CAMBRIDGE HEART INC - FORM 10-Q

Attached files

file	filename
EXCEL - IDEA: XBRL DOCUMENT - CAMBRIDGE HEART INC	Financial_Report.xls
EX-10.3 - LETTER AGREEMENT - CAMBRIDGE HEART INC	camh_ex103.htm
EX-32.2 - CERTIFICATION - CAMBRIDGE HEART INC	camh_ex322.htm
EX-10.2 - LETTER AGREEMENT - CAMBRIDGE HEART INC	camh_ex102.htm
EX-32.1 - CERTIFICATION - CAMBRIDGE HEART INC	camh_ex321.htm
EX-31.1 - CERTIFICATION - CAMBRIDGE HEART INC	camh_ex311.htm
EX-31.2 - CERTIFICATION - CAMBRIDGE HEART INC	camh_ex312.htm
EX-10.4 - LETTER AGREEMENT - CAMBRIDGE HEART INC	camh_ex104.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2012

¨	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 0-20991

CAMBRIDGE HEART, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		13-3679946
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

100 AMES POND DRIVE TEWKSBURY, MASSACHUSETTS		01876
(Address of principal executive offices)		(Zip Code)

978-654-7600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 þ No ¨

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. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

Number of shares outstanding of each of the issuer’s classes of common stock as of November 14, 2012.

Class		Number of Shares Outstanding
Common Stock, par value $.001 per share		100,112,960

CAMBRIDGE HEART, INC.

INDEX

		Page
PART I — FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS		3
	CONDENSED BALANCE SHEETS AT DECEMBER 31, 2011 AND SEPTEMBER 30, 2012 (UNAUDITED)		3
	CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2011 AND 2012 (UNAUDITED)		4
	CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2011 AND 2012 (UNAUDITED)		5
	NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)		6

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		25

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		35

ITEM 4.	CONTROLS AND PROCEDURES		35

PART II — OTHER INFORMATION

ITEM 6.	EXHIBITS		37

SIGNATURE			38

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CAMBRIDGE HEART, INC.

CONDENSED BALANCE SHEETS

(Unaudited)

	December 31,			September 30,
	2011			2012
Assets
Current assets:
Cash and cash equivalents	$	312,610		$	74,594
Restricted cash, current portion		100,000			100,000
Accounts receivable, net of allowance for doubtful accounts of $85,102 at December 31, 2011 and $65,872 at September 30, 2012, respectively		285,815			228,812
Inventory, net of inventory reserve of $1,057,746 and $996,382 at December 31, 2011 and September 30, 2012, respectively		444,377			427,267
Prepaid expenses and other current assets		128,619			131,652
Total current assets		1,271,421			962,325
Fixed assets, net		182,111			154,767
Restricted cash, net current portion		200,000			100,000
Other assets		78,264			40,776
Total Assets	$	1,731,796		$	1,257,868

Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable	$	465,269		$	646,712
Convertible promissory notes payable, net of discount		600,000			499,072
Accrued expenses		1,009,694			908,472
Current portion of capital lease obligation		6,689			8,308
Total current liabilities		2,081,652			2,062,564
Embedded derivative liability on a convertible note		-			18,788
Derivative warrant liability		-			3,415,908
Capital lease obligation, net of current portion		22,014			15,564
Total liabilities		2,103,666			5,512,824
Commitments and contingencies (Note 11)

Convertible Preferred Stock, $.001 par value; 2,000,000 shares authorized at December 31, 2011 and September 30, 2012,
respectively; 6,670 shares issued and outstanding at December 31, 2011 and September 30, 2012, respectively.
Liquidation preference and redemption value of $14,170,000 as of December 31, 2011 and September 30, 2012, respectively		12,747,990			12,747,990
		12,747,990			12,747,990
Stockholders' deficit:

Common Stock, $.001 par value; 250,000,000 and 500,000,000 shares authorized at December 31, 2011 and September 30, 2012, respectively;
100,112,960 shares issued and outstanding at December 31, 2011 and September 30, 2012, respectively		100,113			100,113
Additional paid-in capital		93,338,578			93,687,394
Accumulated deficit		(106,558,551	)		(110,790,453	)
Total stockholders' deficit		(13,119,860	)		(17,002,946	)
Total Liabilities and Stockholders' Deficit	$	1,731,796		$	1,257,868

The accompanying notes are an integral part of these condensed financial statements.

CAMBRIDGE HEART, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2011			2012			2011			2012

Revenue	$	474,911		$	419,062		$	1,653,678		$	1,434,698

Cost of goods sold		342,562			288,004			1,201,011			1,215,043

Gross profit		132,349			131,058			452,667			219,655

Costs and expenses:
Research and development		161,127			63,565			368,116			273,300
Selling, general and administrative		1,263,902			821,103			4,103,043			3,816,485

Total operating expenses		1,425,029			884,668			4,471,159			4,089,785

Loss from operations		(1,292,680	)		(753,610	)		(4,018,492	)		(3,870,130	)

Interest income		9			82			503			1,650

Interest expense		(2,226	)		(335,448	)		(7,229	)		(1,262,961	)

Change in valuation of warrant		-			-			-			761,819

Change in valuation of embedded derivative		-			9,400			-			137,720

Net loss	$	(1,294,937	)	$	(1,079,576	)	$	(4,025,218	)	$	(4,231,902	)

Net loss per common share-basic and diluted	$	(0.01	)	$	(0.01	)	$	(0.04	)	$	(0.04	)

Weighted average common shares outstanding-basic and diluted		98,614,278			100,112,960			98,076,685			100,112,960

The accompanying notes are an integral part of these condensed financial statements.

CAMBRIDGE HEART, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended September 30,
	2011			2012

Net loss	$	(4,025,218	)	$	(4,231,902	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		50,632			94,033
Non-cash interest expense incurred from debt issuance		-			1,075,807
Change in fair value of embedded derivative liability		-			(137,720	)
Change in fair value of derivative warrant liability		-			(761,819	)
Inventory provision		56,085			(61,364	)
Stock based compensation expense		273,226			348,816
Provision (credit) for allowance for doubtful accounts		5,243			(19,230)
Changes in operating assets and liabilities:
Accounts receivable		205,025			76,234
Inventory		(14,186	)		78,474
Prepaid expenses and other current assets		39,429			(3,033	)
Restricted cash		100,000			100,000
Accounts payable and accrued expenses		(225,933	)		80,221

Net cash used for operating activities		(3,535,697	)		(3,361,483	)

Purchases of fixed assets		(51,732	)		(29,202	)

Net cash used in investing activities		(51,732	)		(29,202	)

Proceeds from convertible promissory notes		-			3,157,500
Principal payments on capital lease obligations		(3,618	)		(4,831	)

Net cash provided by (used in) financing activities		(3,618	)		3,152,669

Net decrease in cash and cash equivalents		(3,591,047	)		(238,016)
Cash and cash equivalents, beginning of period		4,188,215			312,610

Cash and cash equivalents, end of period	$	597,168		$	74,594

Supplemental Disclosure of Cash Flow Information

The Company paid $7,229 and $5,848 in interest for the nine month periods ended September 30, 2011 and 2012.

In June 2011, an investor converted 82 shares of Series D Preferred Stock resulting in the issuance of 1,000,000 shares of common stock of the Company.

The accompanying notes are an integral part of these condensed financial statements.

CAMBRIDGE HEART, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

Basis of Presentation and Liquidity

The accompanying condensed financial statements of Cambridge Heart, Inc. (the “Company”) have been prepared in accordance with accounting standards set by the Financial Accounting Standards Board (the “FASB”). The FASB sets generally accepted accounting principles (“GAAP”) that we follow to ensure our financial condition, results of operations, and cash flows are consistently reported.

The Company’s interim financial statements as of September 30, 2011 and 2012 are unaudited and, in the opinion of management, reflect all adjustments (consisting solely of normal and recurring items) necessary to state fairly the Company’s financial position as of September 30, 2012, results of operations for the three and nine months ended September 30, 2011 and 2012 and cash flows for the nine months ended September 30, 2011 and 2012.

The preparation of financial statements requires the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company evaluates its estimates on an on-going basis, including those related to incentive compensation, revenue recognition, allowance for doubtful accounts, inventory valuation, warranty obligations, the fair value of preferred stock, warrants and conversion features, stock-based compensation and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. The results of this evaluation then form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and such differences may be material to the financial statements.

Management believes its existing resources, including cash at September 30, 2012 of $74,594 and the proceeds from the sale of senior secured promissory notes in October 2012 of $150,000, described in further detail in Note 12, and currently projected financial results, are sufficient to fund operations through the end of November 2012. These resources, coupled with the restructuring of the Company’s operations in July 2012 to reduce its cash burn, allows the Company to continue to support its existing customer base and distribution partnerships for a period of time while it continues to execute on certain key activities and explore strategic alternatives. If we encounter material deviations from our plans including, but not limited to, or lower than expected sales of our products, our ability to fund our operations will be negatively impacted.

If the Company is unable to generate adequate cash flows or obtain sufficient additional funding when needed, the Company will have to cut back its operations further, sell some or all of its assets, license potentially valuable technologies to third parties, and/or cease some or all of its operations.

On an as-converted basis as of September 30, 2012, the Company has 124,659,416 shares of common stock issued and outstanding, including 100,112,960 shares of common stock issued, 4,180,602 shares issuable upon conversion of the Series C-1 Convertible Preferred Stock and 20,365,854 shares issuable upon conversion of the Series D Convertible Preferred Stock. Additionally, the Company has reserved 15,660,000 shares of common stock for issuance upon exercise of outstanding warrants issued in connection with the sale of our common stock in December 2010, 34,159,083 shares of common stock for issuance upon conversion of secured convertible promissory notes issued in January, February, May and July 2012, and 34,159,083 shares of common stock for issuance upon exercise of outstanding warrants issued in connection with the sale of secured convertible promissory notes in January, February, May and July 2012. The Company also has stock options outstanding to purchase up to an aggregate of 10,727,080 shares of common stock.

These financial statements assume that the Company will continue as a going concern. If the Company is unable to continue as a going concern, it may be unable to realize its assets and discharge its liabilities in the normal course of business.

The Company’s recurring losses, inability to generate positive cash flows from operations, and liquidity uncertainties from operations raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The interim financial statements of the Company presented herein are intended to be read in conjunction with the financial statements of the Company for the year ended December 31, 2011.

The interim results of operations are not necessarily indicative of results that may occur for the full fiscal year or for future interim periods.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Significant accounting policies followed by the Company are as follows:

Cash and Cash Equivalents

The Company maintains its cash and cash equivalents in bank deposit accounts, which may, at times, exceed federally insured limits. The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. The carrying amount of the Company’s cash equivalents approximates fair value due to the short maturities of these investments. This may include short-term commercial paper, short-term securities of state government agencies with maturities less than three months from date of purchase, money market funds and demand deposits with financial institutions.

At December 31, 2011 and September 30, 2012, respectively, $311,433 and $71,553 of the Company’s cash and cash equivalents were in a transaction account. As of September 30, 2012, this transaction account was covered by Federal Deposit Insurance Coverage (“FDIC”) in the amount of $250,000. At December 31, 2011 and September 30, 2012, respectively, the Company classified investments in money market funds totaling $1,177 and $3,061, respectively, as cash equivalents since these investments are readily convertible into known amounts of cash and do not have significant valuation risk. These investments are currently in a fund that invests exclusively in short-term U.S. Government obligations, including securities issued or guaranteed by the U.S. Government, its agencies and U.S. Treasury securities. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.

In November 2007, the Company entered into a definitive agreement with Farley White Management Company, LLC to lease 17,639 usable square feet of office space. The initial lease term was for 62 months with an option to extend the lease for one extension period of five years. During the term of the lease, the Company is required to maintain a standby letter of credit in favor of the landlord as security for the Company’s obligations under the lease. The amount of the letter of credit is $500,000 for the first and second lease years and is reduced by $100,000 at the end of the second, third and fourth lease years. The Company first occupied the space in February 2008 and the first, second, and third reductions of the letter of credit in the amounts of $100,000 took place during the first three months of 2010, 2011, and 2012, respectively. The Company has recorded this letter of credit as restricted cash on its balance sheets.

Revenue Recognition and Accounts Receivable

Revenue from the sale of product to all of the Company’s customers is recognized upon shipment of goods provided that risk of loss has passed to the customer, all of the Company’s obligations have been fulfilled, persuasive evidence of an arrangement exists, the fee is fixed or determinable, and collectability is probable. Revenue from the sale of product to all of our third-party distributors is subject to the same recognition criteria. Distributors and customers do not have the right to return our products. These distributors provide all direct repair and support services to their customers. Additionally, revenue from the sale of the Microvolt T Wave Alternans (“MTWA”) Module to Cardiac Science is subject to the same revenue recognition criteria. The Company provides standard warranty coverage on the MTWA Module. The HearTwave II System and the CH 2000 Cardiac Stress Test System can be sold with a treadmill or as stand-alone systems, and pursuant to the Company’s Development, Supply and Distribution Agreement with Cardiac Science, the MTWA Module is sold with a start-up kit including Micro-V Alternans Sensors. Therefore, as necessary, the Company allocates the total consideration to the separate items proportionately based on the relative selling price and, accordingly, defers revenue recognition on unshipped elements until shipment. The Company also sells maintenance agreements with the HearTwave II System. Revenue from maintenance contracts is recognized separately based on amounts charged when sold on a stand-alone basis and is recorded over the term of the underlying agreement. Billings of $234,213 at September 30, 2012 ($275,295 at December 31, 2011) in advance of services being performed are recorded as deferred revenue and included in current liabilities in the accompanying balance sheet.

Accounts receivable are stated at the amount management expects to collect from outstanding balances. An allowance for doubtful accounts is provided for those accounts receivable considered to be uncollectible based upon historical experience and management’s evaluation of outstanding accounts receivable at the end of the year. Bad debts are written off when identified. For the three months ended September 30, 2011 and 2012, the Company’s actual experience of customer receivables written off directly was $43,474 and $0, respectively. For the nine months ended September 30, 2011 and 2012, the Company’s actual experience of customer receivables written off directly was $72,603 and $14,089, respectively. At December 31, 2011 and September 30, 2012, the allowance for doubtful accounts was $85,102 and $65,872, respectively.

Shipping and Handling Costs

The Company classifies freight and handling billed to customers as sales revenue and related costs as cost of sales.

Stock-Based Compensation

Stock-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense in the statement of operations over the requisite service period.

Net Loss Per Share

Basic loss per share amounts are based on the weighted average number of shares of common stock outstanding during the period. Due to experiencing a net loss in the three and nine month periods ended September 30, 2011 and 2012 the impact of options to purchase 10,202,545 and 10,727,080 shares of common stock, respectively; 5,000 shares of Series C-1 Convertible Preferred Stock (4,180,602 shares of common stock on an as converted basis); 1,770 and 1,670 shares of Series D Convertible Preferred Stock (21,585,366 and 20,365,854 shares of common stock on an as converted basis, respectively); warrants issued in connection with the December 2010 Private Placement to purchase 15,660,000 shares of common stock; warrants issued in connection with the January 17, 2012, February 28, 2012, May 23, 2012 and July 31, 2012 issuances of secured convertible promissory notes to purchase 0 and 34,159,083 shares of common stock, respectively; and 0 and 34,159,083 shares of common stock issuable upon conversion of secured convertible promissory notes issued on January 17, 2012, February 28, 2012, May 23, 2012 and July 31, 2012, have been excluded from the calculation of diluted weighted average share amounts as their inclusion would have been anti-dilutive for the three and nine month periods ended September 30, 2011 and 2012.

Inventory Valuation

Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which includes allocations of labor and overhead. Standard cost approximates actual cost on a first-in, first-out method. Management assesses the value of inventory for estimated obsolescence or unmarketable inventory on a quarterly basis. If necessary, inventory value may be written down to the estimated fair market value based upon assumptions about future demand and market conditions. In 2009, the Company recorded a provision of $967,148 for excess inventory built up in connection with our contractual obligation as part of the co-marketing agreement with St. Jude Medical. In March 2007, the Company entered into a co-marketing agreement with St. Jude Medical granting St. Jude Medical the exclusive right to market and sell our HearTwave II System and other MTWA products to cardiologists and electrophysiologists in North America. The agreement with St. Jude Medical ended on November 5, 2008. Pursuant to the terms of the co-marketing agreement, the Company was contractually obligated to build up our inventory for HearTwave II Systems. Consequently, the level of our inventory exceeds our current sales projections of the HearTwave II System for the next 12 months. The provision is based on the uncertainty about realizing the value of excess inventory. As of December 31, 2011 and September 30, 2012, the Company’s inventory reserve totaled $1,057,746 and $996,382. The Company does not believe that the inventory is exposed to obsolescence risk. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required from time to time that could adversely affect operating results for the fiscal period in which such write-downs are affected.

Product Warranty

Management warrants all non-disposable products as compliant with their specifications and warrants that the products are free from defects in material and workmanship for a period of 13 months from the date of delivery. Management maintains a reserve for the estimated cost of future repairs of our products during this warranty period. The amount of the reserve is based on our actual return and historical repair cost experience. If the rate and cost of future warranty activities differs significantly from our historical experience, additional costs would have to be reserved that could materially affect our operating results.

Fixed Assets

Fixed assets are stated at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method based on estimated useful lives. Repair and maintenance costs are expensed as incurred. Upon retirement or sale, the costs of the assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the determination of net income.

Licensing Fees and Patent Costs

The Company has entered into a licensing agreement giving the Company the exclusive rights to certain patents and technologies and the right to market and distribute any products developed based upon such patents and technologies, subject to certain covenants. Payments made under the licensing agreement and costs associated with patent applications have generally been expensed as incurred because recovery of these costs is uncertain. However, certain costs associated with patent applications for products and processes which have received regulatory approval and are available for commercial sale, have been capitalized and are being amortized over their estimated economic life of five years.

Recent Accounting Pronouncements

In May 2011, the FASB issued new rules which require changing the wording and disclosing of information in connection with fair value measurements. The amendments are effective for fiscal years beginning after December 15, 2011. This guidance was adopted by the Company on January 1, 2012 and has not had a material impact to the Company’s financial position or results of operations.

In June 2011, the FASB issued new rules which require all nonowner changes in stockholders’ equity to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments are effective for fiscal years beginning after December 15, 2011. This guidance was adopted by the Company on January 1, 2012 and has not had a material impact to the Company’s financial position or results of operations.

3. MAJOR CUSTOMERS, EXPORT SALES AND CONCENTRATION OF CREDIT RISK

There were two major customers that accounted for over 10% of the Company’s total revenue and accounts receivable balances for the three and nine month periods ended September 30, 2011 and September 30, 2012.

International sales accounted for 20% of total revenue for both the three and nine month periods ended September 30, 2011 and 14% and 18% of total revenue for the three and nine month periods ended September 30, 2012, respectively.

4. INVENTORIES

Inventories consist of the following:

	December 31,			September 30,
	2011			2012

Raw materials	$	1,120,450		$	1,116,687
Work in process		6,586			3,400
Finished goods		375,087			303,562
		1,502,124			1,423,649

Inventory reserve		(1,057,746	)		(996,382	)

Total inventory, net	$	444,377		$	427,267

5. CONVERTIBLE PROMISSORY NOTES

November 14, 2011 Convertible Promissory Notes

On November 14, 2011, the Company entered into a Convertible Note Purchase Agreement with two current shareholders of the Company, pursuant to which the Company issued senior unsecured convertible promissory notes (the “2011 Notes”) in the aggregate principal amount of $600,000. As part of the financing, the Company issued a note to Mr. Roderick de Greef, the Company’s Chairman of the Board, in the principal amount of $250,000 and a note to an existing shareholder in the principal amount of $350,000. The 2011 Notes converted into secured convertible promissory notes in an aggregate principal amount of $600,000 together with a corresponding amount of warrants and additional investment rights in connection with the Company’s 2012 private placement financing described below.

The 2011 Notes were accounted for in accordance with Accounting Standards Codification (“ASC”) 480—Distinguishing Liabilities from Equity and were recorded on the December 31, 2011 accompanying balance sheet at fair value.

Secured Convertible Promissory Notes

In closings on January 17, 2012, February 28, 2012, and May 23, 2012, the Company issued and sold secured convertible promissory notes (the “2012 Notes”) in the aggregate principal amount of $3,490,000, together with common stock warrants and additional investment rights described below, to new and current institutional and private accredited investors pursuant to the terms of four subscription agreements dated January 17, 2012, February 28, 2012 and May 23, 2012 between the Company and the investors party thereto (collectively, the “ 2012 Private Placement”).

The 2012 Private Placement provided $3.5 million of gross proceeds, including the conversion of $600,000 of the 2011 Notes. The securities were offered and sold pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

The 2012 Notes are convertible into common stock of the Company at a conversion price of $0.11 per share. The conversion price of the 2012 Notes is subject to adjustment in certain circumstances. If the Company issues shares of common stock, or securities convertible into or exercisable for shares of common stock, at a price lower than the conversion price, then the conversion price of the 2012 Notes will, with limited exceptions, be adjusted to such lower price.

The 2012 Notes will mature on July 17, 2013 and bear interest at the rate of 8% per annum due and payable quarterly in arrears commencing March 31, 2012 and upon maturity. Interest on the 2012 Notes is payable in cash or, at the election of the Company, in shares of common stock, provided that (i) no Event of Default (as defined in the 2012 Notes) has occurred, (ii) the common stock is resellable without transfer or volume limitations, (iii) payment in common stock would not cause the investor to exceed the investor’s Individual Ownership Threshold (as defined below), and (iv) 85% of the volume weighted average price per share of the Company’s common stock for the 20 trading days ending on the due date of the interest payment being made (the “PIK Share Value”) is at least $0.20. Common stock employed to pay interest will be valued at the PIK Share Value. In the event that the 2012 Notes are converted voluntarily by the holder at any time prior to July 17, 2013, the interest payable on the 2012 Note will be increased by an amount equal to $200 per $1,000 of converted principle amount of such 2012 Note, less any interest payments made with respect to the converted 2012 Note (the “Additional Interest”). The Additional Interest is payable in cash, or at the Company’s election in common stock of the Company, at a conversion price equal to the PIK Share Value provided that certain conditions are met. In order for the Company to be able to pay the Additional Interest in common stock, the PIK Share Value must be at least $0.20 and the payment of Additional Interest in common stock must not cause the Investor to exceed the investor’s Individual Ownership Threshold. Additionally, if the PIK Share Value is at least $0.20, the Note holder can elect to receive the Additional Interest in shares of common stock.

The Company has the limited ability to force the 2012 Note holders to convert the 2012 Notes in the event that the following conditions are met for each of the 20 consecutive trading days preceding conversion: (i) the closing bid price for the common stock is equal to or greater than 227% of the conversion price of the 2012 Notes, (ii) a registration statement registering for resale of all of the common stock issuable upon conversion of the 2012 Notes and exercise of the Warrants is effective and included therein as registered all of the common stock issuable upon conversion of the 2012 Notes and exercise of the Warrants (as defined below), and (iii) an Event of Default (as defined in the Note) or an event which with the passage of time would become an Event of Default has not occurred. If the foregoing conditions are met, the Company can force conversion of the 2012 Notes in an aggregate principal amount not to exceed 25% of the aggregate dollar trading volume of shares of the Company’s common stock during the seven trading days immediately preceding the date on which the Company seeks to convert the 2012 Notes.

The 2012 Notes may be accelerated under certain circumstances, including upon a Fundamental Transaction (as defined below) or upon an Event of Default (as defined in the Note). In the event that (a) the Company effects any merger or consolidation with or into another entity, (b) the Company sells all or substantially all of its assets, (c) a tender offer or exchange offer is completed pursuant to which holders of the Company’s common stock are permitted to tender or exchange their shares for other securities, cash or property, (d) the Company completes a stock purchase or other business combination whereby one or more persons acquire more than 50% of the outstanding shares of common stock of the Company, (e) any “person” or “group” (as defined for purposes of Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) acquires, directly or indirectly, 50% of the aggregate common stock of the Company or (f) the Company effects any reclassification of the common stock or any compulsory share exchange pursuant to which the common stock is effectively converted into or exchanged for other securities, cash or property (other than a reverse merger) (each, a “Fundamental Transaction”), then until twenty business days after the Company notifies the Note holder of the occurrence of the Fundamental Transaction, the 2012 Note holder may elect to accelerate the maturity date of the 2012 Note as of the date of the Fundamental Transaction. Upon an Event of Default, then, at the option of the 2012 Note holder, all principal and interest under the 2012 Note then remaining unpaid will be immediately due and payable upon demand by the 2012 Note holder.

The 2012 Note holders may require the Company to redeem the 2012 Notes under certain other circumstances. In the event that the Company is prohibited from issuing the conversion shares, upon the occurrence of any Event of Default, upon the occurrence of a Change in Control (as defined in the Subscription Agreement), or upon the liquidation, dissolution or winding up of the Company, at the investor’s election, the Company must pay to each investor a sum of money determined by multiplying the outstanding principal amount of the 2012 Note designated by each such investor by, at such investor’s election, the greater of (i) 120%, or (ii) a fraction the numerator of which is the highest closing price of the common stock for the thirty (30) days preceding the date demand is made by the investor and the denominator of which is the lowest applicable conversion price during such thirty (30) day period, plus accrued but unpaid interest and any other amounts due to the investor (the “Mandatory Redemption Payment”). Upon the payment of the Mandatory Redemption Payment, the corresponding 2012 Note principal, interest and other amounts will be deemed paid and no longer outstanding.

The 2012 Notes are secured by all of the assets of the Company in connection with which the Company has entered into a Security Agreement granting a first priority security interest in all of the assets of the Company and appointing a collateral agent to act on behalf of the investors with respect to the collateral.

Under the terms of the 2012 Private Placement, the Company issued to the Investors warrants (the “Warrants”) to purchase an aggregate of 31,727,265 shares of common stock (which is equal to 100% of the shares of common stock underlying the 2012 Notes as of the closing of the 2012 Private Placement) at an exercise price of $0.15 per share (which is equal to 125% of the closing price of the common stock on January 13, 2012). The exercise price of the Warrants is subject to adjustment in certain circumstances. If the Company issues shares of common stock, or securities convertible into or exercisable for shares of common stock, at a price lower than the exercise price, then the exercise price of the Warrants will, with limited exceptions, be adjusted to such lower price. The Warrants will terminate on January 17, 2016.

Under the terms of the 2012 Private Placement, the Company also issued to the investors additional investment rights (the “AIRs”) granting each investor the right to purchase an additional principal amount of 2012 Notes equal to 25% of the original principal amount of 2012 Notes purchased by such investor at the closing of the 2012 Private Placement and a corresponding amount of Warrants, at any time prior to July 15, 2012. On July 13, 2012, the Company and the investors amended the subscription agreements to extend the termination date to July 31, 2012. Pursuant to the exercise of certain AIRs, on July 31, 2012, the Company issued secured convertible promissory notes in the aggregate principal amount of $267,500 together with common stock warrants to purchase an aggregate of 2,431,817 shares of common stock of the Company to certain accredited investors including Roderick de Greef, the Chairman of the Board of the Company, and two of the Company's largest shareholders. The notes (hereafter included in the reference of the “2012 Notes”) and related common stock warrants have substantially the same terms as those issued to investors in connection with the 2012 Private Placement, except that all time effective or time triggered clauses and provisions are determined from the issue date of the additional notes and warrants.

The 2012 Notes may not be converted, and the Warrants may not be exercised, to the extent such conversion or exercise would cause the holder, together with the holder’s affiliates, to beneficially own a number of shares of common stock which would exceed 4.99% of the Company’s then outstanding shares of common stock following such conversion or exercise, except that any investor may increase or waive the 4.99% conversion limitation, in whole or in part, by designating a higher amount on such investor’s signature page to the Subscription Agreement and also following the closing date upon and effective after 61 days prior written notice to the Company (the “Individual Ownership Limit”).

Pursuant to the Subscription Agreements, the Company filed a registration statement registering the shares of common stock underlying the 2012 Notes and Warrants on April 13, 2012. The registration statement was declared effective June 27, 2012. If the registration statement after being filed and declared effective, ceases to be effective without being succeeded within 22 business days by an effective replacement or amended registration statement, or for a period of time that exceeds 45 days in the aggregate per year, the Company will be required to pay an amount equal to 0.5% of the principal amount of the outstanding 2012 Notes and purchase price of the Shares and Warrant Shares issued upon conversion of the 2012 Notes and exercise of the Warrants for each 30 day period that the registration statement is not effective, in excess of 22 consecutive business days or 45 aggregate days per year as applicable (or such lesser pro-rata amount for any period of less than 30 days), up to a maximum of 5% of the 2012 Note principal plus the aggregate actual Warrant exercise prices.

Pursuant to the Subscription Agreements, the Company agreed to certain positive and negative covenants as set forth in the Subscription Agreements of the 2012 Notes and the Warrants (collectively, the “Transaction Documents”). The holders of at least sixty-five percent (65%) of each affected component of the securities issued in the 2012 Private Placement may consent to take or forebear from any action permitted under or in connection with the Transaction Documents, modify any Transaction Documents or waive any default or requirement applicable to the Company or the investors under the Transaction Documents provided the effect of such action does not waive any accrued interest or damages and further provided that the relative rights of the Investors to each other remains unchanged.

For a year following January 17, 2012, with limited exceptions, the investors have a right of first refusal with respect to any proposed sale by the Company of its common stock or other securities or equity linked debt obligations. If all 2012 Note holders do not exercise their pro rata share, then the participating 2012 Note holders can take up the balance of the financing round pro rata.

6. FINANCIAL INSTRUMENTS—DERIVATIVES AND HEDGING

Secured Convertible Promissory Notes

At the date of issuances of the 2012 Notes, based upon evaluation under applicable ASC No. 815-15 Derivatives and Hedging guidance, the Company determined that the 2012 Notes included a conversion feature constituting an embedded derivative. The aggregate fair value of the related derivative liabilities at inception was determined to be $156,508, and is recorded as “Embedded derivative liability on convertible note” in the accompanying balance sheet.

More specifically, the Company is subject to the embedded derivative guidance within ASC 815-15 due to the fact that the related contracts are not indexed to its own stock, as specified by ASC No. 815-40, “Derivatives and Hedging-Contracts in Entity’s Own Equity”, and meet each of the three criteria specified in ASC 815-15-25-1 . The derivatives are accounted for and classified as an “Embedded derivative liability on convertible note” within the liabilities section of the balance sheet. The change in the fair value of the derivatives is reported in the statements of operations and in the “Cash flows from operating activities” section of the statements of cash flows.

Warrants

At the date of issuances of the 2012 Notes, based upon evaluation under applicable ASC No. 815 Derivatives and Hedging guidance, the Company determined that the warrant financial instrument constituted derivatives. The aggregate fair value of the derivative liabilities at inception was determined to be $4,177,727, and are recorded as “Derivative warrant liability” in the accompanying balance sheet.

More specifically, the Company is subject to accounting for the warrants as a derivative liability instrument due to the fact that the related contracts are not indexed to its own stock, as specified by ASC No. 815-40, “Derivatives and Hedging-Contracts in entity’s Own Equity”. The derivatives are accounted for and classified as a “Derivative warrant liability” within the liabilities section of the balance sheet. The change in the fair value of the derivatives is reported in the statements of operations and in the “Cash flows from operating activities” section of the statements of cash flows.

At the January 17, 2012, February 28, 2012, May 23, 2012 and July 31, 2012 issuance dates, since the total Embedded Derivative Liabilities in Convertible Note and the fair value balances of the Derivative Warrant Liabilities exceeded the actual proceeds of $3,757,500 from the secured convertible promissory note host instrument, in the aggregate, the excess difference of $639,785 in total was reflected as “Interest expense” within the accompanying statement of operations for the nine months ended September 30, 2012. At the January 17, 2012, February 28, 2012, May 23, 2012 and July 31, 2012 issuance dates, the Company recorded an aggregate debt discount of $3,694,450, which is amortized over the term of the related debt instrument using the effective interest method. At September 30, 2012, the amortized balance of the debt discount is $3,258,428.

7. FINANCIAL INSTRUMENTS—FAIR VALUE

Secured Convertible Promissory Notes

At the date of issuance of the 2012 Notes, based upon evaluation under applicable ASC No. 815-15 Derivatives and Hedging guidance, the Company determined that the 2012 Notes included a conversion feature constituting an embedded derivative. The fair value of the embedded derivative liability at issuance was determined using the Monte Carlo simulation. The derivative liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various assumptions about the future activities and the Company’s stock prices and historical volatility inputs. See Note 8 for disclosure regarding the fair value measurements topic of the FASB Codification. Level 3 is defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

The fair value of the embedded derivative liabilities was estimated at issuances of January 17, 2012, February 28, 2012, May 23, 2012, July 31, 2012 and at the interim measurement dates, including September 30, 2012 using the Monte Carlo simulation with the following assumptions:

	January 17,			February 28,			March 31,			May 23,			June 30,			July 31,			September 30,
	2012			2012			2012			2012			2012			2012			2012

Common Share Price	$	0.12		$	0.10		$	0.08		$	0.08		$	0.06		$	0.03		$	0.05
Volatility		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%
Drift/Risk Free Rate		0.56	%		0.63	%		0.78	%		0.57	%		0.56	%		0.30	%		0.31	%
Forecast Horizon (Years)		4.0			3.83			3.70			3.49			3.34			3.22			2.97
Number of Steps		1,000			958			926			873			835			804			743
Step Size		0.0040			0.0040			0.0040			0.0040			0.0040			0.0040			0.0040

The table below provides a reconciliation of the beginning and ending balances for the liabilities measured using significant unobservable inputs (Level 3).

	January 17,			February 28,			May 23,			July 31,
	2012			2012			2012			2012		Total
Fair Value of Embedded Derivative
Liability at Issuance	$	125,000		$	20,240		$	11,000		$	268	$	156,508

Increase/(Decrease) in Fair Value as of September 30, 2012		(112,500	)		(18,040	)		(8,250	)		1,070		(137,720	)

Balance at September 30, 2012	$	12,500		$	2,200		$	2,750		$	1,338	$	18,788

Warrants

Pursuant to the Subscription Agreements dated January 17, 2012, February 28, 2012, May 23, 2012 and July 31, 2012, the Company issued to the Investors warrants (the “Warrants”) to purchase an aggregate of 34,159,083 shares of common stock. The fair value of the warrant liability at each issuance was determined using the Monte Carlo simulation. The derivative liabilities are considered Level 3 liabilities on the fair value hierarchy as the determination of fair value includes various assumptions about the future activities and the Company’s stock prices and historical volatility inputs. Level 3 is defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

The fair value of the warrant liability was estimated at issuance of January 17, 2012, February 28, 2012, May 23, 2012, July 31, 2012 and at the interim measurement dates, including September 30, 2012 using the Monte Carlo simulation with the following assumptions:

	January 17,			February 28,			March 31,			May 23,			June 30,			July 31,			September 30,
	2012			2012			2012			2012			2012			2012			2012

Common Share Price	$	0.12		$	0.10		$	0.08		$	0.08		$	0.06		$	0.03		$	0.05
Volatility		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%		80.00	%
Drift/Risk Free Rate		0.56	%		0.63	%		0.78	%		0.57	%		0.56	%		0.30	%		0.31	%
Forecast Horizon (Years)		4.0			3.83			3.70			3.49			3.34			3.22			2.97
Number of Steps		1,000			958			926			873			835			804			743
Step Size		0.0040			0.0040			0.0040			0.0040			0.0040			0.0040			0.0040

The table below provides a reconciliation of the beginning and ending balances for the liabilities measured using significant unobservable inputs (Level 3).

	January 17,			February 28,			May 23,		July 31,
	2012			2012			2012		2012		Total

Fair Value of Derivative Warrant
Liability at Issuance	$	2,954,545		$	480,000		$	500,000	$	243,182	$	4,177,727

Increase/(Decrease) in Fair Value as of September 30, 2012		(681,819	)		(80,000	)		-		-		(761,819	)

Balance at September 30,2012	$	2,272,726		$	400,000		$	500,000	$	243,182	$	3,415,908

8. FAIR VALUE MEASUREMENT

The Fair Value Measurements topic of the FASB Codification establishes a framework for measuring fair value in accordance with GAAP, clarifies the definition of fair value within that framework and expands disclosures about fair value measurements. This guidance requires disclosure regarding the manner in which fair value is determined for assets and liabilities and establishes a three-tiered value hierarchy into which these assets and liabilities must be grouped, based upon significant levels of inputs as follows:

●

Level 1—Quoted prices in active markets for identical assets or liabilities.

●

Level 2—Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

●

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The fair value of the embedded derivative liability and warrant liability at issuance was determined using a continuous-variable stochastic process in the form of a Monte-Carlo Simulation that includes unobservable inputs, which in this case are volatility, drift and forecast horizon, supported by little or no market activity, such as various probabilities of occurrences of certain future events. The Monte-Carlo simulation expresses potential future scenarios, that when simulated thousands of times, can be viewed statistically to ascertain fair value, based upon a widely accepted drift calculation, the volatility of the asset, incremental time steps, and a random component known as the Weiner process, which introduces the dynamic behavior in the asset price. Based on our existing business plans, we also contemplated future equity raises of our Company’s stock and the impact on the valuation of the embedded derivative liability if our stock price is below the exercise price at the estimated date of the projected future capital raise. We used the closing price of our stock as of the valuation date for measurement date fair value.

The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy. Financial liabilities measured at fair value on a recurring basis at September 30, 2012 are summarized below:

	Fair Value Measurements Using						Liabilities at Fair Value
	Level 1		Level 2		Level 3		Liabilities at Fair Value

Liabilities
Embedded Derivative Liability in Convertible Note		-		-		18,788		18,788
Warrant Derivative Liability		-		-		3,415,908		3,415,908

Total liabilities	$	-	$	-	$	3,434,696	$	3,434,696

Liabilities measured at fair value were originally recorded in connection with the 2012 Notes (see Note 5). Changes in the initial valuation during the three and nine months ended September 30, 2012 are due to changes in the fair value of the warrants and embedded derivative liability (see Note 7).

The Company’s stock price has the most significant influence on the fair value of the embedded derivative liability and warrant derivative liability. An increase in the Company’s common stock price would cause the fair value of the embedded derivative liability to increase. A decrease in the Company’s stock price would likewise cause the fair value of the embedded derivative liability to decrease and result in a credit to the Company’s statement of operations.

Fair value measurements, including those categorized within Level 3, are prepared and reviewed on their issuance date and then on a quarterly basis and any third-party valuations are reviewed for reasonableness and compliance with the Fair Value Measurement Topic of the FASB’s Accounting Standards Codification. Specifically, we compare prices received from our various pricing service to prices reported by the custodian or third-party investment advisors, and we perform a review of the inputs, validating that they are reasonable and observable in the marketplace, if and as applicable.

The Company’s carrying value of other financial instruments including accounts receivable and accounts payable approximate fair value on September 30, 2012.

9. CONVERTIBLE PREFERRED STOCK

The Company’s authorized capital stock includes 2,000,000 shares of $0.001 par value preferred stock. The preferred stock may be issued at the discretion of the Board of Directors (without further stockholder approval) with such designations, rights and preferences as the Board of Directors may determine from time to time. This preferred stock may have dividend, liquidation, redemption, conversion, voting or other rights, which may be more expansive than the rights of the holders of the Company’s common stock.

Total shares of preferred stock issued and outstanding at December 31, 2011 and September 30, 2012, respectively, were as follows:

	December 31,		September 30,
	2011		2012
Series C-1 Convertible Preferred
Shares issued and outstanding		5,000		5,000
Liquidation preference and redemption value	$	12,500,000	$	12,500,000

Series D Convertible Preferred
Shares issued and outstanding		1,670		1,670
Liquidation preference and redemption value	$	1,670,000	$	1,670,000

Total Convertible Preferred
Shares issued and outstanding		6,670		6,670
Liquidation preference and redemption value	$	14,170,000	$	14,170,000

The preferred stock is entitled to dividends when and if declared by the Board of Directors prior to the payment of any such dividends to the holders of common stock. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of the preferred stock then outstanding are entitled to be paid out of the assets of the corporation before any payment is made to the holders of common stock. Each holder of the preferred stock is entitled to the number of votes equal to the number of shares of common stock into which the preferred stock is convertible on any matter reserved to the stockholders of the Company for their action at any meeting of the stockholders of the corporation.

Series C and Series C-1 Convertible Preferred Stock

On March 21, 2007, the Company and St. Jude Medical entered into an agreement for the sale of $12.5 million of the Company’s Series C Convertible Preferred Stock (the “Series C Preferred Stock”) to St. Jude Medical resulting in $11.7 million of proceeds, net of issuance costs. Under the terms of the financing, the Company issued and sold 5,000 shares of its Series C Preferred Stock at a purchase price of $2,500 per share (the “Series C Original Issue Price”). Each share of Series C Preferred Stock was convertible into a number of shares of common stock equal to $2,500 divided by the conversion price of the Series C Preferred Stock, which was initially $2.99. Each share of Series C Preferred Stock was convertible into approximately 836.12 shares of common stock. The total number of shares of common stock initially issuable upon conversion of the 5,000 shares of Series C Preferred Stock issued and sold in the financing was approximately 4,180,602.

The holders of the Series C Preferred Stock were entitled to receive cumulative cash dividends at the rate of eight percent (8%) of the Series C Original Issue Price per year (the “Series C Dividend”) on each outstanding share of Series C Preferred Stock, provided, however, that the Series C Dividend is only payable when, and if declared by the Board of Directors. The Series C Dividend was payable prior and in preference to any declaration or payment of any dividend on common stock, other series of preferred stock or any other capital stock of the Company.

The conversion price feature of the Series C Preferred Stock was subject to adjustment in certain circumstances if the Company issued shares of common stock under those circumstances on or before March 21, 2008 at a purchase price below the conversion price of the Series C Preferred Stock. No adjustment in the conversion price was made as a result of this provision.

The holders of Series C Preferred Stock were entitled to receive, prior and in preference to any distribution of the proceeds from any liquidation (including change-in-control events), dissolution or winding up of the Company, whether voluntary or involuntary, to holders of common stock, other series of preferred stock or any other capital stock of the Company, an amount per share equal to the Series C Preferred Stock par value, plus declared but unpaid dividends on such shares.

The holders of Series C Preferred Stock were entitled to vote, on an as-if converted basis, along with holders of the Company’s common stock on all matters on which holder of common stock were entitled to vote.

In order to be able to issue securities in the Series D Financing, described below, that are senior to the Series C Preferred Stock previously issued by the Company, the Company entered into a Share Exchange Agreement with St. Jude Medical, dated as of December 23, 2009, pursuant to which St. Jude Medical exchanged 5,000 shares of the Company’s Series C Preferred Stock, representing 100% of the issued and outstanding shares of Series C Preferred Stock, for 5,000 newly issued shares of the Company’s Series C-1 Convertible Preferred Stock (the “Series C-1 Preferred Stock”). The terms of the Series C-1 Preferred Stock are substantially the same as the terms of the Series C Preferred Stock except that the Series C-1 Preferred Stock is junior to the Series D Preferred Stock in the event of a liquidation or a deemed liquidation of the Company.

In the event of a liquidation of the Company (including an Acquisition Transaction or Asset Transfer, each as defined in the Series C-1 Certificate of Designation), the holders of Series C-1 are entitled to receive an amount equal to the Deemed Series C-1 Original Issue Price plus declared but unpaid dividends after the payment to the holders of Series D Preferred Stock, but before any amount to the holders of common stock, and all other equity or equity equivalent securities of the Company other than those securities that are explicitly senior to or on parity with the Series C-1 Preferred Stock with respect to liquidation preference.

Under guidance issued by the Emerging Issues Task Force (“EITF”) of the FASB, preferred securities that are redeemable for cash or other assets are to be classified outside of permanent equity if they are redeemable (i) at a fixed or determinable price on a fixed or determinable date, (ii) at the option of the holder, or (iii) upon the occurrence of an event that is not solely within the control of the issuer. Accordingly, the Company classified the Series C-1 Preferred Stock outside of permanent equity based on the rights of the Series C-1 Preferred Stock in a deemed liquidation.

Series D Convertible Preferred Stock

On December 23, 2009, the Company issued and sold 1,852 shares of the Company’s Series D Convertible Preferred Stock (the “Series D Preferred Stock”) and common stock warrants described below to new and current institutional and private investors pursuant to the terms of a Securities Purchase Agreement dated December 23, 2009 between the Company and the purchasers of Series D Preferred Stock (the “Series D Financing”). The aggregate proceeds from the Series D Financing were $1.8 million, net of issuance costs.

Under the terms of the Series D Financing, the Company issued 1,852 shares of its Series D Preferred Stock at a purchase price of $1,000 per share (the “Series D Original Issue Price”). Each share of Series D Preferred Stock is convertible into a number of shares of common stock of the Company equal to $1,000 divided by the conversion price of the Series D Preferred Stock, which is initially $0.082, representing a 15% premium to the 20-day trailing average of the Company’s closing common stock price as of December 21, 2009 (the “Closing Price”). Each share of Series D Preferred Stock is currently convertible into approximately 12,195 shares of common stock. The total number of shares of common stock initially issuable upon conversion of the 1,852 shares of Series D Preferred Stock issued and sold in the financing was 22,585,366, or approximately 32.69% of the Company’s issued and outstanding common stock at the time assuming that all outstanding shares of preferred stock are converted to common stock.

The Company also issued to the investors in the Series D Financing two types of warrants. The first warrant, which expired on December 23, 2010, entitled the investor to purchase a number of shares of common stock equal to 50% of the number of shares of common stock into which the Series D Preferred Stock purchased by the investor is convertible (the “Short-Term Warrant”). A total of 11,292,686 shares of common stock were issuable under the Short-Term Warrants. The exercise price of the Short-Term Warrants was $0.107 per share, which is 150% of the Closing Price. In May 2010, certain of the investors exercised their Short-Term Warrants, resulting in the issuance of 4,268,294 shares of common stock of the Company. In December 2010, the remaining outstanding Short-Term Warrants were exercised resulting in the issuance of 7,024,392 shares of common stock of the Company. The second warrant, which would have expired on December 23, 2014, entitled the investor to purchase a number of shares of common stock equal to 30% of the number of shares of common stock into which the Series D Preferred Stock purchased by the investor was convertible (the “Long-Term Warrant”). A total of 6,775,611 shares of common stock were issuable under the Long-Term Warrants. The exercise price of the Long-Term Warrants was $0.142 per share, or 200% of the Closing Price. Pursuant to the terms of the Long-Term Warrant, the Company called the Long-Term Warrants in May 2010 resulting in the issuance of 6,775,611 shares of common stock of the Company.

An analysis was performed on the exercise and settlement provisions of the Long-Term and Short-Term Warrants as of December 23, 2009. As a result, it was determined that they were not considered derivative instruments under Accounting Standards Codification 815—Derivatives and Hedging (“ASC 815”) as they met the scope exception since they are both indexed to the Company’s own stock and are classified in stockholders’ deficit in the Company’s balance sheet.

The conversion price of the Series D Preferred Stock is subject to adjustment in certain circumstances. If the Company issues shares of common stock at a purchase price below the conversion price of the Series D Preferred Stock at any time on or before August 23, 2011, the conversion price of the Series D Preferred Stock will be adjusted as set forth in the Series D Certificate of Designation (as defined below). In determining the appropriate accounting for the conversion feature for the Series D Preferred Stock, the Company determined that the conversion feature does not require bifurcation, and as a result is not considered a derivative under the provisions of ASC 815. No adjustment in the conversion price was made as a result of this provision.

The holders of the Series D Preferred Stock are entitled to share in any dividends declared and paid, or set aside for payment, on the common stock, pro rata, in accordance with the number of shares of common stock into which such shares of Series D Preferred Stock are then convertible.

The holders of the Series D Preferred Stock are entitled to the number of votes equal to the number of shares of common stock into which such shares of Series D Preferred Stock could be converted immediately after the close of business on the record date fixed for such meeting or the effective date of such written consent, shall have voting rights and powers equal to the voting rights and powers of the common stock and shall be entitled to notice of any stockholders’ meeting in accordance with the Bylaws of the Company. The Series D Preferred Stock shall vote together with the common stock at any annual or special meeting of the stockholders and not as a separate class, and act by written consent in the same manner as the common stock.

In the event of a liquidation of the Company (including an Acquisition Transaction or Asset Transfer, each as defined in the Series D Certificate of Designation), the holders of Series D Preferred Stock are entitled to receive an amount equal to the Series D Original Issue Price plus declared but unpaid dividends before the payment of any amount to the holders of common stock, Series C-1 Preferred Stock and all other equity or equity equivalent securities of the Company other than those securities that are explicitly senior to or on parity with the Series D Preferred Stock with respect to liquidation preference.

Under EITF issued guidance, preferred securities that are redeemable for cash or other assets are to be classified outside of permanent equity if they are redeemable (i) at a fixed or determinable price on a fixed or determinable date, (ii) at the option of the holder, or (iii) upon the occurrence of an event that is not solely within the control of the issuer. Accordingly, the Company classified the Series D Preferred Stock outside of permanent equity based on the rights of the Series D Preferred Stock in a deemed liquidation.

Under GAAP, proceeds from the sale of securities are to be allocated to each financial instrument based on their relative fair market value. Further, if the convertible preferred stock has an effective price that is less than the fair value of the common stock into which it is convertible on the date of issuance, the difference between the effective price and the fair value represents a beneficial conversion feature. In this regard, we allocated the net proceeds from the Series D Financing based on the relative fair market value of the Series D Preferred Stock using the Company’s closing common stock price as of December 23, 2009 and to the related warrants using the Black-Scholes option pricing model. The following assumptions were used to estimate the fair market value of the warrants using the Black-Scholes option pricing model:

	Short-Term			Long-Term

Dividend Yield		0.0	%		0.0	%
Expected Volatility		170	%		132	%
Risk Free Interest Rate		0.41	%		2.51	%
Expected Option Terms (in years)		1			5

Based on this allocation, the relative fair value of the Series D Preferred Stock was $1,247,780. The aggregate fair value of the common stock into which the Series D Preferred Stock are convertible was $1,355,122. Therefore, the difference between the relative fair value of the Series D Preferred Stock and the fair value of the common stock into which the Series D Preferred Stock are convertible represents a beneficial conversion feature of $107,342. The amount of the beneficial conversion feature was immediately accreted and the accretion resulted in a deemed dividend as the Series D Preferred Stock was immediately convertible. The deemed dividend was reflected as an adjustment to the net loss applicable to common shareholders on the Company’s Statement of Operations for the year ended December 31, 2009. In June 2011, an investor converted 82 shares of Series D Preferred Stock resulting in the issuance of 1,000,000 shares of common stock of the Company. In September 2011, an investor converted 100 shares of Series D Preferred Stock resulting in the issuance of 1,219,512 shares of common stock of the Company. At December 31, 2011 there were 1,670 shares of Series D Preferred Stock outstanding, convertible into 20,365,854 shares of common stock.

Warrants

In December 2010, the Company sold 14,500,000 Units, as described below, in the December 2010 Private Placement. The Units were comprised of one share of common stock and a warrant to purchase one share of common stock. Each warrant included in the Unit entitles the holder to purchase one share of common stock for $0.25 for a period of five years from the date of issuance. In addition, the Company issued 1,160,000 warrants to purchase common stock to the selling agent in the December 2010 Private Placement. An analysis was performed on the exercise and settlement provisions of the warrants issued in connection with the December 2010 Private Placement as of December 31, 2010. As a result, it was determined that they are not considered derivative instruments under ASC 815 as they meet the scope exception because they are both indexed to the Company’s own stock and are classified in stockholders’ deficit in the Company’s balance sheet. In addition, under GAAP, proceeds from the sale of securities are to be allocated to each financial instrument based on their relative fair market value. In this regard, we allocated the proceeds from the sale of the common stock based on the relative fair market value of the common stock and warrants using the Company’s closing common stock price as of December 20, 2010 and to the related warrants using the Black-Scholes option pricing model. The following assumptions were used to estimate the fair market value of the warrants using the Black-Scholes option pricing model:

	December 20, 2010

Dividend Yield		0.0	%
Expected Volatility		146	%
Risk Free Interest Rate		2.06	%
Expected Option Terms (in years)		5

Based on this allocation, the relative fair values of the common stock and the warrants were $1,535,142 and $1,364,858, respectively.

The Company filed a Registration Statement covering the resale of the common stock and the shares of common stock issuable upon the exercise of the warrants in connection with the December 2010 Private Placement in January 2011.

Under the terms of the 2012 Private Placement, the Company issued Warrants to purchase an aggregate of 34,159,083 shares of common stock (which is equal to 100% of the shares of common stock underlying the 2012 Notes as of the closings of the 2012 Private Placement and exercise of certain AIRs) at an exercise price of $0.15 per share (which is equal to 125% of the closing price of the common stock on January 13, 2012). The exercise price of the Warrants is subject to adjustment in certain circumstances. If the Company issues shares of common stock, or securities convertible into or exercisable for shares of common stock, at a price lower than the exercise price, then the exercise price of the Warrants will, with limited exceptions, be adjusted to such lower price. The Warrants underlying the 2012 Notes as of the closing of the 2012 Private Placement will terminate on January 17, 2016. The Warrants underlying the 2012 Notes issued in connection with the exercise of the AIR’s will terminate on July 31, 2016.

At December 31, 2011 and September 30, 2012, there were 15,660,000 and 49,819,083 warrants to purchase shares of common stock outstanding.

Common Stock

In 2012, the stockholders approved an amendment to the Company’s Certificate of Incorporation which increased the number of shares of common stock authorized for issuance from 250,000,000 to 500,000,000 shares. At September 30, 2012, the Company had 100,112,960 common shares outstanding.

10. STOCK-BASED COMPENSATION

The stock-based compensation charge increased the Company’s loss from operations as well as its net loss by $273,226 or $0.00 per share in the nine month period ended September 30, 2011 and $348,816 or $0.00 per share in the nine month period ended September 30, 2012.

The Company uses the Black-Scholes option pricing model which requires extensive use of financial estimates and accounting judgment, including the expected volatility of the Company’s common stock over the estimated term of the options granted, estimates on the expected time period that employees will retain their vested stock options prior to exercising them, and the number of shares that are expected to be forfeited before the options are vested. The use of alternative assumptions could produce significantly different estimates of the fair value of the stock-based compensation and as a result, provide significantly different amounts recognized in the Company’s Statement of Operations.

The following weighted average assumptions were used to estimate the fair market value of options granted using the Black-Scholes valuation method:

	Nine months ended September 30,
	2011			2012

Dividend Yield		0.0	%		0.0	%
Expected Volatility		143.2	%		136.0	%
Risk Free Interest Rate		1.3	%		1.7	%
Expected Option Terms (in years)		5			10

The expected volatility is based on the price of the Company’s common stock over a historical period which approximates the expected term of the options granted. The risk-free interest rate is based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the options granted. The expected term is estimated based on historical experience.

Stock option transactions under the Company’s equity incentive plans and outside of the Company’s incentive plans during the three month period ended September 30, 2012 are summarized as follows:

						Weighted
				Weighted		Average
				Average		Remaining		Aggregate
	Number of			Exercise		Contractual		Intrinsic
	Options			Price		Life		Value

Outstanding at January 1, 2012		10,055,545		$	0.35		7.78
Granted		841,535		$	0.09
Exercised		-			-
Canceled/Forfeited		(170,000	)	$	0.30

Outstanding and expected to vest at September 30, 2012		10,727,080		$	0.33		7.33		-

Exercisable at September 30, 2012		9,116,208		$	0.35		7.25		-

Vested and expected to vest at September 30, 2012		10,727,080		$	0.33		7.33		-

As of September 30, 2012, there was $115,425 of total unrecognized compensation cost related to approximately 1,610,872 unvested outstanding stock options. The expense is anticipated to be recognized over a weighted average period of 0.7 years. The intrinsic value of both the outstanding and expected to vest and exercisable shares was $0, respectively, at September 30, 2012. For the nine months ended September 30, 2012, no stock options were exercised.

The Company recognized the full impact of its share-based payment plans in the statement of operations for the three and nine months ended September 30, 2011 and 2012 and did not capitalize any such costs on the balance sheets. The following table presents share-based compensation expense included in the Company’s statement of operation:

	Three months ended September 30,				Nine months ended September 30,
	2011		2012		2011		2012

Cost of goods sold	$	987	$	855	$	4,505	$	2,807
Research and development		1,471		1,105		6,310		3,291
Selling, general and administrative		80,729		120,188		262,412		342,718
Stock-based compensation expense	$	83,187	$	122,148	$	273,226	$	348,816

At September 30, 2012, there were approximately 1,777,221 shares of common stock available for future grants under all of the Company’s equity incentive plans.

11. COMMITMENTS AND CONTINGENCIES

Guarantor Arrangements

The Company undertakes certain indemnification obligations under its agreements with other companies in the ordinary course of its business, typically with business partners and customers. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company maintains a products liability insurance policy that is intended to limit its exposure to this risk. Based on the Company’s historical activity in combination with its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of December 31, 2011 and September 30, 2012.

The Company warrants all of its non-disposable products as compliant with their specifications and warrants that the products are free from defects in material and workmanship for a period of 13 months from date of delivery. The Company maintains a reserve for the estimated costs of future repairs of its products during this warranty period. The amount of the reserve is based on the Company’s actual repair cost experience. The Company had $15,752 and $27,060 of accrued warranties at September 30, 2011 and 2012, respectively, as set forth in the following table:

	For the three months ended					For the nine months ended
	September 30,					September 30,
	2011			2012		2011			2012

Balance at beginning of period	$	6,923		$	24,867	$	14,609		$	23,933

Provision for warranty for units sold		15,854			2,193		22,218			19,203

Cost of warranty incurred		(7,025	)		-		(21,075	)		(16,076	)

Balance at end of period	$	15,752		$	27,060	$	15,752		$	27,060

12. SUBSEQUENT EVENTS

Under the 2012 Notes, the Company is required to make interest payments on the last date of each calendar quarter. Failure to make any payment within 10 days after such payment is due constitutes an event of default under the 2012 Notes. The Company did not make its required payment of $73,950 for the quarter ended September 30, 2012 which constitutes an event of default under the 2012 Notes. The Company sought and received the consent of the holders of 70% of the outstanding principal balance of the 2012 Notes (the “Consenting Holders”) to defer the interest payments on the 2012 Notes that would otherwise be due on October 1, 2012 and January 1, 2013 until March 31, 2013. Holders of the 2012 Notes who have not agreed to the deferral of the unpaid interest may seek to accelerate the payment of all amounts of principal and interest due to them under the 2012 Notes.

In connection with the issuance of the 2012 Notes, the Company entered into a security agreement granting to the 2012 Note holders a first priority security interest in all of the assets of the Company. In the event of an event of default, the 2012 Note holders are entitled to foreclose on the Company’s assets pursuant to the security agreement, but only in the event that the holders of at least 65% of the outstanding principal balance of the 2012 Notes consent to foreclose. The Consenting Holders, representing more than 65% of the outstanding principal balance of the 2012 Notes, have agreed with the Company to forebear until March 31, 2013 from the taking of any action to accelerate the principal balance of the 2012 Notes and from taking any action to enforce the Consenting Holders’ rights or remedies under the security agreement. Additionally, the Consenting Holders consented to the issuance by the Company of up to $300,000 in additional debt that is senior to the 2012 Notes.

On October 17, 2012, the Company issued and sold in a private placement senior secured promissory notes (the “New Notes”) in the aggregate principal amount of $150,000 pursuant to the terms of a Subscription Agreement dated October 17, 2012 between the Company and two current shareholders of the Company, including Roderick de Greef, the Chairman of the Board of the Company (the “New Subscription Agreement”). The securities were offered and sold pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

The New Notes will mature on March 31, 2013 (the “Maturity Date”) and bear interest at the rate of 8% payable on the Maturity Date. The New Notes may be prepaid at any time without premium.

The New Notes are secured by all of the assets of the Company. The Company is currently seeking an amendment to the Security Agreement between the Company and each of the 2012 Note holders to permit the New Note holders to have the right to receive payments prior and in preference to the holders of the 2012 Notes.

The New Notes may be accelerated under certain circumstances, including upon a Fundamental Transaction (as defined below) or upon an Event of Default (as defined in the New Notes). In the event that (a) the Company effects any merger or consolidation with or into another entity, (b) the Company sells all or substantially all of its assets, (c) a tender offer or exchange offer is completed pursuant to which holders of the Company’s common stock are permitted to tender or exchange their shares for other securities, cash or property, (d) the Company completes a stock purchase or other business combination whereby one or more persons acquire more than 50% of the outstanding shares of common stock of the Company, (e) any “person” or “group” (as defined for purposes of Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) acquires, directly or indirectly, 50% of the aggregate common stock of the Company or (f) the Company effects any reclassification of the common stock or any compulsory share exchange pursuant to which the common stock is effectively converted into or exchanged for other securities, cash or property (other than a reverse merger) (each, a “Fundamental Transaction”), then until twenty business days after the Company notifies the New Note holder of the occurrence of the Fundamental Transaction, the New Note holder may elect to accelerate the Maturity Date of the New Note as of the date of the Fundamental Transaction. Upon an Event of Default, then, at the option of the New Note holder, all principal and interest under the New Note then remaining unpaid will be immediately due and payable upon demand by the New Note holder.

Pursuant to the New Subscription Agreement, the Company agreed to certain positive and negative covenants as set forth in the New Subscription Agreement and the New Notes. The holders of at least 65% of the principal amount of the New Notes, the 2012 Notes and any New Notes issued in any Additional Senior Note Offering (as defined in the New Subscription Agreement) may consent to take or forebear from any action permitted under or in connection with the New Subscription Agreement or the New Notes, modify the New Subscription Agreement or the New Notes or waive any default or requirement applicable to the Company or the subscribers under the New Subscription Agreement or the New Notes provided the effect of such action does not waive any accrued interest or damages and further provided that the relative rights of the holders to each other remains unchanged. Additionally, any amendment, modification or waiver that affects a holder of New Notes in a manner different from other holders of New Notes shall require the consent of such holder of New Notes and any amendment, modification or waiver that adversely affects the holders of New Notes or New Notes issued in any Additional Senior Note Offering in a manner different from holders of 2012 Notes shall require the consent of the holders of at least 70% of the principal amount of New Notes and New Notes issued in any Additional Senior Note Offering.

The Company has not paid rent due under the lease for our current executive and operating facility since July 2012 and, pursuant to an agreement between the Company and the landlord. The landlord has drawn on the standby letter of credit securing the Company’s obligations under the lease in the amount that would otherwise have been due as rent. On November 2, 2012, the Company received a notice from the landlord that it would be in default under the lease if it did not pay all past due amounts within 5 days. The Company has not paid such amounts and consequently is in default under the lease.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

Statements in this Form 10-Q that are not strictly historical are forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “intends,” “estimates,” “could” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements as a result of any number of factors. Factors that may cause or contribute to such differences include failure to obtain funding necessary to fund operations and to develop or enhance our technology, adverse results in future clinical studies of our technology, material deviations from our current operating plan, lower than expected sales, failure to obtain or maintain adequate levels of government and third-party reimbursement for use of our MTWA test, customer delays in making final buying decisions, decreased demand for our products, failure to obtain or maintain patent protection for our technology, and overall economic and market conditions. Many of these factors are more fully discussed, as are other factors, in Part I, Item 1A. “Risk Factors” of the Company’s Form 10-K for the fiscal year ended December 31, 2011, which is on file with the SEC and available at http://sec.gov/edgar.html. In addition, any forward-looking statements represent our estimates only as of today and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so except as may be legally necessary, even if our estimates should change.

Overview

We are engaged in the research, development and commercialization of products for the non-invasive diagnosis of cardiac disease. Using innovative technologies, we are addressing a key problem in cardiac diagnosis—the identification of those at risk of sudden cardiac arrest (“SCA”). Our products incorporate our proprietary technology for the measurement of Microvolt T-Wave Alternans (“MTWA”), and were the first diagnostic tools cleared by the U.S. Food and Drug Administration (“FDA”) to non-invasively measure Microvolt levels of T-Wave Alternans in order to predict the risk of SCA. MTWA is an extremely subtle beat-to-beat fluctuation in the t-wave segment of a patient’s electrocardiogram. Our technology can detect these variations down to one millionth of a volt. The MTWA Test is conducted by elevating the patient’s heart rate through exercise as performed on a treadmill similar to a standard stress test, pharmacologic agents, or pacing with electrical pulses. Our proprietary products in conjunction with our proprietary sensors, when placed on the patient’s chest, can acquire and analyze the patient’s electrocardiogram for MTWA. Published clinical data in a broad range of patients with heart disease has shown that patients with symptoms of, or at risk of, life threatening arrhythmias who test positive for MTWA are at an increased risk for subsequent sudden cardiac events including sudden death, while those who test negative are at minimal risk. Sudden cardiac arrest accounts for approximately one-third of all cardiac deaths, or approximately 300,000 deaths, in the U.S. each year, and is the leading cause of death in people over the age of 45. All of our products, including our first generation HearTwave System and second generation HearTwave II System, CH 2000 Cardiac Stress Test System, MTWA OEM (Original Equipment Manufacturer) Module (“MTWA Module”) and Micro-V Alternans Sensors have received 510(k) clearance from the FDA for sale in the U.S. Our products have also received the CE mark for sale in Europe, which certifies that a product has met European Union consumer, health and environmental requirements. Our first generation HearTwave System, CH 2000 Cardiac Stress Test System and the HearTwave II System have been approved for sale by the Japanese Ministry of Health Labor and Welfare. Our 510(k) clearance allows our MTWA Test to be used to test patients with known, suspected, or at risk of ventricular tachyarrhythmia and/or sudden cardiac arrest, and allows the claim that our MTWA Test is predictive of those events. In March 2006, the Centers for Medicare and Medicaid Services (“CMS”) issued a National Coverage Determination (“NCD”) that allows for reimbursement to healthcare providers for MTWA testing of patients at risk of SCD only when a MTWA Test is done using the Analytic Spectral Method, which is our patented and proprietary method of analysis.

If the Company is unable to generate adequate cash flows or obtain sufficient additional funding when needed, the Company will have to cut back its operations futher, sell some or all of its assets, license potentially valuable technologies to third parties, and/or cease some or all of its operations.

Strategy

Our mission is to have our MTWA Test become a standard of care in the non-invasive diagnostic monitoring regime used to identify and manage the risk of cardiac disease. In the past, the Company’s marketing strategy was focused on providing MTWA testing to those patients at highest risk for SCA, who were already likely candidates to receive an implantable defibrillation device (“ICD”). Although MTWA testing has clearly been demonstrated to be useful in this patient population, clinical experience and a growing body of data suggests that MTWA technology can and should be used in a much broader population of cardiac patients. We estimate that there are approximately 10 to 12 million cardiac patients in the U.S. who are at risk of SCA and can benefit from annual MTWA testing. Our strategy now includes accessing this broader patient population.

We intend to achieve this mission by making our technology readily available, in multiple product embodiments, in cardiology and internal medicine physician practices and in hospitals that provide healthcare services to a broad group of at-risk cardiac patients who routinely undergo cardiac evaluations, including stress testing. Our strategy calls for the Company to partner with manufacturers of cardiac stress testing equipment, who have established distribution networks and existing installed base of users, to integrate our MTWA technology into their systems. In addition to being sold to the manufacturers’ new customers, the Company expects that the MTWA product will be marketed as an upgrade to the manufacturers’ existing installed base of users. We believe that this strategy will result in our technology being marketed to a much larger number of cardiologists and internal medicine practitioners. We also believe that leveraging larger and more established distribution networks will allow us to place more strategic focus on increasing clinical utilization of our Alternans technology and increasing sales of our proprietary Micro-V Alternans Sensors.

We estimate that there are 30 to 40 million patients in the U.S. at moderate or high risk of coronary artery disease. Our pilot data suggests that these patients may benefit when MTWA is used in conjunction with other diagnostic modalities. In September 2011, we concluded a review of data generated at several clinical sites including those that participated in our MTWA-CAD feasibility study (Evaluation of Microvolt T-Wave Alternans Testing for the Detection of Active Ischemia in Patients with Known or Suspected Coronary Artery Disease). The data suggest that MTWA is a statistically significant predictor of ischemic events. In addition, the data revealed instances where our MTWA test identified underlying coronary artery disease that was not identified by other standard diagnostic modalities. The MTWA-CAD trial enrolled 176 patients. The feasibility study provided us with the information required to design a multi-center, prospective clinical trial intended to provide the basis for regulatory approval. Accordingly, we decided to conclude the enrollment in our MTWA-CAD study and commence the design of a prospective clinical trial.

Distribution Update

Post the reduction in force in July 2012, we utilize 6 independent field representatives in the U.S. who provide sales, clinical and training support to our customers. We also have 2 in-house clinical application specialist who provides clinical support to our customers and independent field representatives. We utilize country specific independent distributors for the sales of our products outside the U.S.

In June 2009, we entered into a Development, Supply and Distribution Agreement (the “OEM Agreement”), with Cardiac Science (our “OEM Partner”) as part of our strategy to increase the sales and use of our proprietary MTWA technology. Pursuant to the OEM Agreement, we developed the MTWA Module that allows our MTWA Test, using our proprietary Micro-V Alternans Sensors, to be performed on our OEM Partner’s Q-Stress test platform via customized software and patient interface. Launched in September 2010, our OEM Partner markets the MTWA Module as an upgrade to its existing installed base of Q-Stress Systems and as an optional feature to new stress customers. From July 2011 until March 31, 2012, the MTWA Module was supplied to our OEM Partner at no charge and they agreed to include the MTWA Module on new Q-Stress systems at no incremental cost to their customers. In April 2012, this program was extended through June 30, 2012 and subsequently extended to July 31, 2012.

Under the OEM Agreement, we sell and deliver to our OEM Partner the MTWA Module and our Micro-V Alternans Sensors (together, the “Products”) under purchase orders submitted by our OEM Partner. Our OEM Partner resells the Products for use with their Q-Stress test platform through its direct sales force and through its network of distributors and sub-distributors. Their right to resell the Products is non-exclusive. We may continue to sell, distribute and license our MTWA Test and sensors to other distributors and customers in both generic and customized versions. Our OEM Partner has primary responsibility for preparing sales and marketing materials and for training their sales and service personnel regarding the Products. We provide clinical and technical training and support to our OEM Partner. In addition, we provide installation training service to each purchaser of a MTWA Module for use on our OEM Partner’s Q-Stress test platform. We also have customary warranty obligations with respect to the Products sold under the OEM Agreement.

The initial term of the OEM Agreement expires on June 22, 2014. The term of the OEM Agreement will automatically renew for a one year period unless either party notifies the other of its intention to terminate at least 90 days prior to the expiration of the initial or renewal term. The OEM Agreement may be terminated by either party in the event that the other party has committed a material breach of its obligations under the OEM Agreement that has not been cured within 60 days’ written notice from the terminating party, upon the bankruptcy of either party, and upon 12 months prior written notice to the other party.

Following the clearance by the FDA in April 2010, the MTWA Module was launched by our OEM Partner in late September 2010. While the initial market preparation, product launch and lead generation activities were in line with our expectations, the number of units placed was below our projections. This trend continued through the third quarter of 2011. We believe that the lack of traction was mainly attributable to organizational changes that occurred within our OEM Partner subsequent to the launch of the MTWA Module. In October 2010, our OEM Partner announced it was being acquired by Opto Circuits (India), which was completed in December 2010. We believe the organizational restructuring of our OEM Partner, including extensive personnel changes particularly within sales and marketing, and the merger of our OEM Partner with two subsidiaries of Opto Circuits, resulted in shifts in priorities and focus that negatively impacted sales of our MTWA Module. In July 2011, we reached an agreement with our OEM Partner to include the MTWA Module on new Q-Stress System sales. During this promotion, the MTWA Module was supplied to our OEM Partner at no charge and is included in new Q-Stress Systems at no incremental cost to the customer. In the first and second quarters of 2012, we shipped 110 and 70 MTWA Modules to our OEM Partner, respectively. This program expired at the end of July 2012. In the third quarter of 2012, we shipped a total of 25 MTWA Modules

In the third quarter of 2012, approximately 18% of our total revenue came from sales of our products outside the U.S. which are sold through a network of country specific distributors in Europe, Asia and the Middle East. We market the HearTwave II System, the CH 2000 Cardiac Stress Test System and our Micro-V Alternans Sensors internationally through independent distributors.

Reimbursement Update

In December 2005, CMS released a draft of its NCD concerning MTWA testing, which became final on March 21, 2006. This broad coverage policy allows for payment to physicians for MTWA testing of patients at risk of SCA only when a MTWA Test is performed using the Analytic Spectral Method, which is our patented and proprietary method of analysis. Reimbursement to healthcare providers by Medicare/ Medicaid and third party insurers is critical to the long-term success of our efforts to make the MTWA Test a standard of care for patients at risk of ventricular tachyarrhythmia or sudden cardiac arrest. We estimate that at least one-half of the U.S. patient population that we believe are most likely to benefit from our MTWA Test are at least 65 years old and, therefore, eligible for reimbursement via Medicare. We believe the remaining approximately 50% are covered by private insurers.

Reimbursement rates for services covered by Medicare are determined by reference to the Medicare Physician Fee Schedule (“MPFS”), and are calculated based on multiple components, including relative value units, conversion factor and geographical adjustment. The MPFS rates are updated annually and have resulted in negative updates since 2002.

Effective January 1, 2011 through December 31, 2011, the national average Medicare payment amount for a MTWA Test was $200. Recent legislative action prevented the scheduled reduction of the conversion factor and the geographic practice cost index (GPCI) floor components of the reimbursement calculation until December 31, 2012. However, the remainder of the 2012 MPFS, including the relative value units, went into effect as scheduled on January 1, 2012. For the period of January 1, 2012 through December 31, 2012, the national average Medicare payment amount for a MTWA Test is set at $183.

In July 2010, CMS’s National Correct Coding Initiative (NCCI) changed the edits associated with MTWA testing, allowing our MTWA Tests to be performed on the same day as several stress procedures. The CMS update removes a previous restriction that substantially limited the reimbursement amount when a patient underwent a MTWA Test on the same day as the patient underwent a standard cardiac stress test, echocardiography stress test, nuclear cardiac stress test, or pulmonary stress test. As a result, effective July 1, 2010, CMS allows full reimbursement for both an MTWA Test and a stress test when both tests are performed during the same patient visit.

In 2005, we received positive reimbursement decisions from Horizon Blue Cross/Blue Shield units in New Jersey, and had payment policies from Blue Cross/Blue Shield in New York, Iowa, Maryland, Washington DC, Delaware, Michigan and South Dakota. In 2006, we received favorable reimbursement decisions from Aetna and Humana, which included the use of our patented algorithm. Additionally, in 2006, we received positive reimbursement decisions from other large private payers including CIGNA Healthcare, Healthcare Service Corporation (HCSC) and WellPoint. In 2008, Premera Blue Cross and Blue Cross Blue Shield of Arizona revised their policies to make Microvolt T-Wave Alternans Testing a covered benefit. In February 2009, Harvard Pilgrim Health Care initiated reimbursement for the MTWA Test. In April 2009, WellPoint revised its coverage policy on MTWA testing from a covered service to a non-covered service. In June 2011, the Company learned that UnitedHealthcare made the Company’s MTWA testing a covered benefit for its subscribers. We estimate that approximately 6 million high-risk cardiac patients are currently covered for MTWA testing by either Medicare or other commercial health plans in the United States. Typically, private reimbursement coverage for our MTWA Test is available only to those patients who are otherwise indicated for ICD therapy.

In March 2012, our MTWA Test received reimbursement coverage from Japan’s Ministry of Health, Labor and Welfare (MHLW). Effective April 1, 2012, the MTWA Test will be reimbursed for patients who are considered at risk for lethal arrhythmias including, but not limited to, patients with a history of heart attack, cardiomyopathy and Brugada syndrome.

Any reduction in reimbursement, material change in indication or reversal of private payer coverage for our MTWA Test may affect the demand for, price of, or utilization of our HearTwave II System, the MTWA Module, or Micro-V Alternans Sensors, any of which may in turn have a material adverse effect on our business.

Recent Clinical Developments

In July 2010, the first patients were enrolled in our MTWA-CAD study. MTWA-CAD is a feasibility study, which was sponsored by us and designed to evaluate MTWA testing for the purpose of detecting active ischemia in patients with known or suspected coronary artery disease (CAD). Ischemia is defined as inadequate blood supply to the coronary arteries, which can lead to myocardial infarction or what is commonly referred to as a “heart attack.” Ischemia, a common trigger for arrhythmias, is a well-documented cause of repolarization alternans. Human studies have shown that active ischemia can be associated with visible as well as microvolt-level T-wave alternans. While MTWA testing is traditionally used to evaluate arrhythmic risk, this known association with ischemia may allow MTWA testing to be used as a diagnostic tool to detect underlying CAD. An estimated 40 million cardiac stress tests in various modalities are performed annually in the United States. We filed a patent application relative to ischemia in December of 2009. The MTWA-CAD study was intended to assess the feasibility of this concept by measuring MTWA during routine nuclear stress testing or stress echocardiography with treadmill exercise. This was a feasibility study designed to verify preliminary observations under controlled environments and to generate hypotheses, endpoints, and sample sizes for future investigations. In September 2011, we concluded a review of data generated at several clinical sites including those that participated in our MTWA-CAD feasibility study. The data suggest that MTWA is a statistically significant predictor of ischemic events. In addition, the data revealed instances where our MTWA Test identified underlying coronary artery disease that was not identified by other standard diagnostic modalities. The MTWA-CAD trial enrolled 176 patients. The feasibility study provided us with the information required to design a multi-center, prospective clinical trial intended to provide the basis for regulatory approval. Accordingly, we decided to conclude our enrollment in the MTWA-CAD study, and commence the design of the prospective clinical trial.

In May 2011, new data presented at the Heart Rhythm Society’s 32nd Annual Scientific Sessions in San Francisco confirmed the diagnostic value of MTWA testing in identifying patients at risk of SCA. The pooled analysis of 2,883 patients showed that MTWA is a statistically significant predictor of SCA in patients whose heart muscle is damaged (ejection fraction < 35%), as well as those with more preserved cardiac function (ejection fraction > 35%).

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based upon the financial statements which have been prepared in accordance with U.S. generally accepted accounting principles. The notes to the financial statements contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 include a summary of our significant accounting policies and methods used in the preparation of our financial statements. The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including, when applicable, those related to incentive compensation, revenue recognition, product returns, allowance for doubtful accounts, inventory valuation, intangible assets, income taxes, warranty obligations, the fair value of preferred stock and warrants, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The critical accounting policies and the significant judgments and estimates used in the preparation of our condensed financial statements for the nine months ended September 30, 2012 are consistent with those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates.”

Results of Operations

The following table presents our revenue by product line and geographic region for each of the periods indicated. This information has been derived from our statement of operations included elsewhere in this Quarterly Report on Form 10-Q. You should not draw any conclusions about our future results from our revenue for any prior period.

Revenue:

	Three months ended September 30,													Nine months ended September 30,
			%					%			%					%					%			%
	2011		of Total			2012		of Total			Change			2011		of Total			2012		of Total			Change
Alternans Products:
U.S.	$	207,877		44	%	$	197,299		47	%		-5	%	$	803,318		49	%	$	613,351		43	%		-24	%
Rest of World		42,353		9	%		38,487		9	%		-9	%		204,079		12	%		183,993		13	%		-10	%
Total		250,230		53	%		235,786		56	%		-6	%		1,007,397		61	%		797,344		56	%		-21	%

Stress and Other Products:
U.S		172,814		36	%		161,571		39	%		-7	%		515,485		31	%		561,218		39	%		9	%
Rest of World		51,867		11	%		21,705		5	%		-58	%		130,796		8	%		76,136		5	%		-42	%
Total		224,681		47	%		183,276		44	%		-18	%		646,281		39	%		637,354		44	%		-1	%

Total Revenues	$	474,911		100	%	$	419,062		100	%		-12	%	$	1,653,678		100	%	$	1,434,698		100	%		-13	%

Three and Nine Month Periods Ended September 30, 2011 and 2012

Revenue

Total revenue for the three months ended September 30, 2011 and 2012 was $474,911 and $419,062, respectively. Revenue from the sale of our Microvolt T-Wave Alternans products, which we call our Alternans products, was $235,786 during the three months ended September 30, 2012 compared to $250,230 during the same period of 2011, a decrease of 6%. Our Alternans products accounted for 53% and 56% of total revenue for the three month periods ended September 30, 2011 and 2012, respectively. Revenue from the sale of our stress and other products for the three months ended September 30, 2011 and 2012 was $224,681 and $183,276, respectively. The decrease in revenue from our Alternans products compared to the same period in 2011 is largely attributable to the reduction in force effective in July 2012, which impacted all functions of the Company including our direct sales force.

Total revenue for the nine months ended September 30, 2011 and 2012 was $1,653,678 and $1,434,698, respectively. Revenue from the sale of our Microvolt T-Wave Alternans products was $797,344 during the nine months ended September 30, 2012 compared to $1,007,397 during the same period of 2011, a decrease of 21%. Our Alternans products accounted for 61% and 56% of total revenue for the nine month periods ended September 30, 2011 and 2012, respectively. Revenue from the sale of our stress and other products for the nine months ended September 30, 2011 and 2012 was $646,281 and $637,354, respectively.

Gross Profit

Gross profit, as a percent of revenue, for the three months ended September 30, 2011 and 2012, was 28% and 31%, respectively. Gross profit, as a percent of revenue, for the nine months ended September 30, 2011 and 2012 was 27% and 15%, respectively. For the three months ended September 30, 2012, gross profit increased as a result of selling inventory previously reserved. See Note 2 for disclosure regarding inventory reserve. On a year-to-date basis, the decrease is attributable to our agreement with our OEM Partner to include the MTWA Module on new Q-Stress System sales through July 31, 2012. During this period, the MTWA Module was supplied to our OEM Partner at no charge and was included in new Q-Stress Systems at no incremental cost to the customer.

Operating Expenses

The following table presents, for the periods indicated, our operating expenses. This information has been derived from our statement of operations included elsewhere in this Quarterly Report on Form 10-Q. Our operating expenses for any period are not necessarily indicative of future trends.

	Three months ended September 30,													Nine months ended September 30,
			%					%								%					%
			of Total					of Total			% Inc/(Dec)					of Total					of Total			% Inc/(Dec)
	2011		Revenue			2012		Revenue			2011 vs 2012			2011		Revenue			2012		Revenue			2011 vs 2012
Operating Expenses:
Research and development	$	161,127		16	%	$	63,565		15	%		-61	%	$	368,116		18	%	$	273,300		19	%		-26	%
Selling, general and administrative		1,263,902		265	%		821,103		196	%		-35	%		4,103,043		241	%		3,816,485		266	%		-7	%
Total	$	1,425,029		281	%	$	884,668		211	%		-38	%	$	4,471,159		258	%	$	4,089,785		285	%		-9	%

Research and Development

Research and development expense for the three months ended September 30, 2011 and 2012 was $161,127 and $63,565, respectively, a decrease of 61%. Research and development expense for the nine months ended September 30, 2011 and 2012 was $368,116 and $273,300, respectively, a decrease of 26%. The decrease in research and development for the three and nine-month periods ending September 30, 2012 is primarily attributable to the completion of the MTWA-CAD study and timing of certain patent related costs.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expense for the three and nine month periods ended September 30, 2011 and 2012 was $1,263,902 and $821,103 and $4,103,043 and $3,816,485, respectively, a decrease of 35% and 7% on a three and nine-month basis, respectively. The decrease is primarily due to the reduction in force in July 2012, which impacted all functions of the Company, and the temporary reduction in management’s compensation. SG&A expense for the 2011 and 2012 three and nine month periods included $80,729 and $262,412, and $120,188 and $342,718 in non-cash, stock-based compensation expense, respectively.

Interest Income/Interest Expense

Interest income for the three and nine month periods ended September 30, 2011 and 2012 was $9 and $82 and $503 and $1,650. Interest expense for the three and nine month periods ended September 30, 2011 and 2012 was $2,266 and $335,448 and $7,229 and $1,262,961, respectively. The increase in interest expense is attributable to the issuance of the 2012 Notes. See Note 5. Interest expense for the 2012 three and nine month periods included $260,957 and $1,081,616 of non-cash interest expense, and $74,491 and $181,345 of cash interest expense, related to the 2012 Notes.

Net Loss

As a result of the factors described above, the net loss for the three and nine months ended September 30, 2012 was $1,079,576 and $4,231,902 compared to $1,294,937 and $4,025,218 in the same period in 2011.

Liquidity and Capital Resources

Our financial statements have been prepared on a “going concern basis,” which assumes we will realize our assets and discharge our liabilities in the normal course of business. We have experienced recurring losses from operations of $1,292,680 and $4,018,492for the three and nine months ended September 30, 2011, respectively, and $753,610 and $3,870,130 for the three and nine months ended September 30, 2012, respectively. For the first nine months of 2012, the net loss we incurred included non-cash stock-based compensation expense of $348,816.

Cash and cash equivalents were $74,594 at September 30, 2012 compared to $312,610, at December 31, 2011. In addition, we held restricted cash in a standby letter of credit in favor of the landlord as security for our obligations under the facility lease. The original amount of the letter of credit was $500,000 for the first and second lease years and is reduced by $100,000 at the end of each of the second, third and fourth lease years. At December 31, 2011 and September 30, 2012, cash and cash equivalents included cash held in an operating bank account and cash invested in money market funds. The money market funds are readily convertible into known amounts of cash and, therefore, are classified as cash equivalents. At December 31, 2011 and September 30, 2012, $300,000 and $200,000, of restricted cash was held in money market funds, respectively.

The overall decrease in the Company’s cash and cash equivalents is primarily attributable to net cash used by operations offset by cash received in connection with the 2012 Notes. The main changes in operating assets and liabilities in 2012 were a decrease in accounts receivable, net of allowance for doubtful accounts, of $76,234, attributable to lower revenue, and a decrease in inventory, net of reserve, of $17,110. Due to inventory built up in order to satisfy our contractual obligations to St. Jude Medical, we maintain an inventory reserve, which was $1,057,746 at December 31, 2011 and $996,382 at September 30, 2012, due to the uncertainty of realizing the value of any excess inventory. We do not believe that the inventory is exposed to obsolescence risk. Accounts payable and accrued expenses at September 30, 2012 increased $80,221compared to December 31, 2011, primarily due to accrued severance in connection with the reduction in personnel in July 2012. As a result of the factors described above, we have incurred negative cash flow from operations of $3,361,483 for the nine-month period ended September 30, 2012. In addition, we have an accumulated deficit at September 30, 2012 of $110,790,453.

In November 2011, the Company entered into a Convertible Note Purchase Agreement with two current shareholders of the Company (the “Purchasers”) pursuant to which the Company issued senior unsecured convertible promissory notes (the “2011 Notes”) in the aggregate principal amount of $600,000. The 2011 Notes bore a one-time interest amount equal to 10% percent of the principal amount of the 2011 Notes, paid in full on November 14, 2011 through the issuance of 408,163 shares of common stock of the Company determined by the product of 10% percent of the principal amount of the 2011 Notes divided by the volume weighted average price (“VWAP”) of the common stock for the ten trading days prior to but not including the closing date. The 2011 Notes converted into secured convertible promissory notes in an aggregate principal amount of $600,000 together with a corresponding amount of warrants and additional investment rights in connection with the Company’s 2012 private placement financing described below.

In January, February and May 2012, the Company issued and sold secured convertible promissory notes in the aggregate principal amount of $3,490,000 (the "2012 Notes") together with common stock warrants and additional investment rights to new and current institutional and private accredited investors. The transactions raised gross proceeds of $3,490,000, including the conversion of $600,000 of the 2011 Notes. The 2012 Notes are convertible into common stock of the Company at a conversion price of $0.11 per share, mature on July 17, 2013, bear interest at the rate of 8% per annum due and payable quarterly in arrears, which commenced March 31, 2012 and upon maturity, and are secured by all of the assets of the Company. The Company issued to the investors warrants to purchase an aggregate of 31,727,265 shares of common stock of the Company (which is equal to 100% of the shares of common stock underlying the 2012 Notes as of the closing of the financing) at an exercise price of $0.15 per share (which is equal to 125% of the closing price of the common stock on January 13, 2012). The Company also issued to the investors additional investment rights (the “AIRs”) granting each investor the right to purchase an additional principal amount of 2012 Notes equal to 25% of the original principal amount of 2012 Notes purchased by such Investor at the closing of the private placement and a corresponding amount of warrants, at any time prior to July 15, 2012 (which was later extended to July 31, 2012). The Company filed a registration statement registering the shares of common stock underlying the 2012 Notes and warrants on April 13, 2012, which was declared effective on June 27, 2012. In July 2012, the Company issued secured convertible promissory notes in the aggregate principal amount of $267,500 together with common stock warrants to purchase an aggregate of 2,431,818 shares of common stock of the Company pursuant to the exercise of certain additional investment rights granted to the subscribers pursuant to the subscription agreements dated January 17, 2012, February 28, 2012 and May 23, 2012. The July 2012 notes and related common stock warrants have substantially the same terms as those previously issued to investors under the subscription agreements, except that the maturity date of the July 2012 notes is January 31, 2014 and the term of the warrants will terminate on July 31, 2016.

We believe our existing resources, including cash at September 30, 2012 of $74,594 and the proceeds from the sale of senior secured promissory notes in October 2012 of $150,000, described in further detail in Note 12 to the Condensed Financial Statements in Item 1, and currently projected financial results, are sufficient to fund operations through the end of November 2012. These resources coupled with the restructuring of the Company’s operations to reduce its cash burn allows the Company to continue to support its existing customer base and distribution partnerships for a period of time while it executes on certain key activities and explores strategic alternatives. If we are unable to generate adequate cash flows or obtain sufficient additional funding when needed, we will have to cut back our operations, sell some or all of our assets, license potentially valuable technologies to third parties, and/or cease some or all of our operations. If the Company raises additional funds through the issuance of equity or convertible debt securities, the percentage ownership of the Company by our stockholders would be diluted. The Company may have to issue equity or debt securities that have rights, preferences and privileges senior to our existing securities, including common stock. So long as any 2012 Notes or any New Notes are outstanding, the Company may not, without the consent of holders of 65% of the 2012 Notes and New Notes then outstanding, raise capital through the issuance of debt or rights to acquire debt, or enter into any agreement to modify the terms of any equity securities currently outstanding. Further, the Company may not issue equity securities ranking, as to dividends, redemption or distribution of assets upon a liquidation, senior to or pari passu with the Series C-1 Preferred Stock or the Series D Preferred Stock, without the written consent of the holders of at least a majority of the then-outstanding shares of Series C-1 Preferred Stock and Series D Preferred Stock, respectively, voting as a separate class, and the Company may not, without the written consent of the holders of at least a majority of the then-outstanding shares of Series D Preferred Stock, issue debt securities convertible into any equity securities of the Company.

On an as-converted basis, as of September 30, 2012, the Company had 124,659,416 shares of common stock issued and outstanding, including 100,112,960 shares of common stock issued, 4,180,602 shares issuable upon conversion of the Series C-1 Convertible Preferred Stock and 20,365,854 shares issuable upon conversion of the Series D Convertible Preferred Stock. Additionally, the Company has reserved 49,819,083 shares of common stock for issuance upon exercise of outstanding warrants, including 15,660,000 warrants issued to investors and the selling agent in connection with the sale of our common stock in December 2010 and an aggregate of 34,159,083 issued in connection with the sale of secured convertible promissory notes in January, February, May and July 2012. The Company has also reserved 34,159,083 shares of common stock for issuance upon conversion of secured convertible promissory notes issued in January, February, May and July 2012. The Company also has stock options outstanding to purchase up to an aggregate of 10,727,080 shares of common stock. If we are unable to generate adequate cash flows or obtain sufficient additional funding when needed, we may have to cut back our operations, sell some or all of our assets, license potentially valuable technologies to third parties, and/or cease some or all of our operations.

Contractual Obligations and Commercial Commitments

Our contractual obligations as of September 30, 2012 are set forth in the table below.

	Payments Due by Period
			Less than						More than
Contractual Obligations	Total		1 Year		1-3 Years		3-5 Years		5 Years

Capital Lease Obligations	$	23,872	$	8,308	$	15,564	$	-	$	-
Operating Lease Obligations	$	232,000	$	232,000	$	-	$	-	$	-
Purchase Obligations	$	10,000	$	10,000	$	-	$	-	$	-
Total	$	265,872	$	250,308	$	15,564	$	-	$	-

In November 2007, we entered into a definitive agreement with Farley White Management Company, LLC to lease 17,639 usable square feet of office space located at 100-200 Ames Pond Drive, Tewksbury, Massachusetts, which is our current executive and operating facility. The initial lease term is for 62 months with an option to extend the lease for one extension period of five years. The term of the lease commenced February 2008. We were not required to pay rent for the first two months of the initial lease term. Thereafter, the annual base rent for the first, second, third, fourth and fifth years of the initial lease term will be $262,500, $367,776, $377,992, $388,208 and $398,424, respectively, plus our pro-rata share of real estate taxes and property maintenance, in each case over a base year. During the term of our lease, we are required to maintain a standby letter of credit in favor of the landlord as security for the obligations under the lease. The amount of the letter of credit is $500,000 for the first and second lease years and is reduced by $100,000 at the end of each of the second, third and fourth lease years. The Company first occupied the space in February 2008 and the first, second and third reductions of the letter of credit in the amounts of $100,000 took place during the first three months of 2010, 2011, and 2012 respectively. The landlord for the property was responsible for paying the costs of construction for the interior of the space occupied by us. We are generally responsible for paying for our interior furnishings, telephones, data cabling and equipment. Based on these terms, we account for this agreement as an operating lease.

Under the terms of our license and consulting and technology agreements, we are required to pay royalties on sales of our Alternans products. Minimum license maintenance fees under our license agreement with MIT, which are creditable against royalties otherwise payable for each year, are $10,000 per year through 2013. We are committed to pay an aggregate of $10,000 of such minimum license maintenance fees subsequent to September 30, 2012. In addition, the royalty on net sales related to technologies licensed from third parties and improvements thereon sold or leased by the Company and the monthly royalty under the Amended and Restated Consulting and Technology Agreement between the Company and Richard Cohen was $37,500 at September 30, 2011 and 2012, respectively.

Off-Balance Sheet Arrangements

We have not created, and are not a party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We own financial instruments that are sensitive to market risk. At December 31, 2011 and September 30, 2012, our cash and cash equivalents included money market funds. The money market funds are currently invested in a government-backed money market fund. Given the relative security and liquidity associated with the money market fund, we do not believe that a change in market rates would have a material negative impact on the value of our investment portfolio. Declines in interests rates over time will, however, reduce our interest income from our investments. We have not had any material exposure to factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. None of these instruments are held for trading purposes. Although we have implemented policies to preserve our capital, there can be no assurance that the valuation and liquidity of investments are not exposed to some level of risk due to market conditions.

ITEM 4. CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2012. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2012, our disclosure controls and procedures were not effective. As part of the restructuring of the Company’s operations in July 2012, which impacted all functions of the Company, most of the employees in the accounting department were terminated. As a result, the Company does not maintain adequate segregation of duties within its critical financial reporting applications, the related modules and financial reporting processes.

The term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Controls Over Financial Reporting.

In connection with the evaluation referred to in the foregoing paragraph, we have made changes in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934) during the fiscal quarter ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. As part of the restructuring of the Company’s operations in July 2012, which impacted all functions of the Company, most of the employees in the accounting department were terminated. As a result, the Company does not maintain adequate segregation of duties within its critical financial reporting applications, the related modules and financial reporting processes. Accordingly, management has determined that this control deficiency constituted a material weakness, and that the Company’s internal control over financial reporting was not effective, as of September 30, 2012.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of September 30, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.

A goal of the assessment was to determine whether any material weaknesses or significant deficiencies existed with respect to the Company’s internal control over financial reporting. A “material weakness” is defined as a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A “significant deficiency” is a control deficiency, or a combination of control deficiencies, that adversely affects a company’s ability to initiate, authorize, record, processor report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the annual or interim financial statements that is more than inconsequential will not be prevented or detected.

In the course of its assessment, management determined that the Company lacked sufficient staff to segregate accounting duties. In July 2012, the Company underwent a restructuring of its operations including in order to reduce expenses. The restructuring included significant reductions in personnel and overhead costs across all functions of the Company. Specifically, the reduction in personnel included four employees in the accounting department. As a result, the Company does not maintain adequate segregation of duties within its critical financial reporting applications, the related modules and financial reporting processes. This control deficiency could result in a misstatement of balance sheet and income statement accounts in our interim or annual financial statements that would not be detected. Accordingly, management has determined that this control deficiency constituted a material weakness, and that the Company’s internal control over financial reporting was not effective, as of September 30, 2012.

At present time, the benefit of employing additional personnel to mitigate this weakness does not justify the expense given the Company’s current financial condition. Management will continue to evaluate the situation and make adjusts accordingly.

PART II—OTHER INFORMATION

ITEM 6. EXHIBITS

The exhibits listed in the Exhibit Index filed as part of this report are filed as part of or are included in this report.

SIGNATURE

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

	CAMBRIDGE HEART, INC.

Date: November 14, 2012	By:	/S/ VINCENZO LICAUSI
		Vincenzo LiCausi
		Chief Financial Officer

EXHIBIT INDEX

Exhibit Number		Description

4.1		Form of 8% Senior Secured Note issued on October 17, 2012 is incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K dated October 22, 2012

10.1		Subscription Agreement, dated as of October 17, 2012, by and among the Company and certain Investors is incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K dated October 22, 2012

10.2#		Letter Agreement, dated as of July 31, 2012, by and between the Company and Ali Haghighi-Mood

10.3#		Letter Agreement, dated as of August 1, 2012, by and between the Company and Roderick de Greef

10.4#		Letter Agreement, dated as of September 1, 2012, by and between the Company and Vincenzo LiCausi

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101§		The following financial statements from Cambridge Heart, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, as filed with the SEC on November 14, 2012, formatted in XBRL (Extensible Business Reporting Language), as follows:

		(i) Condensed Balance Sheets at December 31, 2011 and September 30, 2012 (Unaudited)

		(ii) Condensed Statement of Operations for the Three and Nine Month Periods Ended September 30, 2011 and 2012 (Unaudited)

		(iii) Condensed Statements of Cash Flows for the Nine Month Periods Ended September 30, 2011 and 2012 (Unaudited)

		(iv) Notes to Condensed Financial Statements (Unaudited)

§	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended.

#	Management contract or compensatory plan or arrangement filed as an exhibit to this Form pursuant to Item 6 of Form 10-Q.

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