health Services and Magellan Health
Services.  At the time he was CEO of Magellan, it was the largest
managed behavioral healthcare company managing the mental health and substance
abuse benefits of approximately 70 million Americans including persons who were
insured by private employers, Medicaid and Medicare.  In 2002 and
2003, he served on the President’s New Freedom Commission on Mental
Health.  As a part of the Commission he was chair of the subcommittee
for the Interface between Mental Health and General Medicine.  In
2005, he served as co-chair of the National Business Group on Health’s work
group that produced the Employer’s Guide to Behavioral Health Services in
December 2005.  The Board selected Dr. Harbin to serve as a director
because of his over 30 years of experience in the behavioral health field, which
includes an impressive service record in the area of public sector
health.  His experience provides significant vision to a company in
the mental healthcare industry.




George
J. Kallins, M.D., Director




George
Kallins, M.D. joined our board of directors on July 5, 2010.  Dr.
Kallins has served as President and CEO of ACP Management, his family’s property
management, development and real estate investment firm since 2004; however, he
also continues to practice medicine in his specialty field of Obstetrics and
Gynecology.  He founded and was the CEO and President of Mission
Obstetrics and Gynecology which was a 14 physician strong medical group and was
also the founder and CEO of Medical Management Resources, a medical management
and billing company.  Dr Kallins served as the Medical Director of the
USC Center for Women’s Mood Disorders while on the faculty at the University of
Southern California School of Medicine in 1999 through 2000.  During
this time he also authored a book titled, Five Steps to a PMS Free
Life, which includes issues dealing with mood disorders impacting some
women.  He published this book through The Village Healer Press which
he founded.  Dr. Kallins received his B.Sc majoring in Psychobiology
from the University of Southern California and his medical degree from the Rush
School of Medicine in Chicago, IL.  He returned to the University of
Southern California to do his residency in Obstetrics and
Gynecology.  Dr. Kallins also has an MBA from Pepperdine
University.  The Board selected Dr. Kallins to serve as a director
because of his 20-plus years of experience in primary medicine, specifically in
the field of mood disorders, and his business accomplishments.  His
experience provides the Company insight into the field of primary medical care
and its relationship to the prescribing of psychotropic drugs.  We
believe the prescription of psychotropic drugs is an area of medicine which
could benefit from our rEEG technology.




Board
Composition and Committees




Our board
of directors currently consists of six members:  George Carpenter,
Henry Harbin, David Jones, Jerome Vaccaro, John Pappajohn and George
Kallins.  With the exception of George Kallins, who was appointed to
our board on July 5, 2010, each director was elected at our annual meeting of
shareholders held on April 27, 2010.  Each of our directors will serve
until our next annual meeting and until his successor is duly elected and
qualified.




67




We are
not a “listed company” under SEC rules and are therefore not required to have
separate committees comprised of independent directors.  Our board of
directors has, however, determined that David Jones, Jerome Vaccaro, Henry
Harbin, John Pappajohn and George Kallins are “independent” as that term is
defined in Section 5600 of the Equity Rules of the NASDAQ Stock Market (the
“Nasdaq Listing Rules”).  In addition, our former director Tommy
Thompson was “independent” as that term is defined in Section 5600 of the Nasdaq
Listing Rules.  Our board of directors established an audit committee
and a compensation committee at a board meeting held on March 3, 2010, and each
committee has its own charter.  The primary functions of these two
committees are described below.




Audit Committee.




The
Company has a separately-designated standing Audit Committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act of 1934, as
amended.  The primary functions of the Audit Committee are
to:  assist the board of directors in its oversight responsibilities
regarding (1) the integrity of the Company’s financial statements, (2) the
Company’s compliance with legal and regulatory requirements, (3) the independent
accountant’s qualifications and independence and (4) the Company’s internal and
disclosure controls; prepare the report of the Audit Committee required by the
SEC for inclusion in the Company’s annual proxy statement; retain and terminate
the Company’s independent accountant; approve audit and non-audit services to be
performed by the independent accountant; and perform such other functions as the
board of directors may from time to time assign to the committee.




The Audit
Committee is composed of three members, all of whom are “independent” as such
term is defined in the rules and regulations of the SEC and the Nasdaq Listing
Rules.  Our board has also determined that David Jones qualifies as an
“audit committee financial expert” within the meaning of the rules and
regulations of the SEC and meets the independence requirements of Section
5605(c)(2)(A) of the Nasdaq Listing Rules, and that each of our other committee
members is able to read and understand fundamental financial statements and has
substantial business experience that results in that member’s financial
sophistication.




Compensation
Committee.




The
Company’s executive compensation program is administered by the Compensation
Committee.  The Compensation Committee is composed of three directors,
each of whom qualifies as an outside director within the meaning of Section
162(m) of the Internal Revenue Code of 1986, as amended.  The
committee reports to the full board of directors on all matters within the
committee’s responsibilities.




The
Compensation Committee’s primary functions are to:  discharge the
oversight responsibilities of the board of directors with respect to
compensation of the Company’s executives; if required, prepare the report of the
Compensation Committee pursuant to SEC rules for inclusion in the Company’s
annual proxy statement; and administer designated executive compensation plans
of the Company.  The Chief Executive Officer is not present during
voting or deliberations on his or her compensation.




The
following table below sets forth the membership of each Committee:




Name of Director
              
              Audit Committee
              
              Compensation CommitteeJohn
      Pappajohn
              
              Member
              
              ChairDavid
      B. Jones
              
              Chair
              
              MemberJerome
      Vaccaro
              
              MemberHenry
      T. Harbin
              
              
              
              Member





Dr.
Kallins has not been assigned to any board committee at this time.




We do not
have a nominating and corporate governance committee and the function
customarily delegated to such committee is performed by our full board of
directors.  In addition, we do not have any charter that relates to
the functions traditionally performed by such committee.




68




Stockholder
Recommendations for Director Nominees




A CNS
stockholder may nominate one or more persons for election as a director at an
annual meeting of stockholders if the stockholder complies with the requisite
provisions contained in our Bylaws.  Stockholders who desire the Board
to consider a candidate for nomination as a director at the 2011 annual meeting
must submit advance notice of the nomination to our Board a reasonable time
prior to the mailing date of the proxy statement for the 2011 annual meeting.
The recommendation should be in writing and addressed to our Corporate
Secretary.




A
stockholder’s notice of a proposed nomination for director to be made at an
annual meeting must include the following information:




·
            the
      name and address of the stockholder proposing to make the nomination and
      of the person or persons to be
nominated;




·
            a
      representation that the holder is a stockholder entitled to vote his or
      her shares at the annual meeting and intends to vote his or her shares in
      person or by proxy for the person or persons nominated in the
      notice;




·
            a
      description of all arrangements or understandings between the
      stockholder(s) supporting the nomination and each
  nominee;




·
            any
      other information concerning the proposed nominee(s) that we would be
      required to include in the proxy statement if our Board of Directors made
      the nomination; and




·
            the
      consent of the nominee(s) to serve as director if
  elected.




Code
of Ethical Conduct




Our board
of directors has adopted a Code of Ethical Conduct (the “Code of Conduct”) which
constitutes a “code of ethics” as defined by applicable SEC rules and a “code of
conduct” as defined by Section 5610 of the Nasdaq Listing Rules. We require all
employees, directors and officers, including our principal executive officer,
principal financial officer and principal accounting officer to adhere to the
Code of Conduct in addressing legal and ethical issues encountered in conducting
their work. The Code of Conduct requires that these individuals avoid conflicts
of interest, comply with all laws and other legal requirements, conduct business
in an honest and ethical manner and otherwise act with integrity and in our best
interest. The Code of Conduct contains additional provisions that apply
specifically to our principal financial officer and other financial officers
with respect to full and accurate reporting. The Code of Conduct is available on
our website at www.cnsresponse.com.





Section
16(a) Beneficial Ownership Reporting Compliance




Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our directors
and executive officers and the holders of more than 10% of our common stock to
file with the Securities and Exchange Commission initial reports of ownership
and reports of changes in ownership of our equity securities. Based solely on
our review of the copies of the forms received by us and written representations
from certain reporting persons that they have complied with the relevant filing
requirements, we believe that, during the year ended September 30, 2010, all of
our executive officers, directors and the holders of 10% or more of our common
stock complied with all Section 16(a) filing requirements, except for the
following: (i) George Carpenter (late Form 4 reporting one transaction) and (ii)
Michael Darkoch (late Form 4 reporting one transaction).




ITEM
11.           Executive
Compensation





Overview
of Compensation Practices




The
Company’s executive compensation program is administered by the above mentioned
Compensation Committee.  See Item 10 - Directors, Executive Officers
and Corporate Governance - Board Composition and Committees - Compensation
Committee




Compensation
Philosophy




Generally,
we compensate our executive officers with a compensation package that is
designed to drive company performance to maximize shareholder value while
meeting our needs and the needs of our executives.  The following are
objectives we consider:




69




·
            Alignment
      - to align the interests of executives and shareholders through
      equity-based compensation awards;


·
            Retention
      - to attract, retain and motivate highly qualified, high performing
      executives to lead our growth and success;
and


·
            Performance
      - to provide, when appropriate, compensation that is dependent upon the
      executive’s achievements and the company’s
  performance.





In order
to achieve the above objectives, our executive compensation philosophy is guided
by the following principles:




·
            Rewards
      under incentive plans are based upon our short-term and longer-term
      financial results and increasing shareholder
  value;


·
            Executive
      pay is set at sufficiently competitive levels to attract, retain and
      motivate highly talented individuals who are necessary for us to strive to
      achieve our goals, objectives and overall financial
    success;


·
            Compensation
      of an executive is based on such individual’s role, responsibilities,
      performance and experience; and


·
            Annual
      performance of our company and the executive are taken into account in
      determining annual bonuses with the goal of fostering a
      pay-for-performance culture.





Compensation
Elements




We
compensate our executives through a variety of components, which may include a
base salary, annual performance based incentive bonuses, equity incentives, and
benefits and perquisites, in order to provide our executives with a competitive
overall compensation package.  The mix and value of these components
are impacted by a variety of factors, such as responsibility level, individual
negotiations and performance and market practice.  The purpose and key
characteristics for each component are described below.




Base
Salary




Base
salary provides executives with a steady income stream and is based upon the
executive’s level of responsibility, experience, individual performance and
contributions to our overall success, as well as negotiations between the
company and such executive officer.  Competitive base salaries, in
conjunction with other pay components, enable us to attract and retain talented
executives.  The Board typically sets base salaries for our executives
at levels that it deems to be competitive, with input from our Chief Executive
Officer




Annual
Incentive Bonuses




Annual
incentive bonuses are a variable performance-based component of
compensation.  The primary objective of an annual incentive bonus is
to reward executives for achieving corporate and individual goals and to align a
portion of total pay opportunities for executives to the attainment of our
company’s performance goals.  Annual incentive awards, when provided,
act as a means to recognize the contribution of our executive officers to our
overall financial, operational and strategic success.




Equity
Incentives




Equity
incentives are intended to align executive and shareholder interests by linking
a portion of executive pay to long-term shareholder value creation and financial
success over a multi-year period.  Equity incentives may also be
provided to our executives to attract and enhance the retention of executives
and to facilitate stock ownership by our executives.  The Board
considers individual and company performance when determining long-term
incentive opportunities.




Health
& Welfare Benefits




The
executive officers participate in health and welfare, and paid time-off benefits
which we believe are competitive in the marketplace.  Health and
welfare and paid time-off benefits help ensure that we have a productive and
focused workforce.




Severance
and Change of Control Arrangements




We do not
have a formal plan for severance or separation pay for our employees, but we
typically include a severance provision in the employment agreements of our
executive officers that have written employment agreements with
us.  Generally, such provisions are triggered in the event of
involuntary termination of the executive without cause or in the event of a
change in control.  Please see the description of our employment
agreements with each of George Carpenter, Daniel Hoffman and Paul Buck below for
further information.




70




Other
Benefits




In order
to attract and retain highly qualified executives, we may provide our executive
officers with automobile allowances, consistent with current market
practices.




Accounting
and Tax Considerations




We
consider the accounting implications of all aspects of our executive
compensation strategy and, so long as doing so does not conflict with our
general performance objectives described above, we strive to achieve the most
favorable accounting (and tax) treatment possible to the company and our
executive officers.




Process
for Setting Executive Compensation; Factors Considered




When
making pay determinations for named executive officers, the Board considers a
variety of factors including, among others:  (1) actual company
performance as compared to pre-established goals, (2) individual executive
performance and expected contribution to our future success, (3) changes in
economic conditions and the external marketplace, (4) prior years’ bonuses and
long-term incentive awards, and (5) in the case of executive officers, other
than Chief Executive Officer, the recommendation of our Chief Executive Officer,
and in the case of our Chief Executive Officer, his negotiations with our
Board.  No specific weighing is assigned to these factors nor are
particular targets set for any particular factor.  Ultimately, the
Board uses its judgment and discretion when determining how much to pay our
executive officers and sets the pay for such executives by element (including
cash versus non-cash compensation) and in the aggregate, at levels that it
believes are competitive and necessary to attract and retain talented executives
capable of achieving the Company’s long-term objectives.




Summary
Compensation Table




The
following table provides disclosure concerning all compensation paid for
services to us in all capacities for our fiscal years ending September 30, 2010
and 2009 (i) as to each person serving as our principal executive officer
(“PEO”) or acting in a similar capacity during our fiscal year ended September
30, 2010, and (ii) as to our two most highly compensated executive officers
other than our PEO who were serving as executive officers on September 30, 2010,
whose total compensation exceeded $100,000; and (iii) up to two additional
individuals for whom disclosure would have been provided under (ii) but for the
fact that they were not serving as executive officers on September 30, 2010. In
this Item 11, we refer to the people listed in the table below as our “named
executive officers”.




Name and
                                                      Principal Position
                                                    
                                                    Fiscal Year
                                                      Ended
                                                      September
                                                      30,
                                                    
                                                    Salary
                                                      ($)
                                                    
                                                    
                                                    Bonus
                                                      ($)
                                                    
                                                    
                                                    Option
                                                      Awards
                                                      ($)
                                                    
                                                    
                                                    All Other
                                                      Compensation
                                                      ($)
                                                    
                                                    
                                                    Total
                                                      ($)George
      Carpenter (Chief Executive
                                                      Officer,
      Principal Executive Officer,
                                                    
                                                    2010
                                                    
                                                    
                                                    213,700
                                                    (9)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    2,167,300
                                                    (1)(5)
                                                    
                                                    
                                                    20,800
                                                    (3)
                                                    
                                                    
                                                    2,401,800Director)
                                                    
                                                    2009
                                                    
                                                    
                                                    180,000
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    20,500
                                                    (3)
                                                    
                                                    
                                                    200,500Daniel
      Hoffman (President, Chief
                                                    
                                                    2010
                                                    
                                                    
                                                    150,000
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    270,900
                                                    (1)(6)
                                                    
                                                    
                                                    26,000
                                                    (4)
                                                    
                                                    
                                                    446,900Medical
      Officer)
                                                    
                                                    2009
                                                    
                                                    
                                                    150,000
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    33,400
                                                    (4)
                                                    
                                                    
                                                    183,400Paul
      Buck (Chief Financial Officer)
                                                    
                                                    2010
                                                    
                                                    
                                                    127,000
                                                    (10)
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    243,800
                                                    (1)(7)
                                                    
                                                    
                                                    94,900
                                                    (11)
                                                    
                                                    
                                                    465,7002009
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    178,500
                                                    (11)
                                                    
                                                    
                                                    178,500Michael
      Darkoch (Executive Vice
                                                      President
      and Chief Marketing
                                                    
                                                    2010
                                                    
                                                    
                                                    52,000
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    180,000
                                                    (2)(8)
                                                    
                                                    
                                                    6,100
                                                    (3)
                                                    
                                                    
                                                    363,400Officer)
                                                    
                                                    2009
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -





(1)           These
options were granted on March 3, 2010. The amount reflected in the table
represents the aggregate grant-date fair value of options computed in accordance
with FASB ASC Topic 718 (formerly FAS 123R).  The Company estimates
the fair value of each option on the grant date using the Black-Scholes model
with the following assumptions: dividend yield 0%; risk-free interest rate
3.62%; expected volatility 215% and expected life of the option 5
years.


71





(2)           These
options were granted on July 6, 2010. The amount reflected in the table
represents the aggregate grant-date fair value of options computed in accordance
with FASB ASC Topic 718 (formerly FAS 123R).  The Company estimates
the fair value of each option on the grant date using the Black-Scholes model
with the following assumptions: dividend yield 0%; risk-free interest rate
1.81%; expected volatility 516% and expected life of the option 5
years.





(3)          
Relates to healthcare insurance premiums paid on behalf of executive officers by
the Company.




(4)           Relates
to healthcare insurance premiums for the year ended September 30, 2010 of
$22,700 and automobile expenses of $3,400 paid on behalf of Dr. Hoffman by the
Company. For the year ended September 30, 2009, healthcare insurance premiums
were $28,300 and automobile expenses were $4,400.





(5)           The
aggregate number of option awards outstanding for Mr. Carpenter at September 30,
2010 was 4,000,000 from the March 3, 2010 grant and 968,875 from the October 1,
2007 grant.





(6)           The
aggregate number of option awards outstanding for Dr. Hoffman at September 30,
2010 was 500,000 shares from the March 3, 2010 grant and 814,062 and 119,013
shares from grants on August 8, 2007 and August 11, 2006
respectively.





(7)           The
aggregate number of option awards outstanding for Mr. Buck at September 30, 2010
was 450,000 from the March 3, 2010.





(8)           The
aggregate number of option awards outstanding for Mr. Darkoch at September 30,
2010 was 450,000 from the July 6, 2010 grant.





(9)           $33,700
of Mr. Carpenter’s salary is accrued but payment has been deferred.





(10)         $26,000
of Mr. Buck’s salary is accrued but payment has been deferred.  All
other compensation for the year ended September 30, 2010, is made up of 1)
$8,500 healthcare insurance premiums paid on his behalf by the Company; 2)
Consulting fees of $86,400 paid to Mr. Buck prior to joining the Company as
Chief Financial Offer.  For the fiscal year ended 2009 Mr. Buck was
paid $178,500 for his consulting services.





(11)         For
the year ended September 30, 2010, relates to consulting fees of $86,400 and
healthcare insurance premiums of $8,500 paid on behalf of Mr. Buck by the
Company.  For the year ended September 30, 2009, relates to consulting
fees of $178,500.  Prior to his employment by the Company, Mr. Buck
had been working with the Company as an independent consultant since December
2008, assisting management with finance and accounting matters as well as the
Company’s filings with the Securities and Exchange Commission.





Grant
of Plan Based Awards in the Fiscal Year Ending September 30, 2010




Option
grants to executive officers occurred during fiscal year ending September 30,
2010 under our 2006 Stock Incentive Plan as amended and restated, which is the
only plan pursuant to which awards can be granted.  The options to
acquire shares of common stock granted to management were as
follows:





(1)
            On
      March 3, 2010, options were granted to Mr. Carpenter in the amount of
      4,000,000 shares,  Dr. Hoffman in the amount of 500,000 shares,
      and Mr. Buck in the amount of 450,000
shares.





(2)
            On
      July 6, 2010, options were granted to Mr. Darkoch in the amount of 450,000
      shares.




Narrative
Disclosure to Summary Compensation Table and Grants of Plan-Based Awards
Table




Since we
had limited cash and cash equivalent resources as of September 30, 2010, we
elected to preserve our cash and did not pay any bonuses to our executive
officers during our fiscal year ended September 30, 2010.




Please
refer to the footnotes to the Summary Compensation Table for a description of
the components of All Other Compensation received by the named executive
officers.




72


The
following is a summary of each employment agreement that we have entered into
with respect to our named executive officers, which summary includes, where
applicable, a description of all payments the company is required to make to
such named executive officers at, following or in connection with the
resignation, retirement or other termination of such named executive officers,
or a change in control of our company or a change in the responsibilities of
such named executive officers following a change in control.




Employment
Agreements




George
Carpenter




On
October 1, 2007, after our 2007 fiscal year end, we entered into an employment
agreement with George Carpenter pursuant to which Mr. Carpenter served as our
President.  During the period of his employment, Mr. Carpenter will
receive a base salary of no less than $180,000 per annum, which is subject to
upward adjustment at the discretion of the Chief Executive Officer or our Board
of Directors.  On March 3, 2010, the Board of Directors increased the
annual base salary of Mr. Carpenter to $270,000, with the increase in salary
having retroactive effect to January 1, 2010.  In addition, pursuant
to the terms of his initial employment agreement, on October 1, 2007, Mr.
Carpenter was granted an option to purchase 968,875 shares of our common stock
at an exercise price of $0.89 per share pursuant to our 2006 Stock Incentive
Plan.   In the event of a change of control transaction, a
portion of Mr. Carpenter’s unvested options equal to the number of unvested
options at the date of the corporate transaction multiplied by the ratio of the
time elapsed between October 1, 2008 and the date of corporate transaction over
the vesting period (48 months) will automatically accelerate, and become fully
vested.  Mr. Carpenter will be entitled to four weeks vacation per
annum, health and dental insurance coverage for himself and his dependents, and
other fringe benefits that we may offer our employees from time to
time.




Mr.
Carpenter’s employment is on an “at-will” basis, and Mr. Carpenter may terminate
his employment with us for any reason or for no reason.  Similarly, we
may terminate Mr. Carpenter’s employment with or without cause.  If we
terminate Mr. Carpenter’s employment without cause or Mr. Carpenter
involuntarily terminates his employment with us (an involuntary termination
includes changes, without Mr. Carpenter’s consent or pursuant to a corporate
transaction, in Mr. Carpenter’s title or responsibilities so that he is no
longer the President of the company), Mr. Carpenter shall be eligible to receive
as severance his salary and benefits for a period equal to six months payable in
one lump sum upon termination.  If Mr. Carpenter is terminated by us
for cause, or if Mr. Carpenter voluntarily terminates his employment, he will
not be entitled to any severance.




As of
April 10, 2009, Mr. Carpenter was named Chief Executive Officer and a Director
of the company and Daniel Hoffman became our President.




Daniel
Hoffman




On
January 11, 2008, we entered into an employment agreement with Daniel Hoffman
pursuant to which Dr. Hoffman began serving as our Chief Medical Officer
effective January 15, 2008.  During the period of his employment, Dr.
Hoffman will receive a base salary of $150,000 per annum, which is subject to
upward adjustment.  Dr. Hoffman will also have the opportunity to
receive bonus compensation, if and when approved by our Board of
Directors.  Dr. Hoffman’s employment is on an “at-will” basis, and Dr.
Hoffman may terminate his employment with us for any reason or for no
reason.  Similarly, we may terminate Dr. Hoffman’s employment with or
without cause.  If we terminate Dr. Hoffman’s employment without cause
or Dr. Hoffman involuntarily terminates his employment with us (an involuntary
termination includes changes, without Dr. Hoffman’s consent or pursuant to a
corporate transaction, in Dr. Hoffman’s title or responsibilities so that he is
no longer the Chief Medical Officer of the company), Dr. Hoffman will be
eligible to receive as severance his salary and benefits for a period equal to
six months payable in one lump sum upon termination.  If Dr. Hoffman
is terminated by us for cause, or if Dr. Hoffman voluntarily terminates his
employment, he will not be entitled to any severance.  Dr. Hoffman
will be entitled to four weeks vacation per annum, health and dental insurance
coverage for himself and his dependents, and other fringe benefits that we may
offer our employees from time to time.




In
addition to being the Chief Medical Officer, Dr. Hoffman was named President of
the Company on April 10, 2009.




Paul
Buck




On
February 18, 2010, we entered into an employment agreement with Paul Buck
pursuant to which Mr. Buck began serving as our Chief Financial Officer on an
“at will” basis and will be paid a salary of no less than $208,000 per annum,
which is subject to upward adjustment at the discretion of the Chief Executive
Officer or the Board of Directors of the Company.  Pursuant to his
employment agreement, Mr. Buck also received an option to purchase 450,000
shares of the Company’s common stock on March 3, 2010, which options vest in 48
equal installments commencing on March 3, 2010.  Mr. Buck will be
entitled to four weeks vacation per annum, health and dental insurance coverage
for himself and his dependents, and other fringe benefits that the Company may
offer its employees from time to time.  As Mr. Buck’s employment is on
an “at-will” basis, he may terminate his employment with the Company for any
reason or for no reason.  Similarly, the Company may terminate Mr.
Buck’s employment with or without cause.  If the Company terminates
Mr. Buck’s employment without cause or Mr. Buck involuntarily terminates his
employment with the Company, Mr. Buck shall be eligible to receive as severance
his salary and benefits for a period equal to six months payable in one lump sum
upon termination.  If Mr. Buck is terminated by the Company for cause,
or if Mr. Buck voluntarily terminates his employment, he will not be entitled to
any severance.




73




Michael
Darkoch




On July
6, 2010, we entered into an employment agreement with Michael Darkoch pursuant
to which Mr. Darkoch began serving as our Executive Vice President and Chief
Marketing Officer on an “at will” basis and will be paid a salary of no less
than $208,000 per annum, which is subject to upward adjustment at the discretion
of the Chief Executive Officer or the Board of Directors of the Company. 
Pursuant to his employment agreement, Mr. Darkoch also received an option to
purchase 450,000 shares of the company’s common stock on July 6, 2010, which
options vest in 48 equal installments commencing on July 6, 2010.  Mr.
Darkoch will be entitled to four weeks vacation per annum, health and dental
insurance coverage for himself and his dependents, and other fringe benefits
that the Company may offer its employees from time to time. As Mr. Darkoch’s
employment is on an “at-will” basis, he may terminate his employment with the
Company for any reason or for no reason. Similarly, the Company may terminate
Mr. Darkoch’s employment with or without cause. If the Company terminates Mr.
Darkoch’s employment after January 2, 2011, without cause or Mr. Darkoch
involuntarily terminates his employment after January 2, 2011, with the Company,
Mr. Darkoch shall be eligible to receive as severance his salary and benefits
for a period equal to six months payable in one lump sum upon termination. If
Mr. Darkoch is terminated by the Company for cause, or if Mr. Darkoch
voluntarily terminates his employment, he will not be entitled to any
severance.




The
Company has no other employment agreements with its executive
officers.




2006
Stock Incentive Plan




On August
3, 2006, CNS California adopted the CNS California 2006 Stock Incentive Plan
(the “2006 Plan”).  On March 7, 2007, in connection with the closing
of the merger transaction with CNS California, we assumed the CNS California
stock option plan and all of the options granted under the plan at the same
price and terms.  Subsequently, we amended the 2006 Plan on March 3,
2010 to increase the number of shares of common stock reserved for issuance
under the 2006 Plan from 10 million to 20 million shares and increased the limit
on shares underlying awards granted within a calendar year to any eligible
employee or director from 3 million to 4 million shares of common
stock.  The amendment was approved by our shareholders at the annual
meeting held on April 27, 2010.  The following is a summary of the
2006 Plan, as amended, which we use to provide equity compensation to employees,
directors and consultants to the company.




The 2006
Plan provides for the issuance of awards in the form of restricted shares, stock
options (which may constitute incentive stock options (ISO) or nonstatutory
stock options (NSO)), stock appreciation rights and stock unit grants and is
administered by the board of directors.  As of September 30, 2010,
2,124,740 options were exercised and there were 15,670,973 options and 183,937
restricted shares outstanding under the 2006 Plan and 2,020,350 shares available
for issuance of awards.  The option price for each share of stock
subject to an option shall be (i) no less than the fair market value of a share
of stock on the date the option is granted, if the option is an ISO, or (ii) no
less than 85% of the fair market value of the stock on the date the option is
granted, if the option is a NSO; provided, however, if the option is an ISO
granted to an eligible employee who is a 10% shareholder, the option price for
each share of stock subject to such ISO shall be no less than 110% of the fair
market value of a share of stock on the date such ISO is
granted.  Stock options have a maximum term of ten years from the date
of grant, except for ISOs granted to an eligible employee who is a 10%
shareholder, in which case the maximum term is five years from the date of
grant.  ISOs may be granted only to eligible employees.




For a
description of the material terms of the stock options granted to our named
executive officers during the fiscal years ended September 30, 2010 and
September 30, 2009, please refer to the footnotes to the table under “ -
Outstanding Equity Awards at Fiscal Year-End 2010.”




Outstanding
Equity Awards at Fiscal Year-End 2010




The
following table presents information regarding outstanding options held by our
named executive officers as of the end of our fiscal year ended September 30,
2010.


74





Name
                        
                        Number of Securities Underlying
                          Unexercised Options (#)
                        
                        
                        Option Exercise
                          Price ($)
                        
                        Option Expiration
                          DateExercisable
                        
                        
                        UnexercisableGeorge
      Carpenter (1)
                        
                        
                        583,338
                        
                        
                        
                        3,416,662
                        
                        
                        
                        0.55
                        
                        March
      2, 2020726,629
                        
                        
                        
                        242,246
                        
                        
                        
                        0.89
                        
                        October
      1, 2017Daniel
      Hoffman (2)
                        
                        
                        72,919
                        
                        
                        
                        427,081
                        
                        
                        
                        0.55
                        
                        March
      2, 2020712,316
                        
                        
                        
                        101,746
                        
                        
                        
                        1.09
                        
                        August
      8, 2017119,013
                        
                        
                        
                        0
                        
                        
                        
                        0.12
                        
                        August
      11, 2016Paul
      Buck(3)
                        
                        
                        65,625
                        
                        
                        
                        384,375
                        
                        
                        
                        0.55
                        
                        March
      2, 2020Michael
      Darkoch(4)
                        
                        
                        28,125
                        
                        
                        
                        421,875
                        
                        
                        
                        0.44
                        
                        July
      6,
2020





(1)   On
March 3, 2010, Mr. Carpenter was granted options to purchase 4,000,000 shares of
common stock.  The options are exercisable at $0.55 per share and vest
equally over 48 months starting on March 3, 2010.





On
October 1, 2007 Mr. Carpenter was granted options to purchase 968,875 shares of
common stock.  The options are exercisable at an exercise price of
$0.89 and vest as follows: 121,109 shares vested immediately with the remaining
847,766 shares vesting equally over 42 months commencing April 30,
2008.





(2)   On
March 3, 2010, Dr Hoffman was granted options to purchase 500,000 shares of
common stock.  The options are exercisable at $0.55 per share and vest
equally over 48 months starting on March 3, 2010.





On August
8, 2007, Dr. Hoffman was granted options to purchase 814,062 shares of our
common stock.  The options are exercisable at $1.09 per share and vest
as follows: options to purchase 203,516 shares vested on March 8, 2008;
options to purchase 593,600 shares vest in equal monthly installments of 16,960
shares over 35 months commencing on April 30, 2008; the remaining options to
purchase 16,946 shares vest on March 31, 2011.





On August
11, 2006, Dr. Hoffman was granted an option to purchase 119,013 shares of common
stock at an exercise price of $0.12 per share, which is now fully
exercisable.





(3)   On
March 3, 2010, Mr. Buck was granted options to purchase 450,000 shares of common
stock.  The options are exercisable at $0.55 per share and vest
equally over 48 months starting on March 3, 2010.




(4)   On
July 6, 2010, Mr. Darkoch was granted options to purchase 450,000 shares of
common stock.  The options are exercisable at $0.40 per share and vest
equally over 48 months starting on July 6, 2010.





Director
Compensation




During
our fiscal year ended September 30, 2010, each of our non-employee directors
received as compensation for their services on our board options to purchase
250,000 shares of common stock.  The options were granted on March 3,
2010 to all non-employee directors except for Dr. Kallins, whose options were
granted on July 5, 2010.  The options granted on March 3, 2010 were
subject to approval by our stockholders at our 2010 annual meeting of amendments
to our 2006 Stock Incentive Plan, which approval was obtained on April 27,
2010.  The options granted on March 3, 2010 and July 5, 2010 vest in
equal monthly installments over a 36-month period beginning on the date of
grant.  The options granted on March 3, 2010 have an exercise price of
$0.55 per share and the options granted on July 5, 2010 have an exercise price
of $0.40 per share.  Apart from these options, non-employee directors
did not receive any cash or other compensation for their service on our board of
directors or committees thereof during the fiscal year ended September 30,
2010.  We do not pay management directors for board service in
addition to their regular employee compensation.  The full board of
directors has the primary responsibility for reviewing and considering any
revisions to director compensation.  As described below, Dr. Harbin
received compensation for consulting services he provided to the company during
our fiscal year ending September 30, 2010 and Mr. Thompson received compensation
for his advisory services.




Non-Employee
Director Compensation


Name
                    
                    Option
                      Awards ($)
                    
                    
                    All Other
                      Compensation ($)
                    
                    
                    Total ($)Jerome
      Vaccaro M.D. (3)
                    
                    
                    135,500
                    (1)
                    
                    
                    -
                    
                    
                    
                    135,500Henry
      Harbin M.D. (4)
                    
                    
                    342,200
                    (1)
                    
                    
                    45,000
                    
                    
                    
                    387,200John
      Pappajohn (5)
                    
                    
                    135,500
                    (1)
                    
                    
                    -
                    
                    
                    
                    135,500David
      Jones (6)
                    
                    
                    135,500
                    (1)
                    
                    
                    -
                    
                    
                    
                    135,500Tommy
      Thompson (7)
                    
                    
                    81,300
                    (1)
                    
                    
                    -
                    
                    
                    
                    81,300George
      Kallins M.D.(8)
                    
                    
                    100,000
                    (2)
                    
                    
                    -
                    
                    
                    
                    100,000




75





(1)
            These
      options were granted on March 3, 2010.  The amount reflected in
      the table represents the aggregate grant-date fair value of options
      computed in accordance with FASB ASC Topic 718 (formerly FAS
      123R).  The Company estimates the fair value of each option on
      the grant date using the Black-Scholes model with the following
      assumptions:  dividend yield 0%; risk-free interest rate 3.62%;
      expected volatility 215% and expected life of the option 5
      years.




(2)
            These
      options were granted on July 5, 2010.  The amount reflected in
      the table represents the aggregate grant-date fair value of options
      computed in accordance with FASB ASC Topic 718 (formerly FAS
      123R).  The Company estimates the fair value of each option on
      the grant date using the Black-Scholes model with the following
      assumptions:  dividend yield 0%; risk-free interest rate 1.81%;
      expected volatility 536% and expected life of the option 5
      years.




(3)
            On
      March 3, 2010, Dr. Vaccaro was granted 250,000 options having an exercise
      price of $0.55 for his services as a director.  The options vest
      equally over 36 months starting on the date of grant.  The
      aggregate number of option awards outstanding for Dr. Vaccaro at September
      30, 2010 was 270,000.




(4)
            On
      March 3, 2010 Dr Harbin was granted 250,000 options for his services as a
      director and 400,000 options for consulting services pursuant to his March
      26, 2010 Consulting Agreement described below.  These options
      have an exercise price of $0.55 and vest equally over 36 months starting
      on the date of grant.  All other compensation is comprised of
      the cash payment of $24,000 paid in January 2010 for Dr. Harbin’s March
      17, 2009 Consulting Agreement described below, plus $21,000 which have
      been accrued through September 30, 2010 on Dr. Harbin’s March 26, 2010
      Consulting Agreement.  To date, no cash payment has been made on
      the March 26, 2010 agreement.




On March
17, 2009, we entered into a consulting agreement with Dr. Harbin (the “March 17,
2009 Consulting Agreement”), which expired on December 31, 2009 pursuant to
which Dr. Harbin was to be paid an aggregate of $24,000 as compensation for his
consulting services.  Dr. Harbin was paid the $24,000 due to him in
January 2010.  In addition, as further compensation, we granted Dr.
Harbin options to purchase 56,000 shares of our common stock at an exercise
price of $0.40 per share, with the options vesting in equal monthly installments
over a twelve month period commencing on January 1, 2009.  The options
expire on March 17, 2019.




On March
26, 2010, we entered into a consulting agreement with Dr. Harbin (the “March 26,
2010 Consulting Agreement”), pursuant to which Dr. Harbin is to be paid an
aggregate of $36,000 as compensation for his consulting services.  As
of September 30, 2010 we have an accrued liability of $21,000 for the nine
months of the contract term to that date.  Dr. Harbin has not been
paid anything yet on this contact.  The agreement expires on December
31, 2010, but is renewable for two one year terms on January 1, 2011 and
2012.  In addition, as further compensation, we granted Dr. Harbin
options to purchase 400,000 shares of our common stock at an exercise price of
$0.55 per share, with the options vesting in 36 equal monthly installments
commencing on March 3, 2010.  The options expire on March 2,
2020.




The
aggregate number of option awards outstanding for Dr. Harbin at September 30,
2010 was 806,000.




(5)
            On
      March 3, 2010, Mr. Pappajohn was granted 250,000 options having an
      exercise price of $0.55 for his services as a director.  The
      options vest equally over 36 months starting on the date of
      grant.  The aggregate number of option awards outstanding for
      Mr. Pappajohn at September 30, 2010 was
250,000.




(6)
            On
      March 3, 2010, Mr. Jones was granted 250,000 options having an exercise
      price of $0.55 for his services as a director.  The options vest
      equally over 36 months starting on the date of grant.  The
      aggregate number of option awards outstanding for Mr. Jones at September
      30, 2010 was 250,500.  Mr. Jones has assigned his options to
      SAIL Venture Partners, L.P.




(7)
            On
      March 3, 2010, Mr. Thompson was granted 250,000 options having an exercise
      price of $0.55 for his services as a director.  Mr. Thompson
      resigned from the Board effective March 12, 2010 thereby forfeiting his
      options with no options vested.  On March 3, 2010 Mr. Thompson
      was also granted 150,000 options for his services as an advisor to the
      Company.  These options have an exercise price of $0.55 and vest
      equally over 36 months starting on the date of grant.  The
      aggregate number of option awards outstanding for Mr. Thompson at
      September 30, 2010 was 150,000.




(8)
            On
      July 5, 2010, Dr. Kallins was granted 250,000 options having an exercise
      price of $0.40 for his services as a director.  The options vest
      equally over 36 months starting on the date of grant.  The
      aggregate number of option awards outstanding for Dr. Kallins at September
      30, 2010 was 250,000.




76




ITEM
12.           Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters





The
following table presents information regarding the beneficial ownership of our
common stock as of December 15, 2010 by each of our named executive officers,
each of our directors, all of our directors and executive officers as a group,
and each stockholder known by us to be the beneficial owner of more than 5% of
our common stock.





Beneficial
ownership is determined in accordance with the rules of the SEC and generally
includes voting or investment power with respect to securities. Unless otherwise
indicated below, to our knowledge, the persons and entities named in the table
have sole voting and sole investment power with respect to all shares
beneficially owned, subject to community property laws where applicable. Shares
of our common stock subject to options or warrants from the Company that are
currently exercisable or exercisable within 60 days of December 15, 2010 are
deemed to be outstanding and to be beneficially owned by the person holding such
options or warrants for the purpose of computing the percentage ownership of
that person but are not treated as outstanding for the purpose of computing the
percentage ownership of any other person.





The
information presented in this table is based on 56,023,921 shares of our common
stock outstanding on December 15, 2010.





Unless
otherwise indicated, the address of each of the named executive officers,
directors and 5% or more stockholders named below is c/o CNS Response, Inc., 85
Enterprise, Suite 410, Aliso Viejo, CA 92656.





Number of SharesBeneficially OwnedName of Beneficial Owner
                              
                              Number
                              
                              
                              Percentage of Shares OutstandingNamed Executive Officers and
      Directors:George
      Carpenter
                                Chief
      Executive Officer and Chairman of the Board (1)
                              
                              
                              2,347,377
                              
                              
                              
                              4.0
                              %Paul
      Buck
                                Chief
      Financial Officer (2)
                              
                              
                              382,500
                              
                              
                              
                              *Daniel
      Hoffman
                                President
      and Chief Medical Officer (3)
                              
                              
                              1,134,699
                              
                              
                              
                              2.0
                              %Michael
      Darkoch
                                Executive
      VP and Chief Marketing Officer (4)
                              
                              
                              75,000
                              
                              
                              
                              *David
      B. Jones
                                Director
      (5)
                              
                              
                              10,399,021
                              
                              
                              
                              17.3
                              %Dr.
      Jerome Vaccaro
                                Director
      (6)
                              
                              
                              103,344
                              
                              
                              
                              *Dr.
      Henry Harbin
                                Director
      (7)
                              
                              
                              383,514
                              
                              
                              
                              *John
      Pappajohn
                                Director
      (8)
                              
                              
                              15,698,383
                              
                              
                              
                              24.8
                              %George
      Kallins
                                Director(9)
                              
                              
                              3,628,109
                              
                              
                              
                              6.1
                              %Executive
      Officers and Directors as a group (9 persons) (10)
                              
                              
                              34,151,947
                              
                              
                              
                              45.8
                              %5%
      Stockholders:SAIL
      Venture Partners LP (5)
                              
                              
                              10,399,021
                              
                              
                              
                              17.3
                              %Leonard
      Brandt (11)
                              
                              
                              11,081,982
                              
                              
                              
                              19.0
                              %




*
Less than 1%




(1)
            Consists
      of (a) 360,000 shares of common stock (b) 180,000 shares of common stock
      issuable upon the exercise of vested and exercisable warrants to purchase
      common stock and (c) 1,807,377 shares of common stock issuable upon the
      exercise of vested and exercisable
options.





(2)
            Consists
      of (a) 180,000 shares of common stock (b) 90,000 shares issuable upon
      exercise of warrants to purchase common stock and (c) 112,500 shares of
      common stock issuable upon the exercise of vested and exercisable
      options.





(3)
            Consists
      of (a) 98,544 shares of common stock (b) 12,501 shares of common stock
      issuable upon the exercise of vested and exercisable warrants to purchase
      common stock and (c) 1,024,154 shares of common stock issuable upon the
      exercise of vested and exercisable
options.


77





(4)
            Consists
      of 75,000 shares of common stock issuable upon the exercise of vested and
      exercisable options.





(5)
            Consists
      of (a) 6,471,067 shares of common stock held by SAIL Venture Partners,
      L.P., (b) 861,458 shares of common stock issuable upon the conversion of
      convertible notes held by SAIL Venture Partners, L.P., (c) 2,983,152
      shares of Common Stock issuable upon the exercise of vested and
      exercisable warrants held by SAIL Venture Partners, L.P., and (d) 83,344
      shares of common stock issuable upon the exercise of vested and
      exercisable options held by David Jones and assigned to Sail Venture
      Partners, L.P.  The unanimous vote of the managing members of
      SAIL Venture Partners, LLC (who are David B. Jones, Walter Schindler, Alan
      Sellers, Henry Habicht and Michael Hammons), is required to vote and make
      investment decisions over the shares held by SAIL Venture Partners,
      L.P.  The address of SAIL Venture Partners, L.P. is 3161
      Michelson, Suite 750, Irvine, CA
92612.





(6)
            Consists
      of 103,344 shares of common stock issuable upon the exercise of vested and
      exercisable options.





(7)
            Consists
      of (a) 8,333 shares of common stock, (b) 2,501 shares of common stock
      issuable upon the exercise of warrants to purchase common stock and (c)
      372,680 shares of common stock issuable upon the exercise of vested and
      exercisable options.





(8)
            Consists
      of (a) 8,387,578 shares of common stock, (b) 2,624,649 shares of common
      stock issuable upon the conversion of convertible notes, (c) 4,602,812
      shares of common stock issuable upon the exercise of warrants to purchase
      common stock and (d) 83,344 shares of common stock issuable upon the
      exercise of vested and exercisable options.  The address of John
      Pappajohn is 2116 Financial Center, Des Moines, IA
  50309.





(9)
            Consists
      of (a) 38,000 shares of common stock, (b) 2,605,625 shares of common stock
      issuable upon the conversion of the Deerwood Notes, (c) 928,916 shares of
      common stock issuable upon the exercise of warrants and (d) 55,568 shares
      of common stock issuable upon the exercise of vested and exercisable
      options.  The Deerwood Notes and warrants are held by Deerwood
      Partners LLC and Deerwood Holdings LLC, of which the stockholder is the
      co-managing member along with his spouse, and by BGN Acquisition Ltd., LP,
      of which the shareholder is the managing partner.  The address
      of Deerwood Partners LLC and Deerwood Holdings LLC is 16 Deerwood Lane,
      Newport Beach, CA 92660. The address of BGN Acquisition Ltd., LP is 15747
      Woodruff Avenue, Bellflower, CA
90706.





(10)
            Consists
      of (a) 15,543,522 shares of common stock (b) 6,091,732 shares of common
      stock issuable upon the conversion of convertible notes, (c) 8,799,880
      shares of common stock issuable upon the exercise of vested and
      exercisable warrants and (d) 3,717,311 shares of common stock issuable
      upon the exercise of vested and exercisable
  options.





(11)
            Consists
      of (a) 8,890,795 shares of common stock (including 540,000 shares owned by
      Mr. Brandt’s children and 956,164 shares held by Brandt Ventures), (b)
      1,079,728 shares reserved for issuance upon exercise of warrants to
      purchase common stock (including warrants to purchase 478,082 shares of
      common stock held by Brandt Ventures) and (c) 1,111,459 shares reserved
      for issuance upon exercise of options to purchase common stock held by Mr.
      Brandt.  The address of Leonard Brandt is 28911 Via Hacienda San
      Juan Capistrano CA 92675.





Changes
in Control




We do not
have any arrangements which may at a subsequent date result in a change in
control.





Securities
Authorized for Issuance Under Equity Compensation Plans





The
following table sets forth certain information regarding our equity compensation
plans as of September 30, 2010.





Plan Category
                  
                  Number of securities to be
                    issued upon exercise of
                    outstanding options,
                    warrants and rights
                    (a)
                  
                  
                  Weighted-average exercise
                    price of outstanding options,
                    warrants and rights
                    (b)
                  
                  
                  Number of securities
                    remaining available for future
                    issuance under equity
                    compensation plans
                    (c)Equity
      compensation plans approved by security holders
                  
                  
                  15,670,973
                  
                  
                  $
                  0.62
                  
                  
                  
                  2,020,350Equity
      compensation plans not approved by security holders
                  
                  
                  0
                  
                  
                  $
                  0
                  
                  
                  
                  0Total
                  
                  
                  15,670,973
                  
                  
                  $
                  0.62
                  
                  
                  
                  2,020,350




78





ITEM
13.           Certain
Relationships and Related Transactions, and Director Independence




Except as
follows, since October 1, 2008, there has not been, nor is there currently
proposed, any transaction or series of similar transactions to which we are or
will be a party:




·
            in
      which the amount involved exceeds the lesser of $120,000 or 1% of the
      average of our total assets at year-end for the last two completed fiscal
      years;  and





·
            in
      which any director, executive officer, or stockholder of more than 5% of
      our common stock or any member of their immediate family had or will have
      a direct or indirect material
interest.





Transactions
with George Carpenter




On
December 24, 2009, the Company completed a second closing of its private
placement in which it received gross proceeds of approximately $3 million, which
included $108,000 invested by Mr. Carpenter, our CEO.  In exchange for
his investment, the Company issued to Mr. Carpenter 360,000 shares of its common
stock and a five year non-callable warrant to purchase 180,000 shares of its
common stock at an exercise price of $0.30 per share.  This investment
was completed with terms identical to those received by all other investors in
the Company’s private placement closings that took place on August 26, 2009,
December 24, 2009, December 31, 2009 and January 4, 2010.




On
January 4, 2010, Mr. Carpenter’s spouse was paid $36,000 for data discovery
consulting services in support of the Company’s litigation with Mr.
Brandt.  This transaction was done with knowledge of certain board
members and was subsequently ratified by the Board.




Transactions
with SAIL Venture Partners LP




On March
30, 2009, we executed two senior secured convertible promissory notes each in
the principal amount of $250,000 with SAIL Venture Partners, LP (“SAIL”) and
Brandt Ventures, GP (“Brandt”).  David Jones, a member of our board of
directors, is one of four managing members of SAIL Venture Partners, LLC, which
is the general partner of SAIL.  Leonard Brandt, also a member of our
board of directors until December 3, 2009, and our former Chief Executive
Officer, is the general partner of Brandt.




These
notes accrued interest at the rate of 8% per annum and were due and payable upon
a declaration by the note holder(s) requesting repayment, unless sooner
converted into shares of our common stock (as described below), upon the earlier
to occur of:  (i) June 30, 2009, or (ii) an Event of Default (as
defined in the notes), which includes the default that occurred as a result of
Mr. Brandt no longer serving as our Chief Executive Officer effective as of
April 10, 2009.  The notes were secured by a lien on substantially all
of our assets (including all intellectual property).  In the event of
a liquidation, dissolution or winding up of the company, unless Brandt and/or
SAIL informs us otherwise, we were required to pay such investor an amount equal
to the product of 250% multiplied by the principal and all accrued but unpaid
interest outstanding on the note.




In
concert with an equity financing transaction of at least $1,500,000 (excluding
any and all other debt that is converted), the principal and all accrued, but
unpaid interest outstanding under the notes would be automatically converted
into the securities issued in the equity financing by dividing such amount by
90% of the per share price paid by the investors in such financing.




On May
14, 2009, we entered into a Bridge Note and Warrant Purchase Agreement with
SAIL.  Pursuant to the Purchase Agreement, on May 14, 2009, SAIL
purchased a Secured Promissory Note in the principal amount of $200,000 from
us.  In order to induce SAIL to purchase the note, we issued to SAIL a
warrant to purchase up to 100,000 shares of our common stock at a purchase price
equal to $0.25 per share.  The warrant expires on the earlier to occur
of May 31, 2016, or a change of control of the company.




The
Purchase Agreement also provided that, at any time on or after June 30, 2009,
and provided that certain conditions are satisfied by us, SAIL would purchase
from us a second Secured Convertible Promissory Note in the principal sum of
$200,000 and would be issued a second warrant identical in terms to the warrant
described above.  The aforementioned conditions include our entry into
a term sheet in which investors commit to participate in an equity financing by
us of not less than $2,000,000 (excluding any and all other debt that are to be
converted).




The notes
issued or issuable pursuant to the Purchase Agreement accrue interest at the
rate of 8% per annum and were due and payable, unless sooner converted into
shares of our common stock (as described below), upon the earlier to occur
of:  (i) a declaration by SAIL on or after June 30, 2009, or (ii) an
Event of Default as defined in the notes.  The note(s) were secured by
a lien on substantially all of our assets (including all intellectual
property).  In the event of a liquidation, dissolution or winding up
of the company, unless SAIL informs us otherwise, we were required to pay SAIL
an amount equal to the product of 250% multiplied by the principal and all
accrued but unpaid interest outstanding on the note(s).




79




In the
event we consummate an equity financing transaction of at least $1,500,000
(excluding any and all other debt that is converted), then the principal and all
accrued, but unpaid interest outstanding under the note(s) were automatically
converted into the securities issued in the equity financing by dividing such
amount by 85% of the per share price paid by the investors in such
financing.




In
addition, in the event we issued preferred stock that was not part of an equity
financing described above, SAIL was entitled, at its option, to convert the
principal and all accrued, but unpaid interest outstanding under the note(s)
into preferred stock by dividing such amount by 85% of the per share price paid
by the purchasers’ of our preferred stock.




On August
26, 2009, the Company completed an equity financing transaction of approximately
$2 million.  As a result of the financing, each of the notes described
above that were held by SAIL and Brandt were automatically converted into common
stock, with SAIL receiving 1,758,356 shares and Brandt receiving 956,164
shares.  In addition, pursuant to the terms of the notes issued on
March 30, and May 14, 2009, SAIL was issued a non-callable five year warrant to
purchase 879,178 shares of common stock at an exercise price of $0.30 per share
and Brandt was issued a non-callable five year warrant to purchase 478,082
shares of common stock at an exercise price of $0.30 per share.




In
connection with the equity financing referred to above, on August 26, 2009, SAIL
purchased 6 “units” for $324,000.  Each “unit” consisted of 180,000
shares of common stock and a five year non-callable warrant to purchase an
additional 90,000 shares of common stock at an exercise price of $0.30 per
share.  The shares of common stock and warrants comprising the Units
were immediately separable and were issued separately.  This
investment was completed with terms identical to those received by all other
investors in the Company’s private placement closings that took place on August
26, 2009, December 24, 2009, December 31, 2009 and January 4, 2010.




On July
5, 2010 and August 20, 2010, we issued unsecured promissory notes (each, a
“Deerwood Note”) in the aggregate principal amount of $500,000 to Deerwood
Partners LLC and Deerwood Holdings LLC, with each investor purchasing two notes
in the aggregate principal amount of $250,000. Our director George Kallins and
his spouse are the managing members of these investors.   SAIL issued
unconditional guaranties to each of these investors, guaranteeing the prompt and
complete payment when due of all principal, interest and other amounts under
each Deerwood Note.  In addition, on August 20, 2010, we granted SAIL
warrants to purchase up to an aggregate of 100,000 shares of common stock at an
exercise price (subject to anti-dilution adjustments, including for issuances of
securities at prices below the then-effective exercise price) of $0.56 per
share.  We entered into an oral agreement to indemnify SAIL and grant
to SAIL a security interest in our assets in connection with the guaranties
..




On
October 1, 2010, we entered into a Note and Warrant Purchase Agreement (the
“Purchase Agreement”) with John Pappajohn and SAIL as investors, pursuant to
which we issued to SAIL secured convertible promissory notes (the “October
Notes”) in the aggregate principal amount of $250,000 and warrants to purchase
up to 416,666 shares of common stock.  The Company received $250,000
in gross proceeds from the issuance to SAIL.  The October Notes mature
on October 1, 2011 (subject to earlier conversion or prepayment), earn interest
equal to 9% per year with interest payable at maturity, and are convertible into
shares of common stock of the Company at a conversion price of
$0.30.  The conversion price is subject to adjustment upon (1) the
subdivision or combination of, or stock dividends paid on, the common stock; (2)
the issuance of cash dividends and distributions on the common stock; (3) the
distribution of other capital stock, indebtedness or other non-cash assets; and
(4) the completion of a financing at a price below the conversion price then in
effect.    The October Notes are furthermore convertible, at
the option of the holder, into securities to be issued in subsequent financings
at the lower of the then-applicable conversion price or price per share payable
by purchasers of such securities.  The October Notes can be declared
due and payable upon an event of default, defined in the October Notes to occur,
among other things, if the Company fails to pay principal and interest when due,
in the case of voluntary or involuntary bankruptcy or if the Company fails to
perform any covenant or agreement as required by the October
Note.   As of September 30, 2010, SAIL holds $250,000 in
aggregate principal amount of October Notes.




On
November 3, 2010, we issued October Notes in the aggregate principal amount of
$512,250, and related warrants to purchase up to 512,250 shares, to Deerwood
Holdings LLC and Deerwood Partners LLC, two entities controlled by Mr. Kallins,
in exchange for the cancellation of the Deerwood Notes originally issued on July
5, 2010 and August 20, 2010 in the aggregate principal amount of $500,000 (and
accrued and unpaid interest on those notes) and warrants to purchase an
aggregate of up to 150,000 shares originally issued on August 20,
2010.  The related guaranties and oral indemnification and security
agreement that had been entered into in connection with the Deerwood Notes were
likewise terminated.  SAIL issued unconditional guaranties to each of
the Deerwood investors, guaranteeing the prompt and complete payment when due of
all principal, interest and other amounts under the October Notes issued to such
investors.  The obligations under each guaranty are independent of our
obligations under the October Notes and separate actions may be brought against
the guarantor.  In connection with its serving as guarantor, we
granted SAIL warrants to purchase up to an aggregate of 341,498 shares of common
stock.  The warrants to purchase 100,000 shares of common stock
previously granted to SAIL on August 20, 2010 were canceled.




Our
obligations under the terms of the October Notes are secured by a security
interest in the tangible and intangible assets of the Company, pursuant to a
Security Agreement, dated as of October 1, 2010, by and between us and John
Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.


80


The
warrants related to the October Notes expire on September 20, 2017 and are
exercisable for shares of common stock of the Company at an exercise price of
$0.30.  Exercise price and number of shares issuable upon exercise are
subject to adjustment (1) upon the subdivision or combination of, or stock
dividends paid on, the common stock; (2) in case of any reclassification,
capital reorganization or change in capital stock and (3) upon the completion of
a financing at a price below the exercise price then in effect. Any provision of
the October Notes or related warrants can be amended, waived or modified upon
the written consent of the Company and holders of a majority of the aggregate
principal amount of such notes outstanding.  Any such consent will
affect all October Notes or warrants, as the case may be, and will be binding on
all holders thereof.




For a
table showing the differences in terms between the October Notes (and related
warrants), on the one hand, and the exchanged Bridge Notes and Deerwood Notes
(and related warrants), on the other hand, please refer to “ - Differences
between October Notes and Bridge Notes/Deerwood Notes” below.




Transactions
with Leonard Brandt




Please
see the discussion above under the heading “Transaction with Sail Venture
Partners LP” for a summary of a bridge financing transaction which closed on
March 30, 2009, in which Mr. Brandt participated.




Transactions
with Henry Harbin, M.D.




On April
15, 2008, we entered into a consulting agreement with Dr. Harbin, which expired
on December 31, 2008, pursuant to which Dr. Harbin was paid an aggregate of
$24,000 and was granted options to purchase 56,000 shares of our common stock at
an exercise price of $0.96 per share, with options to purchase 14,000 shares
vesting on the date of grant, options to purchase 37,328 shares vesting in eight
equal monthly installments of 4,666 options commencing on April 30, 2008, and
the remaining options to purchase 4,672 shares vesting on December 31,
2008.




On March 17, 2009, we entered into a
consulting agreement with Dr. Harbin which expired on December 31, 2009 pursuant
to which Dr. Harbin was paid an aggregate of $24,000 as compensation for his
consulting services.  Dr. Harbin was paid the $24,000 due to him in
January 2010.  In addition, as further compensation, we granted Dr.
Harbin options to purchase 56,000 shares of our common stock at an exercise
price of $0.40 per share, with the option vesting in equal monthly installments
over a twelve month period commencing on January 1, 2009.




On March
26, 2010, we entered into a new Consulting Agreement with Dr. Harbin, pursuant
to which Dr. Harbin is to be paid an aggregate of $36,000 as compensation for
his consulting services.  The agreement expires on December 31, 2010,
but is renewable for two one-year terms on January 1, 2011 and
2012.  In addition to his cash compensation, on March 3, 2010 we
granted Dr. Harbin options to purchase 400,000 shares of our common stock at an
exercise price of $0.55 per share as further compensation for such services,
with the options vesting in equal monthly installments over a 36 month period
commencing on March 3, 2010.  The options expire on March 3,
2020.




Transactions
with Daniel Hoffman, M.D.




On
January 11, 2008, we, through our wholly owned subsidiary, Colorado CNS
Response, Inc. and pursuant to the terms of a Stock Purchase Agreement, acquired
all of the outstanding common stock of Neuro-Therapy Clinic, PC, a Colorado
professional medical corporation wholly owned by Dr. Hoffman (“NTC”) in exchange
for a non-interest bearing note of $300,000 payable in equal monthly
installments over 36 months.  At the time of the transaction, NTC was
our largest customer.  Upon the completion of the acquisition, Dr.
Hoffman was appointed our Chief Medical Officer.  The Stock Purchase
Agreement provides that upon the occurrence of certain events, as defined in the
purchase agreement, Dr. Hoffman 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 we acquired.  As of September
30, 2009 and 2010, $[  ] and $[  ], respectively, of the
aggregate principal amount of such note remained outstanding.




Transactions
with John Pappajohn




In
conjunction with the closing of the Company’s private placement on August 26,
2009, Mr. Pappajohn joined the Company’s Board of Directors.




On June
12, 2009, we entered into a Bridge Note and Warrant Purchase Agreement with Mr.
John Pappajohn (“Pappajohn”).




Pursuant
to the Purchase Agreement, on June 12, 2009, Pappajohn purchased a Secured
Convertible Promissory Note in the principal amount of $1,000,000 from
us.  In order to induce Pappajohn to purchase the note, we issued to
Pappajohn a warrant to purchase up to 2,333,333 shares of our common stock and
issued to relatives of Pappajohn warrants to purchase up to a total of 1,000,000
shares, all at a purchase price equal to $0.30 per share.  These
warrants were exercised for shares of common stock in cashless exercises on
February 23, 2010 and February 24, 2010.




The note
issued pursuant to the Purchase Agreement provided that the principal amount of
$1,000,000 together with a single Premium Payment of $90,000 which is due and
payable, unless sooner converted into shares of our common stock (as described
below), upon the earlier to occur of:  (i) a declaration by Pappajohn
on or after June 30, 2010 or (ii) an Event of Default as defined in the
note.  The note was secured by a lien on substantially all of our
assets (including all intellectual property).  In the event of a
liquidation, dissolution or winding up of the company, unless Pappajohn informs
us otherwise, we were required to pay Pappajohn an amount equal to the product
of 250% multiplied by the then outstanding principal amount of the note and the
Premium Payment.


81




The note
also contained a provision that, in the event we consummated an equity financing
transaction of at least $1,500,000 (excluding any and all other debt that is
converted), the then outstanding principal amount of the note (but excluding the
Premium Payment, which will be repaid in cash at the time of such equity
financing) shall be automatically converted into the securities issued in the
equity financing by dividing such amount by the per share price paid by the
investors in such financing.




On August
26, 2009, the Company completed an equity financing transaction of approximately
$2 million.  As a result of the financing, the note described above
held by Mr. Pappajohn automatically converted into common stock, with Mr.
Pappajohn receiving 3,333,334 shares.  In addition, pursuant to the
terms of the note, Mr. Pappajohn received a five year non-callable warrant to
purchase 1,666,667 shares of common stock at an exercise price of $0.30 per
share.




In
connection with the equity financing referred to above, on August 26, 2009, Mr.
Pappajohn invested an additional $1,000,000 in the Company.  In
exchange for his investment, the Company issued an additional 3,333,333 shares
of common stock to Mr. Pappajohn and a five year non-callable warrant to
purchase 1,666,667 shares of common stock at an exercise price of $0.30 per
share.  The terms of this investment were identical to the terms
received by all other investors in the Company’s private placement closings that
took place on August 26, 2009, December 24, 2009, December 31, 2009 and January
4, 2010.




The
Company intends to reimburse Equity Dynamics, Inc., a company solely owned by
Mr. Pappajohn, for expenses which Equity Dynamics incurred between May and
December, 2009 on behalf of CNS Response, Inc.  These expenses include
$34,700 incurred in connection with the Company’s private placement financing
and other activities.




On
February 23, 2010 Mr. Pappajohn exercised 2,333,333 warrants and was issued
1,720,910 shares of common stock in a net exercise of warrants in lieu of cash
transaction.




On June
3, 2010, we entered into a Bridge Note and Warrant Purchase Agreement with John
Pappajohn, pursuant to which Mr. Pappajohn agreed to purchase two secured
promissory notes (each, a “Bridge Note”) in the aggregate principal amount of
$500,000, with each Bridge Note in the principal amount of $250,000 maturing on
December 2, 2010.  On June 3, 2010, Mr. Pappajohn loaned the Company
$250,000 in exchange for the first Bridge Note (there were no warrants issued in
connection with this first note) and on July 25, 2010, Mr. Pappajohn loaned us
$250,000 in exchange for the second Bridge Note.  In connection with
his purchase of the second Bridge Note, Mr. Pappajohn received a warrant to
purchase up to 250,000 shares of our common stock in accordance with the Bridge
Note and Warrant Purchase Agreement.  The exercise price of the
warrant (subject to anti-dilution adjustments, including for issuances of
securities at prices below the then-effective exercise price) was $0.50 per
share.




Pursuant
to a separate agreement that we entered into with Mr. Pappajohn, we granted him
a right to convert the Bridge Notes into shares of our common stock at a
conversion price of $0.50. The conversion price was subject to customary
anti-dilution adjustments, but would never be less than
$0.30.




Each
Bridge Note accrued interest at a rate of 9% per annum which would have been
paid together with the repayment of the principal amount at the earliest of (i)
the maturity date; (ii) prepayment of the Bridge Note at the option of the
Company (iii) closing of a financing in which the aggregate proceeds to the
Company are not less than $3,000,000 or (iv) the occurrence of an Event of
Default (as defined in the Bridge Note).  The Purchase Agreement and
each Bridge Note grants the investor a senior security interest in and to all of
the Company’s existing and future right, title and interest in its tangible and
intangible property.




On
October 1, 2010, we entered into a Note and Warrant Purchase Agreement (the
“Purchase Agreement”) with John Pappajohn and SAIL as investors, pursuant to
which we issued to the Mr. Pappajohn secured convertible promissory notes (the
“October Notes”) in the aggregate principal amount of $761,688 and warrants to
purchase up to 1,269,478 shares of common stock.  The Company received
$250,000 in gross proceeds from the issuance to Mr. Pappajohn.  We
also issued October Notes in the aggregate principal amount of $511,688, and
related warrants to purchase up to 852,812 shares, to Mr. Pappajohn in exchange
for the cancellation of the two Bridge Notes originally issued to him on June 3,
2010 and July 25, 2010 in the aggregate principal amount of $500,000 (and
accrued and unpaid interest on those notes) and a warrant to purchase up to
250,000 shares originally issued to him on July 25, 2010.  As of
September 30, 2010, Mr. Pappajohn holds $511,688 in aggregate principal amount
of October Notes.




The
October Notes issued to Mr. Pappajohn mature on October 1, 2011 (subject to
earlier conversion or prepayment), earn interest equal to 9% per year with
interest payable at maturity, and are convertible into shares of common stock of
the Company at a conversion price of $0.30.  The conversion price is
subject to adjustment upon (1) the subdivision or combination of, or stock
dividends paid on, the common stock; (2) the issuance of cash dividends and
distributions on the common stock; (3) the distribution of other capital stock,
indebtedness or other non-cash assets; and (4) the completion of a financing at
a price below the conversion price then in effect. The October Notes are
furthermore convertible, at the option of the holder, into securities to be
issued in subsequent financings at the lower of the then-applicable conversion
price or price per share payable by purchasers of such securities. The October
Notes can be declared due and payable upon an event of default, defined in the
October Notes to occur, among other things, if the Company fails to pay
principal and interest when due, in the case of voluntary or involuntary
bankruptcy or if the Company fails to perform any covenant or agreement as
required by the October Note.




82




Our
obligations under the terms of the October Notes are secured by a security
interest in the tangible and intangible assets of the Company, pursuant to a
Security Agreement, dated as of October 1, 2010, by and between us and John
Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.




The
warrants related to the October Notes expire on September 20, 2017 and are
exercisable for shares of common stock of the Company at an exercise price of
$0.30.  Exercise price and number of shares issuable upon exercise are
subject to adjustment (1) upon the subdivision or combination of, or stock
dividends paid on, the common stock; (2) in case of any reclassification,
capital reorganization or change in capital stock and (3) upon the completion of
a financing at a price below the exercise price then in effect.  Any
provision of the October Notes or related warrants can be amended, waived or
modified upon the written consent of the Company and holders of a majority of
the aggregate principal amount of such notes outstanding.  Any such
consent will affect all October Notes or warrants, as the case may be, and will
be binding on all holders thereof.




For a
table showing the differences in terms between the October Notes (and related
warrants), on the one hand, and the exchanged Bridge Notes and Deerwood Notes
(and related warrants), on the other hand, please refer to “ - Differences
between October Notes and Bridge Notes/Deerwood Notes” below.




On
November 24, 2010 the Board of Directors, excluding Mr. Pappajohn, ratified an
engagement agreement with Equity Dynamics, Inc., a company owned by Mr.
Pappajohn, to provide financial advisory serviced to assist us with our fund
raising efforts.  These efforts have included advice and assistance
with the preparation of Private Placement Memoranda, investor presentations,
financing strategies, identification of potential and actual investors, and
introductions to placement agents and investment bankers. The engagement letter
calls for a retainer fee of $10,000 per month starting February 1,
2010.  As of September 30, 2010, we have accrued $80,000 for the
services provided by Equity Dynamics.  The term of the agreement is
for 12 months from its initiation and can be cancelled by either party, with or
without cause, with 30 days written notice.




Transactions
with George Kallins M.D.




On July
5, 2010 and August 20, 2010, we issued unsecured promissory notes (each, a
“Deerwood Note”) in the aggregate principal amount of $500,000 to Deerwood
Partners LLC and Deerwood Holdings LLC, with each investor purchasing two notes
in the aggregate principal amount of $250,000. The managing members of each of
Deerwood Partners LLC and Deerwood Holdings LLC are George J. Kallins, M.D., who
joined the Company’s Board of Directors on July 5, 2010, and his spouse Bettina
Kallins. We received $250,000 in gross proceeds from the issuance of the first
two notes on July 5, 2010 and another $250,000 in gross proceeds from the
issuance of the second two notes on August 20, 2010.  In connection
with the August 20, 2010 transaction, each of the two investors also received a
warrant to purchase up to 75,000 shares of our common stock at an exercise price
(subject to anti-dilution adjustments, including for issuances of securities at
prices below the then-effective exercise price) of $0.56 per share.




SAIL
Venture Partners L.P. (“SAIL”), of which our director David Jones is a managing
partner, issued unconditional guaranties to each of these investors,
guaranteeing the prompt and complete payment when due of all principal, interest
and other amounts under each Deerwood Note.  The obligations under
each guaranty were independent of our obligations under the Deerwood Notes and
separate actions could be brought against the guarantor.  We entered
into an oral agreement to indemnify SAIL and grant to SAIL a security interest
in our assets in connection with the guaranties.  In addition, on
August 20, 2010, we granted SAIL warrants to purchase up to an aggregate of
100,000 shares of common stock at an exercise price (subject to anti-dilution
adjustments, including for issuances of securities at prices below the
then-effective exercise price) of $0.56 per share.




Each
Deerwood Note accrued interest at a rate of 9% per annum, which was payable
together with the repayment of the principal amount, unless earlier converted,
at the earliest of (i) the maturity date; (ii) prepayment of the Deerwood Note
at our option (iii) closing of a financing in which the aggregate proceeds to us
are not less than $3,000,000 or (iv) the occurrence of an Event of Default (as
defined in the Deerwood Note).  Each Deerwood Note was convertible
into shares of our common stock at a conversion price of $0.50.  The
conversion price was subject to customary anti-dilution adjustments, but would
never be less than $0.30. As of September 30, 2010, Deerwood Partners LLC and
Deerwood Holdings LLC held Deerwood Notes in the aggregate principal amount of
$500,000.




On
November 3, 2010, we issued October Notes in the aggregate principal amount of
$762,250 and warrants to purchase up to 1,270,414 shares of common stock to
three investors affiliated with Dr. Kallins.  We received $250,000 in
gross proceeds from the issuance to BGN Acquisition Ltd., LP, an entity
controlled by Dr. Kallins, of October Notes in the aggregate principal amount of
$250,000 and related warrants to purchase up to 416,666 shares.  We
also issued October Notes in the aggregate principal amount of $512,250, and
related warrants to purchase up to 512,250 shares, to Deerwood Holdings LLC and
Deerwood Partners LLC in exchange for the cancellation of the Deerwood Notes
originally issued on July 5, 2010 and August 20, 2010 in the aggregate principal
amount of $500,000 (and accrued and unpaid interest on those notes) and warrants
to purchase an aggregate of up to 150,000 shares originally issued on August 20,
2010.  The related guaranties and oral indemnification and security
agreement that had been entered into in connection with the Deerwood Notes were
likewise terminated.   SAIL, of which our director David Jones is
a managing partner, issued unconditional guaranties to each of the Deerwood
investors in connection with the October Notes.




83




The
Purchase Agreement pursuant to which the October Notes were issued also provides
that the Company and the holders of the October Notes will enter into a
registration rights agreement covering the registration of the resale of the
shares underlying the October Notes and the related warrants.




The
October Notes mature on October 1, 2011 (subject to earlier conversion or
prepayment), earn interest equal to 9% per year with interest payable at
maturity, and are convertible into shares of common stock of the Company at a
conversion price of $0.30.  The conversion price is subject to
adjustment upon (1) the subdivision or combination of, or stock dividends paid
on, the common stock; (2) the issuance of cash dividends and distributions on
the common stock; (3) the distribution of other capital stock, indebtedness or
other non-cash assets; and (4) the completion of a financing at a price below
the conversion price then in effect.  The October Notes are
furthermore convertible, at the option of the holder, into securities to be
issued in subsequent financings at the lower of the then-applicable conversion
price or price per share payable by purchasers of such
securities.  The October Notes can be declared due and payable upon an
event of default, defined in the October Notes to occur, among other things, if
the Company fails to pay principal and interest when due, in the case of
voluntary or involuntary bankruptcy or if the Company fails to perform any
covenant or agreement as required by the October Note.




Our
obligations under the terms of the October Notes are secured by a security
interest in the tangible and intangible assets of the Company, pursuant to a
Security Agreement, dated as of October 1, 2010, by and between us and John
Pappajohn, as administrative agent for the holders of the October
Notes.  The agreement and corresponding security interest terminate if
and when holders of a majority of the aggregate principal amount of October
Notes issued have converted their October Notes into shares of common
stock.




The
warrants related to the October Notes expire at various times in September and
October, 2017 and are exercisable for shares of common stock of the Company at
an exercise price of $0.30.  Exercise price and number of shares
issuable upon exercise are subject to adjustment (1) upon the subdivision or
combination of, or stock dividends paid on, the common stock; (2) in case of any
reclassification, capital reorganization or change in capital stock and (3) upon
the completion of a financing at a price below the exercise price then in
effect.  Any provision of the October Notes or related warrants can be
amended, waived or modified upon the written consent of the Company and holders
of a majority of the aggregate principal amount of such notes
outstanding.  Any such consent will affect all October Notes or
warrants, as the case may be, and will be binding on all holders
thereof.




For a
table showing the differences in terms between the October Notes (and related
warrants), on the one hand, and the exchanged Bridge Notes and Deerwood Notes
(and related warrants), on the other hand, please refer to “ - Differences
between October Notes and Bridge Notes/Deerwood Notes” below.




Transactions
with Paul Buck




Prior to
his employment by the Company, Mr. Buck, our Chief Financial Officer, had been
working with the Company as an independent consultant since December 2008,
assisting management with finance and accounting matters as well as the
Company’s filings with the Securities and Exchange Commission.  Mr.
Buck earned $264,900 in consulting services rendered to the
Company.




On
December 24, 2009, the Company completed a second closing of its private
placement in which it received gross proceeds of approximately $3 million, which
included $54,000 invested by Mr. Buck.  In exchange for his
investment, the Company issued to Mr. Buck 180,000 shares of its common stock
and a five year non-callable warrant to purchase 90,000 shares of its common
stock at an exercise price of $0.30 per share.  This investment was
completed with the identical terms as received by all other investors in the
Company’s private placement closings that took place on August 26, 2009,
December 24, 2009, December 31, 2009 and January 4, 2010.




Transactions
with Non-Executive Directors




On March
3, 2010, the Board granted options to purchase 250,000 shares to each
non-executive Director (Dr. Harbin, Mr. Jones, Mr. Pappajohn, Mr. Thompson, and
Dr. Vaccaro) for their board service.  Each of the options have an
exercise price of $0.55 per share, vest in equal monthly installments over a
period of three years and have a term of 10 years from the date of
grant.




As Mr.
Thompson has subsequently resigned from the board, he has forfeited the option
to purchase the 250,000 shares granted to him.  However, on March 3,
2010, the Board also granted options to Mr. Thompson to purchase 150,000 shares
for his services as an advisor to the Company.  Each of the options
have an exercise price of $0.55 per share, vest in equal monthly installments
over a period of three years and have a term of 10 years from the date of
grant.




Transaction
with a Staff Member of Equity Dynamics, Inc.




On July
5, 2010 the Board granted warrants to purchase 500,000 shares of common stock to
members of staff of Equity Dynamics, Inc, a company owned by Mr. Pappajohn, for
consulting services they had rendered to the Company, advising on and assisting
with fund raising activities.  Using the Black-Scholes model, these
warrants were valued at $199,000 and expensed to consulting
fees.   These warrants have an exercise price of $0.30 cents per
share, are exercisable from the date of grant and have a term of 10 years from
the date of grant.




84




Difference
between October Notes and Bridge Notes/Deerwood Notes




The terms
of the October Notes (and related warrants) differed from the terms of the
Bridge Notes and Deerwood Notes (and related warrants), which certain related
parties exchanged for October Notes, as follows:




Term
                                  
                                  Bridge Note/Deerwood Note
                                  
                                  October NoteMaturity
                                  
                                  December
      15, 2010
                                  
                                  One
      year from the date of issuanceInitial
      Conversion Price
                                  
                                  $0.50,
      with any adjustment being subject to a $0.30 floor
                                  
                                  $0.30If
      Company issues common stock (or securities convertible, exercisable or
      exchangeable for common stock), at a consideration (or conversion,
      exercise or exchange price) (the “Offering Price”) less than the
      Conversion Price, Conversion Price will be adjusted to match the Offering
      Price (“Ratchet”)
                                  
                                  No
                                  
                                  YesPrepayment
      upon financing with aggregate proceeds of not less than
      $3million
                                  
                                  Yes
                                  
                                  NoNoteholder
      has Security Interest
                                  
                                  Yes
      (Bridge Note); No (Deerwood Note)
                                  
                                  Yes.  Benefits
      of security agreement expire on the date that holders of a majority of
      aggregate principal amount of notes issued have converted their Notes in
      accordance with their terms.Events
      of Default (Differences only)
                                  
                                  ·General
      assignment to creditors
                                    ·Bankruptcy proceeding, which is not dismissed within 60
      days
                                    ·Entry
      of final judgment for the payment of money in excess of $25,000 and
      failure to satisfy for 30 days
                                  
                                  ·Voluntary bankruptcy filing
                                    ·Failure
      to comply with Use of Proceeds covenant in purchase
      agreement
                                    ·Court
      enters bankruptcy order that is not vacated, set aside or reversed within
      60 daysOption
      to convert notes into securities to be issued in subsequent financings at
      the lower of conversion price or price per share payable by purchasers of
      such securities
                                  
                                  No
                                  
                                  YesAmendments,
      waivers or modification of the note or related warrants requires written
      consent of the holders of a majority of the aggregate principal amount of
      the notes outstanding, and such written consent will be binding on all
      holders
                                  
                                  N/A
      - single investors
                                  
                                  YesWarrant
      Coverage
                                  
                                  25%
      (in case of Deerwood Notes, 40% of which was issued to guarantor of
      Deerwood Notes)
                                  
                                  50%
      (in case of Deerwood entities, 40% of which was issued to guarantor of
      notes issued to Deerwood entities)Initial
      Exercise Price of Warrants
                                  
                                  $0.50
      (Bridge Note); $0.56 (Deerwood Note)
                                  
                                  $0.30Ratchet
      as applied to Warrants (see definition above)
                                  
                                  Results
      in a decrease in exercise price
                                  
                                  Results
      in a decrease in exercise price and corresponding increase in number of
      shares
issuable




Not
included in this table are certain representations and warranties in the
Deerwood notes that were either immaterial or were included in the note and
warrant purchase agreements for the Bridge Notes and the October
Notes.




85




ITEM
14.           Principal
Accounting Fees and Services




Audit
Fees




The
aggregate fees billed for professional services rendered by Cacciamatta
Accountancy Corporation for professional services rendered for the audit of our
annual financial statements and review of the financial statements included in
our Form 10-Q’s or services that are normally provided by the accountant in
connection with statutory and regulatory filings or engagements for fiscal years
2010 and 2009 were $149,823 and $134,300 respectively.




Audit-Related
Fees




Cacciamatta
Accountancy Corporation billed us $0 in fees for assurance and related services
related to the performance of the audit or review of our financial statements
for the fiscal years ended September 30, 2010 and September 30, 2009,
respectively.




Tax
Fees




The
aggregate fees to be billed by Cacciamatta Accountancy Corporation for
professional services rendered for tax compliance, tax advice, and tax planning
during our fiscal years ending September 30, 2010 and September 30, 2009 were $0
and $0, respectively.




All
Other Fees




None.




Audit
Committee Policies and Procedures




Our Audit
Committee, which consists of three of our member of the Board of Directors, is
directly responsible for interviewing and retaining our independent accountant,
considering the accounting firm’s independence and effectiveness, and
pre-approving the engagement fees and other compensation to be paid to, and the
services to be conducted by, the independent accountant. During each of the
fiscal years ended September 30, 2010 and September 30, 2009, respectively, our
Board of Directors pre-approved 100% of the services described
above.





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
      Exhibit Index following the signature pages to this Annual Report, which
      is incorporated by reference in this Item. The Exhibits listed in the
      accompanying Exhibit Index are filed or incorporated by reference as part
      of this Annual Report.(b)
            Exhibits.
      See Exhibit Index, which is incorporated by reference in this Item. The
      Exhibits listed in the accompanying Exhibit Index  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/
      George CarpenterGeorge
      Carpenter
                Chief
      Executive OfficerDate:
      December 20, 2010




POWER OF
ATTORNEY




The
undersigned directors and officers of CNS Response, Inc. do hereby constitute
and appoint George Carpenter and Paul Buck with full power of substitution and
resubstitution, as their true and lawful attorneys and agents, 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 attorneys and agents, 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, may lawfully 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/
      George Carpenter
              
              Chief
      Executive Officer, Director
              
              December
      20, 2010George
      Carpenter
              
              (Principal
      Executive Officer)/s/
      Paul Buck
              
              Chief
      Financial Officer (Principal Financial
              
              December
      20, 2010Paul
      Buck
              
              Officer
      and Principal Accounting Officer)/s/
      David B. Jones
              
              Director
              
              December
      20, 2010David
      B. Jones/s/
      Jerome Vaccaro
              
              Director
              
              December
      21, 2010Jerome
      Vaccaro, M.D./s/
      Henry T. Harbin
              
              Director
              
              December
      20, 2010Henry
      T. Harbin, M. D./s/
      John Pappajohn
              
              Director
              
              December
      21, 2010John
      Pappajohn/s/
      George Kallins
              
              Director
              
              December
      20, 2010George
      Kallins, M.D.




87




EXHIBIT
INDEX


Exhibit
      Number
              
              Exhibit
      Title2.1
              
              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 Amendment of Certificate of Incorporation, dated January 8,
      2007.  Incorporated by reference to Exhibit 3.1.5 to the
      Registrant’s Registration Statement on Form S-1/A (File No. 333-164613)
      filed with the Commission on July 6, 2010.3.1.6
              
              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, 2007.3.2.1
              
              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, 1999.3.2.2
              
              Amendment
      No. 1 to Bylaws of CNS Response, Inc.  Incorporated by reference
      to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K (File No.
      000-26285) filed with the Commission on July 2, 2009.3.2.3
              
              Amendment
      No. 2 to Bylaws of CNS Response, Inc.  Incorporated by reference
      to Exhibit 3.3 to the Registrant’s Current Report on Form 8-K (File No.
      000-26285) filed with the Commission on July 23, 2009.4.1
              
              Amended
      and Restated 2006 Stock Incentive Plan.  Incorporated by
      reference to Appendix A to the Registrant’s Definitive Proxy Statement on
      Schedule 14A (File No. 000-26285) filed with the Commission on April 1,
      2010.*
  88
  Exhibit
      Number
              
              Exhibit
      Title10.1
              
              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, 2007.10.2
              
              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, 2007.10.3
              
              Form
      of Indemnification Agreement by and among the Registrant, CNS Response,
      Inc., a California corporation, and certain individuals, dated March 7,
      2007.  Incorporated by reference to Exhibit 10.5 to the
      Registrant’s Current Report on Form 8-K (File No. 000-26285) filed with
      the Commission on March 13, 2007.10.4
              
              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,
      2007.10.5
              
              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, 2007.10.6
              
              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.*10.7
              
              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.*10.8
              
              Stock
      Purchase Agreement by and among Colorado CNS Response, Inc.,
      Neuro-Therapy, P.C. and Daniel A. Hoffman, M.D. dated January 11,
      2008.  Incorporated by reference to the Registrant’s Annual
      Report on Form 10-K (File No. 000-26285) filed with the Commission on
      January 13, 2009.10.9
              
              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, 2007.10.10
              
              Senior
      Secured Convertible Promissory Note, dated March 30, 2009, by and between
      the Company and Brandt Ventures, GP.  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 April 3, 2009.10.11
              
              Senior
      Secured Convertible Promissory Note, dated March 30, 2009, by and between
      the Company and SAIL Venture Partners, LP.  Incorporated by
      reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K
      (File No. 000-26285) filed with the Commission on April 3
      2009.10.12
              
              Bridge
      Note and Warrant Purchase Agreement, dated May 14, 2009 by and between the
      Company and SAIL Venture Partners, LP.  Incorporated by
      reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K
      (File Number 000-26285) filed with the Securities and Exchange Commission
      on May 20, 2009.
  89
  Exhibit
      Number
              
              Exhibit
      Title10.13
              
              Form
      of Secured Convertible Promissory Note.  Incorporated by
      reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K
      (File Number 000-26285) filed with the Securities and Exchange Commission
      on May 20, 2009.10.14
              
              Form
      of Warrant to Purchase Shares.  Incorporated by reference to
      Exhibit 10.3 to the Registrant’s Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on May 20,
      2009.10.15
              
              Bridge
      Note and Warrant Purchase Agreement, dated June 12, 2009, by and between
      the Company and John Pappajohn.  Incorporated by reference to
      Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on June 18,
      2009.10.16
              
              Form
      of Secured Convertible Promissory Note.  Incorporated by
      reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K
      (File Number 000-26285) filed with the Securities and Exchange Commission
      on June 18, 2009.10.17
              
              Form
      of Warrant to Purchase Shares.  Incorporated by reference to
      Exhibit 10.3 to the Registrant’s Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on June 18,
      2009.10.18
              
              Form
      of Subscription Agreement.  Incorporated by reference to Exhibit
      10.18 to the Registrant’s Annual Report on Form 10-K (File Number
      000-26285) filed with the Securities and Exchange Commission on December
      30, 2009.10.19
              
              Form
      of Warrant.  Incorporated by reference to Exhibit 10.19 to the
      Registrant’s Annual Report on Form 10-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on December 30,
    2009.10.20
              
              Registration
      Rights Agreement.  Incorporated by reference to Exhibit 10.20 to
      the Registrant’s Annual Report on Form 10-K (File Number 000-26285) filed
      with the Securities and Exchange Commission on December 30,
      2009.10.21
              
              Amendment
      No. 1 to Registration Rights Agreement.  Incorporated by
      reference to Exhibit 10.21 to the Registrant’s Annual Report on Form 10-K
      (File Number 000-26285) filed with the Securities and Exchange Commission
      on December 30, 2009.10.22
              
              Form
      of Indemnification Agreement.  Incorporated by reference to
      Exhibit 10.22 to the Registrant’s Annual Report on Form 10-K (File Number
      000-26285) filed with the Securities and Exchange Commission on December
      30, 2009.10.23
              
              Employment
      Agreement by and between the Registrant and Paul Buck effective as of
      February 18, 2010.  Incorporated by reference to Exhibit 10.23
      to the Registrant’s Registration Statement on Form S-1/A (File No.
      333-164613) filed with the Commission on July 6, 2010.*10.24
              
              Consulting
      Agreement by and among CNS Response, Inc. and Henry T. Harbin, effective
      January 1, 2010.  Incorporated by reference to Exhibit 10.1 to
      the Registrant’s Quarterly Report on Form 10-Q (File Number 000-26285)
      filed with the Securities and Exchange Commission on May 14,
      2010.10.25
              
              Bridge
      Note and Warrant Purchase Agreement, dated as of June 3, 2010, between CNS
      Response, Inc. and John Pappajohn.  Incorporated by reference to
      Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on June 7,
      2010.
  90
 
 Exhibit
      Number
                                                                                                                              
                                                                                                                              Exhibit
      Title10.26
                                                                                                                              
                                                                                                                              Form
      of Note.  Incorporated by reference to Exhibit 10.2 to the
      Registrant’s Current Report on Form 8-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on June 7, 2010.10.27
                                                                                                                              
                                                                                                                              Form
      of Warrant.  Incorporated by reference to Exhibit 10.3 to the
      Registrant’s Current Report on Form 8-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on June 7, 2010.10.28
                                                                                                                              
                                                                                                                              Placement
      Agent Agreement dated August 3, 2009 between the Registrant and Maxim
      Group LLC.  Incorporated by reference to Exhibit 10.28 to the
      Registrant’s Registration Statement on Form S-1/A (File No. 333-164613)
      filed with the Commission on July 6, 2010.10.29
                                                                                                                              
                                                                                                                              Form
      of Warrant issued to Placement Agent.  Incorporated by reference
      to Exhibit 10.29 to the Registrant’s Registration Statement on Form S-1/A
      (File No. 333-164613) filed with the Commission on July 6,
      2010.10.30
                                                                                                                              
                                                                                                                              Registration
      Rights Agreement dated August 26, 2009 between the Registrant and Maxim
      Group, LLC.   Incorporated by refrence to Exhibit 10.30 to
      the Registrant’s Registration Statement on Form S-1/A (File No.
      333-164613) filed with the Commission on November 8,
  2010.10.31
                                                                                                                              
                                                                                                                              Amendment
      No.1 to Placement Agent Agreement dated July 21, 2010 between the
      Registrant and Maxim Group LLC.    Incorporated by
      refrence to Exhibit 10.31 to the Registrant’s Registration Statement on
      Form S-1/A (File No. 333-164613) filed with the Commission on November 8,
      2010.10.32
                                                                                                                              
                                                                                                                              Amendment
      No.1 to Form of Warrant issued to Placement Agent dated July 23,
      2010.   Incorporated by refrence to Exhibit 10.32 to the
      Registrant’s Registration Statement on Form S-1/A (File No. 333-164613)
      filed with the Commission on November 8, 2010.10.33
                                                                                                                              
                                                                                                                              Form
      of Unsecured Promissory Note.  Incorporated by reference to
      Exhibit 4.1 to the Registrant’s Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on July 9,
      2010.10.34
                                                                                                                              
                                                                                                                              Form
      of Guaranty.  Incorporated by reference to Exhibit 4.2 to the
      Registrant’s Current Report on Form 8-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on July 9, 2010.10.35
                                                                                                                              
                                                                                                                              Form
      of Deerwood Note.  Incorporated by reference to Exhibit 4.1 to
      the Registrant’s Current Report on Form 8-K (File Number 000-26285) filed
      with the Securities and Exchange Commission on August 24,
      2010.10.36
                                                                                                                              
                                                                                                                              Form
      of Deerwood Warrant.  Incorporated by reference to Exhibit 4.2
      to the Registrant’s Current Report on Form 8-K (File Number 000-26285)
      filed with the Securities and Exchange Commission on August 24,
      2010.10.37
                                                                                                                              
                                                                                                                              Engagement Agreement, dated
      September 30, 2010, between the Registrant and Monarch Capital Group, LLC,
      as Placement Agent.  Incorporated by reference to Exhibit 10.3
      to the Registrant's Current Report on Form 8-K (File Number 000-26285)
      filed with the Securities and Exchange Commission on October 13,
      2010.10.38
                                                                                                                              
                                                                                                                              Form of Note and Warrant Purchase
      Agreement, dated October 1, 2010, by and between the Registrant and the
      Investors party thereto.  Incorporated by reference to Exhibit
      10.1 to the Registrant's Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on October 7,
      2010.10.39
                                                                                                                              
                                                                                                                              Security Agreement, dated October
      1, 2010, by and between the Registrant and John Pappajohn, as
      administrative agent for the secured parties.  Incorporated by
      reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K
      (File Number 000-26285) filed with the Securities and Exchange Commission
      on October 7, 2010.10.40
                                                                                                                              
                                                                                                                              Form of October
      Note.  Incorporated by reference to Exhibit 4.1 to the
      Registrant's Current Report on Form 8-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on October 7,
      2010.10.41
                                                                                                                              
                                                                                                                              Form of October
      Warrant.  Incorporated by reference to Exhibit 4.2 to the
      Registrant's Current Report on Form 8-K (File Number 000-26285) filed with
      the Securities and Exchange Commission on October 7,
      2010.10.42
                                                                                                                              
                                                                                                                              Form of Placement Agent Warrant
      issued to Monarch Capital Group, LLC.  Incorporated by reference
      to Exhibit 4.3 to the Registrant's Current Report on Form 8-K (File Number
      000-26285) filed with the Securities and Exchange Commission on October
      27, 2010.10.43*
                                                                                                                              
                                                                                                                              Employment Agreement, dated July
      6, 2010, by and between the Registrant and Michael
      Darkoch.    Incorporated by refrence to Exhibit 10.43
      to the Registrant’s Registration Statement on Form S-1/A (File No.
      333-164613) filed with the Commission on November 8, 2010.10.44
                                                                                                                              
                                                                                                                              Form
      of Guaranty, dated as of November 3, 2010, by SAIL Venture Partners, LP in
      favor of in favor of [Deerwood Holdings, LLC][Deerwood Partners,
      LLC].21.1
                                                                                                                              
                                                                                                                              Subsidiaries
      of the Registrant.  Incorporated by reference to the
      Registrant’s Annual Report on Form 10-K (File No. 000-26285) filed with
      the Commission on January 13, 2009.23.1
                                                                                                                              
                                                                                                                              Consent
      of Independent Registered Public Accounting Firm.24
                                                                                                                              
                                                                                                                              Power
      of Attorney (included in the signature page hereto)31.1
                                                                                                                              
                                                                                                                              Certification
      by Principal 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 Principal Executive Officer pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002.32.2
                                                                                                                              
                                                                                                                              Certification
      of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
 
 *
Indicates a management contract or compensatory
plan.