UNITED
      STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q


(Mark
One)




x
            Quarterly
      Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934




For the
quarterly period ended December 31, 2009




 ̈
            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 0-26285




CNS
RESPONSE, INC.


(Exact
name of registrant as specified in its charter)




Delaware
              87-0419387(State
      or other jurisdiction of
              (I.R.S.
      Employerincorporation
      or organization)
              Identification
      No.)





85
Enterprise, Suite 410


Aliso
Viejo, CA 92656


(Address
of principal executive offices)




(714)
545-3288


(Registrant’s
telephone number, including area code)




2755
Bristol Street, Suite 285


Costa
Mesa, CA 92626


(Former
name, former address, former fiscal year, if changed since last
report)




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.


Yesx     No ̈




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 ̈     Nox




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 Exchange Act).          Yes  ̈No x




As
      of February 12, 2009, the issuer had 53,567,795 shares of common stock,
      par value $.001 per share, issued and outstanding.





CNS
RESPONSE, INC.





INDEX
TO FORM 10-Q




PagePART
      I
                  FINANCIAL
      INFORMATION
                  3Item
      1.
                  Financial
      Statements
                  3Unaudited
      Condensed Consolidated Statements of Operations for the three months ended
      December 31, 2009 and 2008
                  3Condensed
      Consolidated Balance Sheets as of December 31, 2009 (unaudited) and
      September 30, 2009
                  4Unaudited
      Condensed Consolidated Statements of Cash Flows for the three months ended
      December 31, 2009 and 2008
                  5Unaudited
      Condensed Consolidated Statements of Stockholders’ Equity
      (Deficit)  for the three months ended December 31, 2009 and
      2008
                  6Notes
      to Unaudited Condensed Consolidated Financial Statements
                  7Item
      2.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  22Item
      3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  33Item
      4.
                  Controls
      and Procedures
                  33PART
      II
                  OTHER
      INFORMATION
                  35Item
      1.
                  Litigation
                  35Item
      1A.
                  Risk
      Factors
                  35Item
      6.
                  Exhibits
                  35




2


PART
I


FINANCIAL
INFORMATION




Item
      1.
            Financial
      Statements


CNS
RESPONSE, INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS





For
      the three months ended
                        December
      31,2009
                      
                      
                      2008REVENUESLaboratory
      Information Services
                      
                      $
                      22,400
                      
                      
                      $
                      28,400Clinical
      Services
                      
                      
                      121,100
                      
                      
                      
                      143,200143,500
                      
                      
                      
                      171,600OPERATING
      EXPENSESCost
      of laboratory services revenues
                      
                      
                      29,600
                      
                      
                      
                      33,500Research
      and development
                      
                      
                      233,200
                      
                      
                      
                      682,400Sales
      and marketing
                      
                      
                      200,400
                      
                      
                      
                      263,200General
      and administrative
                      
                      
                      1,537,100
                      
                      
                      
                      625,500Total
      operating expenses
                      
                      
                      2,000,300
                      
                      
                      
                      1,604,600OPERATING
      LOSS
                      
                      
                      (1,856,800
                      )
                      
                      
                      (1,433,000
                      )OTHER
      INCOME (EXPENSE):Interest
      income (expense), net
                      
                      
                      (1,600
                      )
                      
                      
                      1,100Total
      other income
                      
                      
                      (1,600
                      )
                      
                      
                      1,100LOSS
      BEFORE PROVISION FOR INCOME TAXES
                      
                      
                      (1,858,400
                      )
                      
                      
                      (1,431,900
                      )Income
      taxes
                      
                      
                      800
                      
                      
                      
                      -NET
      LOSS
                      
                      $
                      (1,859,200
                      )
                      
                      $
                      (1,431,900
                      )NET
      LOSS PER SHARE:Basic
                      
                      $
                      (0.04
                      )
                      
                      $
                      (0.06
                      )Diluted
                      
                      $
                      (0.04
                      )
                      
                      $
                      (0.06
                      )WEIGHTED
      AVERAGE SHARES OUTSTANDING:Basic
                      
                      
                      42,584,297
                      
                      
                      
                      25,299,547Diluted
                      
                      
                      42,584,297
                      
                      
                      
                      25,299,547




See
accompanying Notes to Condensed Consolidated Financial
Statements.


3


CNS
RESPONSE, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS





As at
                    December 31,
                    2009
                    (Unaudited)
                  
                  
                  As at
                    September 30,
                    2009ASSETSCURRENT
      ASSETS:Cash
                  
                  $
                  1,925,000
                  
                  
                  $
                  988,100Accounts
      receivable (net of allowance for doubtful accounts of $12,100 and $11,700
      as of December 31 and September 30, 2009 respectively)
                  
                  
                  57,400
                  
                  
                  
                  61,700Prepaids
      and other (including  $7,200 and $0 from related parties as of
      December 31 and September 30, 2009, respectively)
                  
                  
                  46,300
                  
                  
                  
                  89,500Total
      current assets
                  
                  
                  2,028,700
                  
                  
                  
                  1,139,300Furniture
      and fixtures
                  
                  
                  15,100
                  
                  
                  
                  17,600Other
      assets
                  
                  
                  20,700
                  
                  
                  
                  4,000TOTAL
      ASSETS
                  
                  $
                  2,064,500
                  
                  
                  $
                  1,160,900LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable (including $60,000 and $7,000 to related parties as of December 31
      and September 30, 2009, respectively)
                  
                  $
                  1,087,800
                  
                  
                  $
                  1,285,600Accrued
      liabilities
                  
                  
                  259,400
                  
                  
                  
                  261,400Deferred
      compensation (including $89,600 and $81,200 to related parties as of
      December 31 and September 30, 2009, respectively)
                  
                  
                  226,900
                  
                  
                  
                  220,100Accrued
      patient costs
                  
                  
                  198,300
                  
                  
                  
                  305,500Accrued
      consulting fees (including $0 and $18,000 to related parties as of
      December 31 and September 30, 2009, respectively)
                  
                  
                  52,100
                  
                  
                  
                  72,100Current
      portion of long-term debt
                  
                  
                  97,900
                  
                  
                  
                  95,900Total
      current liabilities
                  
                  
                  1,922,400
                  
                  
                  
                  2,240,600LONG-TERM
      LIABILITIESNote
      payable to officer
                  
                  
                  -
                  
                  
                  
                  24,800Capital
      lease
                  
                  
                  5,000
                  
                  
                  
                  5,600Total
      long-term liabilities
                  
                  
                  5,000
                  
                  
                  
                  30,400TOTAL
      LIABILITIES
                  
                  
                  1,927,400
                  
                  
                  
                  2,271,000COMMITMENTS
      AND CONTINGENCIES
                  
                  
                  -
                  
                  
                  
                  -STOCKHOLDERS'
      EQUITY:Common
      stock, $0.001 par value; authorized 750,000,000 shares; 53,207,795
      and 41,781,129 shares outstanding as of December 31 and September 30,
      2009, respectively
                  
                  
                  53,200
                  
                  
                  
                  41,800Additional
      paid-in capital
                  
                  
                  27,139,000
                  
                  
                  
                  24,044,000Accumulated
      deficit
                  
                  
                  (27,055,100
                  )
                  
                  
                  (25,195,900
                  )Total
      stockholders' equity
                  
                  
                  137,100
                  
                  
                  
                  (1,110,100
                  )TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                  
                  $
                  2,064,500
                  
                  
                  $
                  1,160,900





See
accompanying Notes to Condensed Consolidated Financial
Statements.


4


CNS
RESPONSE, INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





For
      the three months ended
                        December
      31,2009
                      
                      
                      2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
                      
                      $
                      (1,859,200
                      )
                      
                      $
                      (1,431,900
                      )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and Amortization
                      
                      
                      2,400
                      
                      
                      
                      2,300Stock-based
      compensation
                      
                      
                      183,800
                      
                      
                      
                      227,500Doubtful
      Debt write-off
                      
                      
                      5,800
                      
                      
                      
                      -Changes
      in operating assets and liabilities:Accounts
      receivable
                      
                      
                      (1,500
                      )
                      
                      
                      8,900Prepaids
      and other current assets
                      
                      
                      43,200
                      
                      
                      
                      63,900Accounts
      payable
                      
                      
                      (197,800
                      )
                      
                      
                      (50,600
                      )Accrued
      liabilities
                      
                      
                      (2,000
                      )
                      
                      
                      22,400Deferred
      compensation
                      
                      
                      6,800
                      
                      
                      
                      (25,100
                      )Accrued
      consulting fees
                      
                      
                      (20,000
                      )
                      
                      
                      (2,600
                      )Accrued
      patient costs
                      
                      
                      (107,200
                      )
                      
                      
                      231,300Security
      deposit on new lease
                      
                      
                      (16,600
                      )
                      
                      
                      -Net
      cash used in operating activities
                      
                      
                      (1,962,300
                      )
                      
                      
                      (953,900
                      )CASH
      FLOWS FROM FINANCING ACTIVITIESRepayment
      of note
                      
                      
                      (22,900
                      )
                      
                      
                      (21,000
                      )Repayment
      of lease
                      
                      
                      (500
                      )
                      
                      
                      (500
                      )Proceeds
      from sale of common stock, net of  offering
costs
                      
                      
                      2,922,600
                      
                      
                      
                      -Net
      cash provided by (used in) financing activities
                      
                      
                      2,899,200
                      
                      
                      
                      (21,500
                      )Net
      increase (decrease) in cash
                      
                      
                      936,900
                      
                      
                      
                      (975,400
                      )Cash,
      beginning of period
                      
                      
                      988,100
                      
                      
                      
                      1,997,000Cash,
      end of period
                      
                      $
                      1,925,000
                      
                      
                      $
                      1,021,600SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash  paid
      during the period for:Interest
                      
                      $
                      1,600
                      
                      
                      $
                      -Income
      taxes
                      
                      $
                      800
                      
                      
                      $
                      800





See
accompanying Notes to Condensed Consolidated Financial
Statements.


5


CNS
RESPONSE, INC.


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)




For
      the three months ended December 31, 2009
                
                Common
      Stock
                
                
                Additional
                  Paid-in
                
                
                AccumulatedShares
                
                
                Amount
                
                
                Capital
                
                
                Deficit
                
                
                TotalBALANCE
      - September 30, 2009 (Audited)
                
                
                41,781,129
                
                
                $
                41,800
                
                
                $
                24,044,000
                
                
                $
                (25,195,900
                )
                
                $
                (
      1,110,100
                )Stock-based
      compensation
                
                
                -
                
                
                
                -
                
                
                
                183,800
                
                
                
                -
                
                
                
                183,800Issuance
      of stock in connection with the Maxim PIPE net of offering cost of
      $505,300
                
                
                11,426,666
                
                
                
                11,400
                
                
                
                2,911,200
                
                
                
                -
                
                
                
                2,922,600Warrants
      issued in association with the Maxim PIPE
                
                
                -
                
                
                
                -
                
                
                
                7,383,400
                
                
                
                -
                
                
                
                7,383,400Offering
      cost pertaining to the Maxim PIPE
                
                
                -
                
                
                
                -
                
                
                
                (7,383,400
                )
                
                
                -
                
                
                
                (7,383,400
                )Net
      loss for the three months ended December 31, 2009
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,859,200
                )
                
                
                (1,859,200
                )Balance
      at December 31, 2009
                
                
                53,207,795
                
                
                $
                53,200
                
                
                $
                27,139,000
                
                
                $
                (27,055,100
                )
                
                $
                137,100





For
      the three months ended December 31, 2008
                
                Common
      Stock
                
                
                Additional
                  Paid-in
                
                
                AccumulatedShares
                
                
                Amount
                
                
                Capital
                
                
                Deficit
                
                
                TotalBALANCE
      - September 30, 2008 (Audited)
                
                
                25,299,247
                
                
                $
                25,300
                
                
                $
                17,701,300
                
                
                $
                (16,673,700
                )
                
                $
                1,052,900Stock-based
      compensation
                
                
                -
                
                
                
                -
                
                
                
                227,500
                
                
                
                -
                
                
                
                227,500Net
      loss for the three months ended December 31, 2008
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,431,900
                )
                
                
                (1,431,900
                )Balance
      at December 31, 2008
                
                
                25,299,247
                
                
                $
                25,300
                
                
                $
                17,928,800
                
                
                $
                (18,105,600
                )
                
                $
                (151,500
                )





See
accompanying Notes to Condensed Consolidated Financial
Statements.


6


CNS
RESPONSE, INC.





NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL


STATEMENTS





1.
            NATURE OF OPERATIONS AND BASIS
      OF PRESENTATION




Organization
and Nature of Operations




CNS
Response, Inc. (the “Company”) was incorporated as Strativation, Inc. in
Delaware on July 10, 1984.  In connection with a merger on March 7,
2007 with CNS Response, Inc., a California corporation, the Company changed its
name to its current name and commenced its current operations.  The
Company utilizes a patented system that guides psychiatrists and other
physicians to determine a proper treatment for patients with mental, behavioral
and/or addictive disorders.  The Company also intends to identify,
develop and commercialize new indications of approved drugs and drug candidates
for this patient population.




In
addition, as a result of its acquisition of Neuro-Therapy Clinic, Inc. (“NTC”)
on January 11, 2008, the Company provides behavioral health care
services.  NTC is a center for highly-advanced testing and treatment
of neuropsychiatric problems, including learning, attentional and behavioral
challenges, mild head injuries, as well as depression, anxiety, bipolar and all
other common psychiatric disorders. Through this acquisition, the Company
expects to advance neurophysiology data collection, beta-test planned
technological advances in rEEG, advance physician training in rEEG and
investigate practice development strategies associated with rEEG.




Going
Concern Uncertainty




The
Company has a limited operating history and its operations are subject to
certain 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 Quarterly
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.




Basis
of Presentation




The
unaudited condensed consolidated financial statements of CNS Response, Inc.
(“CNS,” “we,” “us,” “our” or the “Company”) have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission and include all
the accounts of CNS and its wholly owned subsidiaries CNS California and
NTC.  Certain information and note disclosures, normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States, have been condensed or omitted pursuant to such
rules and regulations. The unaudited condensed consolidated financial statements
reflect all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of our financial position as of December 31, 2009
and our operating results, cash flows, and changes in stockholders’ equity for
the interim periods presented. The September 30, 2009 balance sheet was derived
from our audited consolidated financial statements but does not include all
disclosures required by accounting principles generally accepted in the United
States of America. These unaudited condensed consolidated financial statements
and the related notes should be read in conjunction with our consolidated
financial statements and notes for the year ended September 30, 2009 which are
included in our current report on Form 10-K, filed with the Securities and
Exchange Commission on December 30, 2009.


7


CNS
RESPONSE, INC.





NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL


STATEMENTS




The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and revenues and expenses in the
financial statements. Examples of estimates subject to possible revision based
upon the outcome of future events include, among others, recoverability of
long-lived assets and goodwill, stock-based compensation, the allowance for
doubtful accounts, the valuation of equity instruments, use and other taxes.
Actual results could differ from those estimates.




The
results of operations for the three months ended December 31, 2009 are not
necessarily indicative of the results that may be expected for future periods or
for the year ending September 30, 2010.




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.





As of
December 31, 2009 the Company did not identify any assets or liabilities that
are required to be presented on the balance sheet at fair value in accordance
with ASC 820-10.


8


CNS
RESPONSE, INC.





NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL


STATEMENTS





Recent
Accounting Pronouncements





In April
2009, the FASB issued ASC 825-10 (formerly FASB Staff Position
No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of
Financial Instruments) (“ASC 825”) , which requires that the fair value
disclosures required for all financial instruments within the scope of SFAS 107,
"Disclosures about Fair Value of Financial Instruments", be included in interim
financial statements. This FSP also requires entities to disclose the method and
significant assumptions used to estimate the fair value of financial instruments
on an interim and annual basis and to highlight any changes from prior periods.
FSP 107-1 was effective for interim periods ending after June 15, 2009, with
early adoption permitted. The adoption of FSP 107-1 did not have a material
impact on the Company’s consolidated financial statements.





In May
2009, the FASB issued ASC 855-10 (formerly Statement No. 165, Subsequent
Events) (“ASC 855”). ASC 855 establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. In accordance
with this Statement, entities should apply the requirements to interim or annual
financial periods ending after June 15, 2009.  The adoption of this
statement did not have a material impact on the Company’s consolidated
financial statements.





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 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 August
2009, the FASB issued Accounting Standards Update No. 2009-05 (ASU 2009-05),
“Fair Value Measurements and Disclosures (Topic 820) – Measuring Liabilities at
Fair Value.” ASU 2009-05 amends Subtopic 820-10, “Fair Value Measurements and
Disclosures – Overall,” and provides clarification for the fair value
measurement of liabilities. ASU 2009-05 is effective for the first reporting
period including interim period beginning after issuance. The adoption of ASU
2009-05 did not have a material impact on the Company’s consolidated financial
statements.





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 consolidated financial statements.


9


CNS
RESPONSE, INC.





NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL


STATEMENTS





2.
            CONVERTIBLE
      DEBT AND EQUITY FINANCING




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





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





The
Private Placement Transactions





Completion
of First Closing of 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, first exercisable no earlier than
February 26, 2010.




Secondary
placement agents who provided services in connection with 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, first exercisable no earlier than February
26, 2010.  These warrants were issued during the three months ended
December 31, 2009.


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 that 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 on February 1,
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 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.


11


CNS
RESPONSE, INC.





NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL


STATEMENTS





Events
Relating to 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.





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.


12




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS




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 and Third Closings of Private Placement Transaction




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





Pursuant
to Subscription Agreements entered into with the investors, the Company sold
approximately 63 Investment Units in the two 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 at the second closing and $380,200 at the third
closing.  The Company intends to use the proceeds from the second and
third 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 Leonard
Brandt.





A FINRA
member firm, the Maxim Group acted as lead placement agent in connection with
the second and third 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, first exercisable no
earlier than June 24, 2010.  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, first
exercisable no earlier than June 30, 2010.


13




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS


Secondary
placement agents who provided services in connection with 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, first exercisable no earlier than June 24,
2010.  In connection with the third closing of the private placement,
secondary placement agents who provided services to the Company 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,
first exercisable no earlier than June 30, 2010.





In
connection with the second and third 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.




3.
            STOCKHOLDERS’
      EQUITY




Common
and Preferred Stock




As of
December 31, 2009 the Company is authorized to issue 750,000,000 shares of
common stock.




As of
December 31, 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
December 31, 2009, Colorado CNS Response, Inc. is authorized to issue 1,000,000
shares of common stock.




As of
December 31, 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 are reserved for issuance under the 2006 Plan.  As of December
31, 2009, 2,124,740 options were exercised and there were 6,470,973 options and
183,937 restricted shares outstanding under the 2006 Plan and 1,220,350 shares
available for issuance of awards.


14




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS


The 2006
Plan provides that in any calendar year, no eligible employee or director shall
be granted an award to purchase more than 3 million shares of stock. The option
price for each share of stock subject to an option shall be (i) no less than the
fair market value of a share of stock on the date the option is granted, if the
option is an ISO, or (ii) no less than 85% of the fair market value of the stock
on the date the option is granted, if the option is a NSO; provided, however, if
the option is an ISO granted to an eligible employee who is a 10% shareholder,
the option price for each share of stock subject to such ISO shall be no less
than 110% of the fair market value of a share of stock on the date such ISO is
granted. Stock options have a maximum term of ten years from the date of grant,
except for ISOs granted to an eligible employee who is a 10% shareholder, in
which case the maximum term is five years from the date of grant. ISOs may be
granted only to eligible employees. The Company has adopted ASC 718-20
(formerly, SFAS No. 123R-revised 2004, “Share-Based Payment”), and related
interpretations. Under ASC 718-20, 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.  No options were granted during the three months
ended December 31, 2009.




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 three months ended December 31, 2009 and 2008
is as follows:




For the three months ended December 31,2009
                                  
                                  
                                  2008Operations
                                  
                                  $
                                  4,000
                                  
                                  
                                  $
                                  4,000Research
      and development
                                  
                                  
                                  65,000
                                  
                                  
                                  
                                  65,200Sales
      and marketing
                                  
                                  
                                  29,600
                                  
                                  
                                  
                                  41,800General
      and administrative
                                  
                                  
                                  85,200
                                  
                                  
                                  
                                  116,500Total
                                  
                                  $
                                  183,800
                                  
                                  
                                  $
                                  227,500




Total
unrecognized compensation as of December 31, 2009 amounted to
$765,100




A summary
of stock option activity is as follows:




Number of
                          Shares
                        
                        
                        Weighted
                          Average Exercise
                          PriceOutstanding
      at September 30, 2009
                        
                        
                        6,662,014
                        
                        
                        $
                        0.76Granted
                        
                        
                        -
                        
                        
                        
                        -Exercised
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        (191,041
                        )
                        
                        $
                        1.14Outstanding
      at December 31, 2009
                        
                        
                        6,470,973
                        
                        
                        $
                        0.74


15




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS
  Following
is a summary of the status of options outstanding at December 31,
2009:


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
                    
                    
                    
                    56,000
                    
                    10
      years
                    
                    $
                    0.40Total
                    
                    
                    
                    6,470,973
                    
                    
                    
                    $
                    0.74




Warrants
to Purchase Common Stock




At
September 30, 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
      23,333,333
      shares
                              
                              $
                              0.30
                              
                              A
      $1,000,000 bridge note with Pappajohn on June 12, 2009 as described
      in Note 23,404,991
      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
  23,023,927
      shares
                              
                              $
                              0.30
                              
                              Associated with the
      automatic conversion of$1,700,000 of
      convertible promissory notes and$20,900 accrued
      interest upon completion an equityfinancing
      in excess of $1,500,000 as described  in Note
      2274,867
      shares
                              
                              $
                              0.33
                              
                              The
      placement agent for private placement as described in Note
    2




At
September 30, 2009, there were warrants outstanding to purchase 15,537,485
shares.  During the three months ended December 31, 2009, a further
6,877,601 warrants were granted as follows:


5,713,334
      shares
                        
                        $
                        0.30
                        
                        Associated
      with the second and third closing of the private placement transaction of
      11,426,667 shares at $0.30 with 50% warrant coverage as described in Note
      21,164,267
      shares
                        
                        $
                        0.33
                        
                        Associated
      with warrants for the lead and secondary placement agents for private
      placement as described in Note
2


16




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS




At
December 31, 2009, there were warrants outstanding to purchase 22,415,086 shares
of the Company’s common stock at exercise prices ranging from $0.01 to $1.812
with a weighted average exercise price of $0.55.  The warrants expire
at various times through 2017.




4. 
RELATED PARTY TRANACTIONS





As at
December 31, 2009 accounts payable included the following: $24,000 of accrued
fees due to a director in accordance with a consulting agreement; and $36,000
due to a family member of the Company’s Chief Executive Officer, who provided
data discovery consulting services in support of the Company’s litigation with
Mr. Brandt.





5.  LONG-TERM DEBT





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 December 31, 2009 and
September 30, 2009 the note has an outstanding principal balance in the amount
of $95,800 and $118,600 respectively.  The entire balance is current
as of December 31, 2009.





6.  REPORTABLE
SEGMENTS





The
Company operates in two business segments: Laboratory Information Services and
Clinic.  Laboratory Information Services provide reports (“rEEG
Reports”) that assist physicians with treatment strategies for patients with
behavioral (psychiatric and/or addictive) disorders based on the patient’s own
physiology.  Clinic operates NTC, a full service psychiatric
practice.





The
following tables show operating results for 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:


Three Months ended December 31, 2009Laboratory
                      Information
                      Services
                    
                    
                    Clinic
                    
                    
                    Eliminations
                    
                    
                    TotalRevenues
                    
                    $
                    26,400
                    
                    
                    $
                    154,400
                    
                    
                    $
                    (37,300
                    )
                    
                    $
                    143,500Operating
      expenses:Cost
      of revenues
                    
                    
                    29,600
                    
                    
                    
                    4,000
                    
                    
                    
                    (4,000
                    )
                    
                    
                    29,600Research
      and development
                    
                    
                    233,200
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    233,200Sales
      and marketing
                    
                    
                    198,400
                    
                    
                    
                    2,000
                    
                    
                    
                    
                    
                    
                    
                    200,400General
      and administrative
                    
                    
                    1,422,000
                    
                    
                    
                    148,400
                    
                    
                    
                    (33,300
                    )
                    
                    
                    1,537,100Total
      operating expenses
                    
                    $
                    1,883,200
                    
                    
                    $
                    154,400
                    
                    
                    $
                    (37,300
                    )
                    
                    $
                    2,000,300Loss
      from operations
                    
                    $
                    (1,856,800
                    )
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    (1,856,800
                    )


17




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS




Three Months ended December 31, 2008Laboratory
                    Information
                    Services
                  
                  
                  Clinic
                  
                  
                  Eliminations
                  
                  
                  TotalRevenues
                  
                  $
                  32,200
                  
                  
                  $
                  149,600
                  
                  
                  $
                  (10,200
                  )
                  
                  $
                  171,600Operating
      expenses:Cost
      of revenues
                  
                  
                  33,500
                  
                  
                  
                  3,800
                  
                  
                  
                  (3,800
                  )
                  
                  
                  33,500Research
      and development
                  
                  
                  682,400
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  682,400Sales
      and marketing
                  
                  
                  260,600
                  
                  
                  
                  2,600
                  
                  
                  
                  -
                  
                  
                  
                  263,200General
      and administrative
                  
                  
                  481,300
                  
                  
                  
                  150,600
                  
                  
                  
                  (6,400
                  )
                  
                  
                  625,500Total
      operating expenses
                  
                  $
                  1,457,800
                  
                  
                  $
                  157,000
                  
                  
                  $
                  (10,200
                  )
                  
                  $
                  1,604,600Loss
      from operations
                  
                  $
                  (1,425,600
                  )
                  
                  $
                  (7,400
                  )
                  
                  $
                  -
                  
                  
                  $
                  (1,433,000
                  )





The
following table includes selected segment financial information as of December
31, 2009, related to goodwill and total assets:





Laboratory
                      Information Services
                    
                    
                    Clinic
                    
                    
                    TotalGoodwill
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Total
      assets
                    
                    $
                    2,019,900
                    
                    
                    $
                    44,600
                    
                    
                    $
                    2,064,500




7.
            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 three months ended December
31, 2009 and 2008, the Company has excluded all common equivalent shares from
the calculation of diluted net loss per share as such securities are
anti-dilutive.


18




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS
  A summary
of the net income (loss) and shares used to compute net income (loss) per share
for the three months ended December 31, 2009 and 2008 is as
follows:




2009
                        
                        
                        2008Net
      loss for computation of basic net loss per share
                        
                        $
                        (1,859,200
                        )
                        
                        $
                        (1,431,900
                        )Net
      loss for computation of dilutive net loss per share
                        
                        $
                        (1,859,200
                        )
                        
                        $
                        (1,431,900
                        )Basic
      net loss per share
                        
                        $
                        (0.04
                        )
                        
                        $
                        (0.06
                        )Diluted
      net loss per share
                        
                        $
                        (0.04
                        )
                        
                        $
                        (0.06
                        )Basic
      weighted average shares outstanding
                        
                        
                        42,584,297
                        
                        
                        
                        25,299,547Dilutive
      common equivalent shares
                        
                        
                        -
                        
                        
                        
                        -Diluted
      weighted average common shares
                        
                        
                        42,584,297
                        
                        
                        
                        25,299,547Anti-dilutive
      common equivalent shares not included in the computation of dilutive net
      loss per share:Convertible
      debt
                        
                        
                        -
                        
                        
                        
                        4,995,000Warrants
                        
                        
                        16,089,296
                        
                        
                        
                        6,899,353Options
                        
                        
                        6,630,174
                        
                        
                        
                        8,941,598




8.
            COMMITMENTS
      AND CONTINGENT LIABILITIES




Litigation




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.




Since
June of 2009, we have been involved in litigation against Leonard J. Brandt, a
stockholder, former director and our 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, 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, which the Company believes is without merit and intends to
vigorously defend.




The Chancery
Court also denied an injunction sought by Mr. Brandt to prevent the voting
of shares issued by the Company in connection with our 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 the Company believes is without merit and
intends to vigorously defend.


19




CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS




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.




An action
before the United States District Court for the Central District of California
remains outstanding.  The Company is evaluating its options in
connection with this lawsuit.




Lease
Commitments




The
Company leased its headquarters and Laboratory 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 Laboratory
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
Company leases space for its Clinical Services operations under an operating
lease. The base rental as of December 31, 2009 is $6,000 per
month.  This lease terminates on February 28, 2010.




The
Company also sub-leases space for its Clinical Services operations on a
month-to-month basis for $1,000 per month.




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 $37,600 and $32,800 for the three months ended
December 31, 2009 and 2008, respectively.




9.
            SUBSEQUENT
      EVENTS




Completion
of fourth and final Closing of Private Placement Transaction




On
January 4, 2010, the Company completed its 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 $108,000 from
accredited investors.





Pursuant
to Subscription Agreements entered into with the investors, the Company sold 2
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.


20


CNS
RESPONSE, INC.
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIALSTATEMENTS
 
 After
commissions and expenses, the Company received net proceeds of approximately
$95,000 at the fourth closing.  The Company intends to use the
proceeds from this closing 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 Leonard
Brandt.
 
 A FINRA
member firm, the Maxim Group acted as lead placement agent in connection with
the fourth closing of the private placement.  For its services in
connection with 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, first exercisable no earlier than July
4, 2010.
 
 In
connection with the fourth closing of the Company’s private placement, each
investor who participated in the financing became party to the Registration
Rights agreement described above under Note 2 and will receive the same rights
and benefits as the investors in the first three closings of the Company’s
Private Placement which commenced on August 26, 2009.
  21
  Item
2.     Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
  The
information contained in this Form 10-Q is intended to update the information
contained in our Annual Report on Form 10-K for the year ended September 30,
2009 and presumes that readers have access to, and will have read, the
“Management's Discussion and Analysis or Plan of Operation” and other
information contained in such Form 10-K. The following discussion and analysis
also should be read together with our consolidated financial statements and the
notes to the consolidated financial statements included elsewhere in this Form
10-Q.
  This
discussion summarizes the significant factors affecting the condensed
consolidated operating results, financial condition and liquidity and cash flows
of CNS Response, Inc. for the three months ended December 31, 2009 and 2008.
Except for historical information, the matters discussed in this management's
discussion and analysis or plan of operation are “forward-looking statements”
that involve risks and uncertainties and are based upon judgments concerning
various factors that are beyond our control. Actual results could differ
materially from those projected in the forward-looking statements as a result
of, among other things, the factors referred to below under the caption
“Cautionary Statements and Risk Factors.”
  Overview
  We are a
life sciences company with two distinct business segments. Our Laboratory
Information Services business operated by CNS California, which we consider our
primary business, is focused on the commercialization of a patented system that
guides psychiatrists and other physicians to determine a proper treatment for
patients with behavioral (psychiatric and/or addictive)
disorders.  Our Clinical Services business operated by Neuro-Therapy
Clinic, ("NTC") is a full service psychiatric clinic.
  Laboratory
Information Services
  In
connection with our Laboratory Information Services business, we have developed
an extensive proprietary database (the “CNS Database”) consisting of over 17,000
clinical outcomes across more than 2,000 patients who had psychiatric or
addictive problems. For each patient, we have compiled electroencephalographic
(“EEG”) data, symptoms and outcomes, often across multiple treatments from
multiple psychiatrists and physicians. Using this database, our technology
compares a patient’s EEG to the outcomes in the database and ranks
treatment options based on treatment success of patients having similar
neurophysiology.
  Trademarked
as Referenced-EEG ® (“rEEG
®
”), this patented technology allows us to create and provide simple reports
(“rEEG Reports”) that specifically guide physicians to treatment strategies
based on the patient’s own physiology. The vast majority of these patients were
considered long-term “treatment-resistant”, the most challenging, high-risk and
expensive category to treat.
 
 rEEG
identifies relevant neurophysiology that is variant from the norm and identifies
medications that have successfully treated database patients having similar
aberrant physiology.  It does this by comparing a patient’s standard
digital EEG to an external normative database, which identifies the presence of
abnormalities. The rEEG process then identifies a set of patients having similar
abnormalities as recorded in our CNS Database and reports on historical relative
medication success for this stratified group. Upon completion, the physician is
provided the analysis in a report detailing and ranking classes of agents (and
specific agents within the class) by treatment success for patients having
similar abnormal electrophysiology.
  Our
business is focused on increasing the demand for our rEEG
services.  We believe the key factors that will drive broader adoption
of rEEG will be acceptance by healthcare providers of its clinical benefits,
demonstration of the cost-effectiveness of using our test, reimbursement by
third-party payers, expansion of our sales force and increased marketing
efforts.
  22
  Clinical
Services
  In
January 2008, we acquired our 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 largest psychiatric
medication management practices in the state of Colorado, with six full time and
four part time employees including psychiatrists and clinical nurse specialists
with prescribing privileges.  Daniel A. Hoffman, M.D. is the medical
director at NTC, and, after the acquisition, became our Chief Medical Officer
and more recently, our President.
 
 NTC,
having performed a significant number of rEEG’s, serves an important resource in
our product development, the expansion of our CNS Database, production system
development and implementation, along with the integration of our rEEG services
into a medical practice.  Through NTC, we also expect to successfully
develop marketing and patient acquisition strategies for our Laboratory
Information Services business. Specifically, NTC is learning how to best
communicate the advantages of rEEG to patients and referring physicians in the
local market.  We will share this knowledge and developed
communication programs learned through NTC with other physicians using our
services, which we believe will help drive market acceptance of our
services.  In addition, we plan to use NTC to train practitioners
across the country in the uses of rEEG technology.
 
 We view
our Clinical Services business as secondary to our Laboratory Information
Services business, and we have no current plans to expand this
business.
 
 Business
operations
  Since our
inception, we have generated significant net losses. As of December 31, 2009, we
had an accumulated deficit of $27.0 million. We incurred operating losses of
$1.9 million and $1.4 million for the three months ended December 31, 2009 and
2008, respectively.  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 research and development, scale
up of our commercial organization, and other general corporate purposes,
including the payment of legal fees associated with 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 type
of behavioral disorders, the enhancement of the CNS Database and, to a lesser
extent, the identification of new medications that are often combinations of
approved drugs.
 
 The
2009 Private Placement Transaction
  On August
26, 2009, we received gross proceeds of approximately $2,043,000 in the first
closing of our private placement transaction with six
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.  In
connection with the first closing, and as more fully described in Note 2 to the
unaudited condensed consolidated financial statements, certain promissory notes
then outstanding were converted into shares of common stock and we issued
warrants to the investors in connection with these note
conversions.
  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
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.
  23
  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 5
investors.  At the third closing, we sold 8 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.
  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 2 of the unaudited condensed
consolidated financial statements.
 
 Matters
Involving our Former Chief Executive Officer and Former Director, Leonard
Brandt
  On April
10, 2009, our Board of Directors voted to remove Len Brandt as the CEO of the
Company and appointed George Carpenter as our CEO. On the same date, Mr.
Brandt resigned as Chairman of the Board, but retained his seat on the Board of
Directors.  On June 19, 2009, Mr. Brandt informed us of his
intention to call a special meeting of Company stockholders in lieu of an annual
meeting, for the purpose of unseating the other members of the Board and
replacing them with his nominees.  Subsequently, Mr. Brandt made
multiple mailings to stockholders purporting to give notice of a meeting,
scheduled multiple dates for the meeting, and attempted to call and adjourn
meetings on at least six occasions.  Mr. Brandt failed to convene
a quorum or take any action at any of these meetings.
 
 Mr. Brandt
finally attempted to call a special meeting of stockholders to be held on
September 4, 2009, and purportedly held a meeting on that date, at which he
claimed to have elected his own slate of directors.  Subsequent to
this purported meeting, Mr. Brandt filed an action under Section 225
of the Delaware General Corporation Law (“DGCL”) seeking to validate the results
of that purported meeting.  Mr. Brandt also filed several other
actions in the Delaware Chancery Court.  He filed claims for breach of
fiduciary duty in connection with the approval by our Board of the May 14, 2009
and June 18, 2009 bridge loans and the first closing of the private placement on
August 26, 2009, and made a motion to preliminarily enjoin the voting of certain
shares of our common stock and to prevent action by written consent by such
stockholders.  Mr. Brandt also sought a permanent injunction against
the voting of these shares and to rescind their issuance.  While these
actions were pending, we were operating under what is commonly referred to as a
“status quo” order, which maintained the Board of Directors in place immediately
prior to the purported September 4 meeting (Messrs. Carpenter, Jones, Pappajohn,
Thompson and Brandt, and Drs. Harbin and Vaccaro).  The status quo
order also placed certain restrictions on certain corporate actions during the
pendency of the Section 225 action described above.
 
 On
December 2, 2009, following a two day trial, the Delaware Court of Chancery
entered judgment for the Company and its incumbent directors in the Section 225
action and dismissed the action with prejudice.  The entry of Judgment
for the Company in the Section 225 action and dismissal of that action
terminated the “status quo” order, including its restrictions on the Company’s
ability to engage in certain corporate actions.  The Chancery Court
also denied Brandt’s motion for an injunction that sought to prevent the voting
of shares issued by us in connection with the our bridge financings in May and
June of 2009 and the securities offering in August 2009, dismissed Mr. Brandt's
counterclaims alleging breaches of duties in connection with those transactions,
and dismissed with prejudice another action brought by Mr. Brandt that
claimed he had not been provided with information owed to
him.  Finally, the Court dismissed the claims by us against Mr.
Brandt, without prejudice.  On January 4, 2010, Brandt filed appeals
with the Supreme Court of the State of Delaware in relation to certain of the
above matters, including the Section 225 action, which the Company believes are
without merit and intends to vigorously defend.
 
 On
September 29, 2009, we held our annual meeting of Stockholders at which each of
George Carpenter, Henry Harbin, M.D., David Jones, John Pappajohn, Jerome
Vaccaro, M.D. and Tommy Thompson were elected.
  24
  We filed
an action in the United States District Court for the Central District of
California against Mr. Brandt and certain others in
July 2009.  Our complaint alleges 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 have
filed counterclaims against us, alleging violations of federal securities laws
relating to alleged actions and statements taken or made by us or our officers
and directors in connection with Mr. Brandt’s proxy and consent
solicitations.  Given our victory in the Delaware Court of Chancery
(which is now being appealed by Brandt), we have not determined whether or how
we will pursue this action.  Mr. Brandt may choose to proceed
with his counterclaim.
 
 We have
expended substantial resources to pursue the defense of legal proceedings
initiated by Mr. Brandt.  Although the ruling by the Delaware
Chancery Court appeared to be demonstrative, we will be required to expend
additional resources as a result of the appeals to the Delaware Supreme Court
filed by Brandt.  We also do not know whether Mr. Brandt will
institute new claims against us and the defense of any such claims could involve
the expenditure of additional resources by the Company.
  Publicly
Announced Results of Clinical Trial
 
 On
November 2, 2009, we reported the results of a landmark study presented by
Charles DeBattista, D.M.H, M.D., at the U.S. Psychiatric and Mental Health
Congress.  The poster presentation, titled Referenced-EEG® (rEEG)
Efficacy Compared to STAR*D For Patients With Depression Treatment
Failure:  First Look At Final Results, highlighted a dramatic
improvement in outcomes for patients with treatment resistant
depression.  In this study, our rEEG technology proved effective at
predicting medication response for treatment-resistant patients approximately
65 percent of the time.
 
 The study
included 114 patients in 12 medical centers, including Harvard,
Stanford, Cornell, UCI and Rush.  The 12-week study found that rEEG
significantly outperformed the modified STAR*D treatment
algorithm.  The difference, or separation, between rEEG and the
control group was 50 and 100 percent for the study’s two primary
endpoints.  Typically, separation between a new treatment and a
control group is less than 10 percent in antidepressant
studies.
 
 The
study, the largest in our history, was a randomized, blinded, controlled,
parallel group, multicenter study.  The patients in the study
experienced depression treatment failure of one or more SSRIs and/or had failure
with at least two classes of antidepressants.  The patients fell into
two groups:  1) those treated with rEEG medication guidance, and
2) those treated with the modified STAR*D treatment algorithm.
 
 Financial
Operations Overview
  Revenues
  Our LaboratoryInformationServices revenues are derived from the sale of rEEG
Reports to physicians. Physicians are generally billed upon delivery of a rEEG
Report.  The list prices of our rEEG Reports to physicians range from
$200 to $800 with $400 being the most frequent charge.
  Patient service revenue is generated as a result of
providing services to patients on an outpatient basis. Patient service revenue
is recorded at our established billing rates less contractual adjustments.
Generally, collection in full is not expected on our established billing rates.
Contractual adjustments are recorded to state our patient service revenue at the
amount we expect to collect for the services provided based on amounts due from
third-party payors at contractually determined rates.
  Cost of Revenues
  Cost of revenues are for LaboratoryInformationServices and represent the cost of direct labor,
costs associated with external processing, analysis and consulting review
necessary to render an individualized test result and 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 an rEEG Report.
  25
  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 LaboratoryInformationServices 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 to additional clinical
diagnosis. We charge all research and development expenses to operations as they
are incurred.
  Sales and Marketing
  For our LaboratoryInformationServices, our selling and marketing expenses
consist primarily of personnel and media cost to inform 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 LaboratoryInformationServices 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 unaudited condensed
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these unaudited condensed 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.
  The following critical accounting policies reflect
our more significant estimates and assumptions used in the preparation of our
unaudited condensed consolidated financial statements.
  Revenue Recognition
  We have generated limited revenues since our
inception.  Revenues for our Laboratory 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.
  26
  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.
  Results
of Operations for the three months Ended December 31, 2009 and 2008
  As
earlier described, we operate in two business segments: Laboratory Information
Services and Clinical Services.  Our Laboratory Information Services
business focuses on the delivery of reports ("rEEG Reports") that assist
physicians with treatment strategies for patients with behavioral (psychiatric
and/or addictive) disorders based on the patient's own physiology. Our Clinical
Services business, operated through NTC, provides full psychiatric
services.
  The
following table presents unaudited consolidated statement of operations data for
each of the periods indicated as a percentage of revenues.
  ThreeMonths
                      Ended
                      December31,2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,2008Revenues
                    
                    
                    100
                    %
                    
                    
                    100
                    %Cost
      of revenues
                    
                    
                    21
                    
                    
                    
                    20Gross
      profit
                    
                    
                    79
                    
                    
                    
                    80Research
      and development
                    
                    
                    163
                    
                    
                    
                    398Sales
      and marketing
                    
                    
                    140
                    
                    
                    
                    153General
      and administrative expenses
                    
                    
                    1,071
                    
                    
                    
                    365Operating
      loss
                    
                    
                    (1,294
                    )
                    
                    
                    (835
                    )Other
      income (expense), net
                    
                    
                    (2
                    )
                    
                    
                    (1
                    )Net
      income (loss)
                    
                    
                    (1,296
                    )%
                    
                    
                    (834
                    )%
  Revenues
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeLaboratory
      Service Revenues
                    
                    $
                    22,400
                    
                    
                    $
                    28,400
                    
                    
                    
                    (21
                    )%Clinical
      Service Revenues
                    
                    
                    121,100
                    
                    
                    
                    143,200
                    
                    
                    
                    (15
                    )%Total
      Revenues
                    
                    $
                    143,500
                    
                    
                    $
                    171,600
                    
                    
                    
                    (16
                    )%
  With
respect to our Laboratory Information Services business, the number of
non-clinical study related rEEG Reports delivered for the period decreased from
74 in 2008 to 58 in 2009 (clinical study and training related rEEG reports
are provided free of charge).  We anticipate that Laboratory Services
Revenues will increase with the publication of our Clinical Trial results in a
peer reviewed journal later this year and with our planned increase in sales and
marketing activities.
  Our
Clinical Services revenue is as a result of patient billings for psychiatric
services rendered.  Revenues fell by $22,100 in the three months ended
December 31, 2009 versus the same period in 2008 due to fewer new patients being
treated.  Currently, we do not plan to significantly expand our
Clinical Services business, and therefore we do not anticipate a significant
increase in revenues generated by this business segment.
  27
  Cost
of Revenues
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeCost
      of Laboratory Information Services revenues
                    
                    $
                    29,700
                    
                    
                    $
                    33,500
                    
                    
                    
                    (11
                    )%
 
 Cost of
Laboratory InformationServices 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 three months
ended December 31, 2009, cost of revenues of $29,700 consist primarily of direct
labor and benefit costs of $24,700, which includes stock-based compensation, and
consulting fees of $5,000.  For the same period ended December 31,
2008, cost of revenues of $33,500 consisted primarily of direct labor and
benefit costs of $26,400, including stock-based compensation, and consulting
fees of $6,800.  We expect costs of revenues will increase as an
absolute number as more rEEG Reports are processed.  However, we
expect cost of revenues to decrease as a percentage of revenues as we improve
our operating efficiency.
  Research
and Development
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeLaboratory
      Information Services research and development
                    
                    $
                    233,100
                    
                    
                    $
                    682,400
                    
                    
                    
                    66
                    %
 
 Research
and development expenses consist of clinical study patient expenses, payroll and
benefit costs (including stock-based compensation), costs associated with our
patent portfolio, consulting fees, marketing and recruitment costs, database
enhancements and maintenance costs, travel and conference and other
miscellaneous costs.  Research and development costs for the three
months ended December 31, 2009, totaled $233,100 and were largely comprised of
the following: payroll and benefit costs of $189,500, patent costs of $10,600,
consulting costs of $18,400, database costs of $1,000, insurance costs of $9,400
and travel and conference costs of $1,300.  For the three months
ended December 31, 2008 research and development costs totaled $682,400 and were
largely comprised of the following: clinical study patient costs of $359,300,
payroll and benefit costs of $199,600, patent costs of $56,700, consulting costs
of $8,600, marketing and recruiting costs $34,000, database costs of $6,300,
insurance costs of $9,000 and travel and conference costs of
$5,700.
  Clinical
study patient costs decreased by $359,000 in the 2009 quarter as our clinical
trial had met its recruitment goals and the enrollees had been processed before
the start of the 2009 quarter, whereas the study was in process during the 2008
quarter.  Similarly, marketing and recruitment costs, database costs
and travel and conference costs decreased by $34,000, $5,300 and $4,500
respectively in the 2009 quarter as compared with the 2008
quarter.  However, consultant costs for the 2009 quarter increased by
$9,800 from the prior year as the clinical trial results were being analyzed by
specialist consultants.  Patent costs decreased by $46,100 in the 2009
quarter as the company did not incur costs associated with the filing of new
patent applications during the period.  Payroll and benefit and
miscellaneous costs remained consistent for the 2009 and 2008
quarters.
  28
  We expect that Research and Development expenses
will increase as we conduct additional clinical studies to validate the efficacy
of our rEEG technology.  We also plan to increase Research and
Development expenditures to expand the pharmacological range of our CNS Database
and improve its functionality.   We are applying for grants which, if
obtained, will fund and help us accelerate our research and development
efforts.
 
 Sales
and marketing
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeSales
      and MarketingLaboratory
      Information Services
                    
                    $
                    198,400
                    
                    
                    $
                    260,600
                    
                    
                    
                    (24
                    )%Clinical
      Services
                    
                    
                    2,000
                    
                    
                    
                    2,600
                    
                    
                    
                    (23
                    )%Total
      Sales and Marketing
                    
                    $
                    200,400
                    
                    
                    $
                    263,200
                    
                    
                    
                    (24
                    )%
  Sales and marketing expenses associated with our
LaboratoryInformationServices business consist primarily of payroll and
benefit costs, consulting fees, marketing costs, computer services, travel and
conference costs.  Sales and marketing expenses for the three months
ended December 31, 2009 were comprised of the following: payroll and benefit
costs of $135,600, consulting fees of $22,600, marketing costs of $33,200,
computer services costs of $3,000, and travel and conference costs of
$2,700.  For the three months ended December 31, 2008 the company
incurred: payroll and benefit costs of $172,700, consulting fees of $19,100,
marketing costs of $21,000, computer services costs of $24,600, and travel and
conference costs of $17,800.
 
 In the
2009 quarter, payroll and benefits decreased by $37,100 from the comparable
prior year period as a result of a reduction in personnel.  Computer
services and software costs and travel and conference costs also decreased by
$21,600 and $15,200 respectively due to cost cutting
measures.  Marketing and recruitment costs increased by $12,200 in an
effort to increase patient volume using direct-to-consumer advertizing in key
markets
  In fiscal
2010, we plan to introduce our rEEG technology to additional psychiatric
providers and medical insurance payers, which will increase our sales and
marketing costs.
  Clinical Services sales and marketing expenses
consist of advertising in various media so as to attract patients to our clinic
in Denver.  We do not anticipate materially increasing sales and
marketing expenses relating to our Clinical Services business in fiscal
2010.
  General
and administrative
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeGeneral
      and administrativeLaboratory
      Information Services
                    
                    $
                    1,388,700
                    
                    
                    $
                    474,900
                    
                    
                    
                    192
                    %Clinical
      Services
                    
                    $
                    148,400
                    
                    
                    $
                    150,600
                    
                    
                    
                    (1
                    )%Total
      General and administrative
                    
                    $
                    1,537,100
                    
                    
                    $
                    625,500
                    
                    
                    
                    146
                    %
  29
  General and administrative expenses for our
LaboratoryInformationServices business are primarily related to salaries
and benefits (including stock-based compensation), legal and other professional
fees, consulting service costs, general administration and occupancy costs, dues
and fees, marketing and investor relations costs, and travel and conference
costs.  For the three months ended December 31, 2009 these expenses
were as follows: Salaries and benefits $140,600, legal fees $877,600, other
professional fees $61,900, consulting costs $114,700, general administration and
occupancy costs $62,800, dues and fees $11,500, marketing and investor relations
$68,600, and travel and conference costs $48,800.  For the three
months ended December 31, 2008 these expenses were: Salaries and benefits
$238,800, legal fees $72,400, other professional fees $32,200, consulting costs
$50,000, general administration and occupancy costs $42,500, dues and fees
$15,400, marketing and investor relations costs $14,400, and travel and
conference costs of $15,100.
 
 Changes
in general and administrative expenditures for the 2009 quarter were as
follows:  Salaries and benefit costs decreased by $98,200 as a result
of staff reductions, including the termination of our former CEO, Leonard
Brandt, in April 2009.  Partly offsetting the reduction in salaries
and benefits was an increase in consulting fees of $64,700 as a result of the
hiring of consultants to perform functions previously undertaken by salaried
personnel.  Legal fees increased by $805,200 in the 2009 quarter
primarily due to costs associated with defending against lawsuits brought by our
former CEO, Leonard Brandt.  Other professional fees increased by
$29,700 partly due to audit fees being incurred in this quarter whereas they
were incurred in the following quarter in the prior year.  Marketing
and investor relations costs increased by $54,200 due to increased
communications with our investors during the quarter and as a result of the
development of a publicity plan for the announcement of our clinical trial
results.  General administrative and occupancy costs increased by
$20,300 compared to the prior year period, partially as a result of increased
insurance costs.  Travel and conference costs increased by $33,700
during the quarter ended December 31, 2009 compared to the prior year largely as
a result of travel associated with our litigation with Mr. Brandt and our
efforts to complete our private placement transaction.
  General
and administrative costs for our Clinical Services business for the three months
ended December 31, 2009 were $148,400 which was consistent with costs incurred
for the same period in the prior year.  These costs include all
expenses associated with running NTC, including all payroll costs, medical
supply costs, occupancy costs and other general and administrative
costs.
  Interest
income (expense)
  ThreeMonths
                      Ended
                      December31,
                      2009
                    
                    
                    ThreeMonths
                      Ended
                      December31,
                      2008
                    
                    
                    Percent
                      ChangeLaboratory
      Information Services (Expense), net
                    
                    $
                    (1,400
                    )
                    
                    $
                    1,200
                    
                    
                    
                    *Clinical
      Services (Expense)
                    
                    
                    (200
                    )
                    
                    
                    (100
                    )
                    
                    
                    100
                    %Total
      interest income (expense)
                    
                    $
                    (1,600
                    )
                    
                    $
                    1,100
                    
                    
                    
                    *
 * not meaningful
  With
respect to our Laboratory Information Services business, we earned interest
income of $1,000 for the quarter ended December 31, 2009 from interest bearing
accounts which amount was offset by $2,400 of interest expense.  For
the comparable period in 2008, net interest income was $1,200.
  30




Net
Loss




ThreeMonths
                  Ended
                  December31,
                  2009
                
                
                ThreeMonths
                  Ended
                  December31,
                  2008
                
                
                Percent
                  ChangeLaboratory
      Information Services net loss
                
                $
                (1,859,000
                )
                
                $
                (1,424,400
                )
                
                
                31
                %Clinical
      Services net loss
                
                
                (200
                )
                
                
                (7,500
                )
                
                
                (97
                )%Total
      Net Loss
                
                $
                (1,859,200
                )
                
                $
                (1,431,900
                )
                
                
                30
                %




The
increase in net loss of $427,300 is due to an increase in our general and
administrative costs, primarily due to litigation, which was partly offset by
reductions in research and development costs with the completion of our clinical
trial and reductions in sales and marketing costs.




We expect
to incur a net loss in fiscal 2010 as we continue improving our rEEG technology
and focus on the commercialization of our products.




Liquidity
and Capital Resources




Since our inception, we have incurred significant
losses and as of December 31, 2009, we had an accumulated deficit of
approximately $27.0 million. We have not yet achieved profitability and
anticipate that we will continue to incur net losses for the next year. We
expect that our research and development, sales and marketing and general and
administrative expenses will continue to grow.  As a result, we will
need to generate significant product revenues to achieve profitability which we
may never achieve.




As of December 31, 2009 we had approximately $1.93
million in cash and cash equivalents and a working capital balance of
approximately$106,000compared to approximately $1.02 million in cash and
cash equivalents and a working capital deficit of approximately$395,200as at
December 31, 2008.




Subsequent
to the end of the quarter, on January 4, 2010, we raised additional net proceeds
of $95,000 in connection with the fourth and final closing of our private
placement.




Sources of Liquidity




Since our inception substantially all of our
operations have been financed primarily from equity and debt
financings.  Through December 31, 2009, we had received proceeds of
$13.6 million from the sale of stock, $4.8 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.




Cash Flows




Net cash used in operating activities for the three
months ended December 31, 2009 was $1.96 million compared to $0.95 million for
the three months ended December 31, 2008.  The increase of $1.01
million in cash used was primarily attributable to increased legal fees
associated with the Brandt litigation and increases in marketing and investor
relations, travel and general administration and occupancy costs.




Net cash
proceeds from financing activities for the three months ended December 31, 2009
were $2.92 million, net of placement agent fees, legal fees and other offering
costs, raised on December 24 and 31, 2009 in connection with the second and
third closings of our private placement transaction.  These proceeds
were partly offset by the repayment of $22,900 on a promissory note issued to
Daniel Hoffman M.D. in connection with our acquisition of NTC.  Net
cash used by financing activities in the period ended December 31, 2008
primarily related to the payment of $21,000 on the promissory note issued to
Daniel Hoffman M.D in connection with our NTC acquisition.


31




Contractual Obligations and Commercial
Commitments




As of December 31, 2009, we have a contractual
obligation to pay the remaining balance on a promissory note to Daniel Hoffman
M.D. of $95,800 issued in connection with our acquisition of NTC, which bears
interest at a rate of 8% per annum.  In December 2009, we signed a
lease for our new headquarters and Laboratory Information Services premises
located in Aliso Viejo, California.  This lease expires on January 31,
2013 and our total rent obligation during the term of the lease is
$129,300.  Our lease for our Clinical Operation premises expires on
February 28, 2010 and contractual obligations associated with this lease are
immaterial.  As of December 31, 2008, the balance outstanding on the
aforementioned promissory note was $184,300 and our obligations for leased space
were $97,300.  Please see Notes 5 and 8 to our unaudited condensed
consolidated financial statements mentioned earlier in this report for further
details.




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 we recently received net
proceeds of $2.92 million on December 24 and 31, 2009 upon the second
and third closings of our private placement, we anticipate that our cash on hand
(including the proceeds of $95,000 received from the fourth and final private
placement closing on January 4, 2009) and cash generated through our operations
will not be sufficient to fund our operations for at least the next 12
months.  We therefore anticipate raising additional funds in the
future.




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;





·
            the
      extent to which we incur additional legal fees in our litigation with
      Brandt in relation to his appeals pending before the Delaware Supreme
      Court and his pending counterclaims in the United States District Court;
      and





·
            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.


32




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 December 31, 2009, we had net operating loss
carryforwards for federal income tax purposes of $22.6 million. If not utilized,
the federal net operating loss carryforwards will expire beginning in
2028.  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
      3.
            Quantitative
      and Qualitative Disclosures about Market
Risk.




Not
applicable.




Item
      4.
            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
Rules 13a-15, as of December 31, 2009, the end of the period covered by
this report.  Based on this evaluation, our PEO and PFO concluded that
our disclosure controls and procedures were not effective as of December 31,
2009 for the reasons described below.





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




·
            We
      do not have proper segregation of duties within the accounting and finance
      function.





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





·
            We
      do not have personnel with sufficient financial expertise in the capacity
      of CFO.




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, none of the
aforementioned significant deficiencies led to a misstatement of our results of
operations for the three months ended December 31, 2009, or statement of
financial position as of December 31, 2009.





To
address the identified significant deficiencies, the Company plans to increase
its segregation of duties, particularly with respect to NTC, by having more
accounting functions undertaken by personnel at Company
headquarters.  The Company is also planning to develop a comprehensive
and formal accounting and procedures manual and intends to hire a Chief
Financial Officer.


33




Changes
in Internal Control Over Financial Reporting




Other
than as stated above, there were no changes in our internal control over
financial reporting or in other factors identified in connection with the
evaluation required by paragraph (d) of exchange act rules 13a-15 or 15d-15 that
occurred during the quarter ended December 31, 2009 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.


34


PART
II


OTHER
INFORMATION




Item
      1.
            Litigation




Please
see Note 8 to our Notes to Unaudited Condensed Consolidated Financial Statements
as well as the litigation summary beginning on page 24 under the heading
“Matters Involving our Former Chief Executive Officer and Former Director,
Leonard Brandt” for an update on our ongoing litigation with Leonard
Brandt.





Item
      1A.
            Risk
      Factors




This
Quarterly Report on Form 10-Q contains forward-looking statements, which are
subject to a variety of risks and uncertainties. Other actual results could
differ materially from those anticipated in those forward-looking statements as
a result of various factors, including those set forth in Item 7A of our Annual
Report on Form 10-K for the year ended September 30, 2009.




Item
      6.
            Exhibits




The
following exhibits are filed as part of this report:




Exhibit
                  Number
                
                Exhibit Title10.1
                
                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, 2009.10.2
                
                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,
      2009.10.3
                
                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, 2009.10.4
                
                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, 2009.31.1
                
                Certification
      of Principal Executive Officer pursuant to Securities Exchange Act Rules
      13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                
                Certification
      of Principal Financial Officer pursuant to Securities Exchange Act Rules
      13a-14(a) and 15d-14(a) as adopted pursuant to section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                
                Certification
      of Principal Executive Officer and Principal Financial Officer pursuant to
      18 U.S.C. Section 1350, as adopted pursuant to section 906 of the
      Sarbanes-Oxley Act of
2002.


35




SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.




CNS
      Response, Inc.Date:
      February 16, 2009
              
              /s/ George CarpenterBy:
              George
      CarpenterIts:
              Chief
      Executive Officer(Principal
      Executive, Financial andAccounting
      Officer)


36