NWCI Newcardio Inc (CE)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

  

For the quarterly period ended September 30, 2011

         . 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: 333-149166

 

NEWCARDIO, INC.

(Exact name of registrant as specified in its charter)

Delaware		20-1826789
(State or other jurisdiction of		(I.R.S. Employer
Incorporation or organization)		Identification No.)

103 Carnegie Center, Suite 300, Princeton NJ 05870

(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code: (877) 332-4324

2350 Mission College Blvd., Suite 1175, Santa Clara CA 95054

(Former address, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.  

Yes       . No   X   .

 

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   X   . 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.

Large accelerated filer	.	Accelerated filer	.
Non-accelerated filer	. (Do not check if a smaller reporting company)	Smaller reporting company	X .

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) 

Yes       . No   X   .

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class		Shares Outstanding at November 14, 2011
Common Stock, $0.001 Par Value		33,148,307

   

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NEWCARDIO, INC.

INDEX

 

PART I	Financial Information	Page Number
	Item 1.	Financial Statements (unaudited)
		Condensed Consolidated Balance Sheets –September 30, 2011 (Unaudited) and December 31, 2010	3
		Unaudited Condensed Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2011 and September 30, 2010	4
		Unaudited Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and September 30, 2010	5
		Notes to Unaudited Condensed Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
	Item 4.	Controls and Procedures	32
PART II	Other Information
	Item 1	Legal Proceedings	33
	Item 1A.	Risk Factors	33
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
	Item 3.	Defaults Upon Senior Securities	33
	Item 4.	Removed and Reserved	33
	Item 5	Other Information	33
	Item 6.	Exhibits	34
SIGNATURES	35

2

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PART I.

FINANCIAL INFORMATION

Item 1.   FINANCIAL STATEMENTS

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NEWCARDIO, INC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
		Three months ended September 30,		Nine months ended September 30,
		2011		2010		2011		2010
Revenue	$	9,883	$	99,210	$	150,511	$	169,328
Cost of sales		27,461		46,325		125,106		109,632
Gross profit (loss)		(17,578)		52,885		25,405		59,696
Operating expenses:
Selling, general and administrative		962,411		1,185,170		3,267,878		4,732,292
Depreciation		11,752		12,058		35,998		34,027
Research and development		566,350		748,401		1,983,536		2,674,089
Total operating expenses		1,540,513		1,945,629		5,287,412		7,440,408
Net loss from operations		(1,558,091)		(1,892,744)		(5,262,007)		(7,380,712)
Other income (expense)
(Loss) gain on change in fair value of warrant derivative liability and preferred stock derivative liability		(14,313)		97,473		2,069,957		711,706
Amortization of commitment fees		(550,910)		(626,352)		(1,976,412)		(1,407,795)
Other financing costs		(35,685)		(1,655)		(136,123)		(86,655)
Interest, net		(119,600)		(80,360)		(323,839)		(121,473)
Total other income (expense):		(720,508)		(610,894)		(366,417)		(904,217)
Net loss before income taxes		(2,278,599)		(2,503,638)		(5,628,424)		(8,284,929)
Provision for income taxes		-		-		-		-
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS	$	(2,278,599)	$	(2,503,638)	$	(5,628,424)	$	(8,284,929)
Net (loss) per share-basic and fully diluted	$	(0.07)	$	(0.08)	$	(0.18)	$	(0.29)
Weighted average number of shares-basic and fully diluted		32,571,537		29,520,144		31,853,724		28,126,775
See the accompanying notes to these unaudited condensed consolidated financial statements

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NEWCARDIO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
		Nine months ended September 30,
		2011		2010
Cash flows from operating activities:
Net loss for the period	$	(5,628,424)	$	(8,284,929)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		61,399		59,191
Amortization of commitment fees		1,976,412		1,407,795
Common stock issued for services rendered		110,408		218,749
Fair value of options issued for services rendered		2,747,422		2,625,497
Fair value of warrants issued as compensation for services		17,677		183,617
Fair value of restricted stock units issued for services rendered		199,846		631,682
Change in fair value of warrants derivative liability and preferred stock derivative liability		(2,069,957)		(711,706)
(Increase) decrease in:
Accounts receivable		42,905		(86,053)
Prepaid expenses		10,553		14,388
Increase (decrease) in:
Unearned revenue		(1,500)		1,500
Accounts payable and accrued liabilities		637,604		58,146
Net cash (used in) operating activities		(1,895,655)		(3,882,123)
Cash flows from investing activities:
Purchase of property plant and equipment		(1,699)		(33,551)
Payment of patent costs		(30,964)		(15,986)
Proceeds from short term investments		-		25,010
Net cash (used in)  investing activities		(32,663)		(24,527)
Cash flows from financing activities:
Proceeds from line of credit		900,000		3,000,000
Proceeds from advances		256,000		-
Proceeds from exercise of common stock options		408		11,768
Proceeds from exercise of common stock warrants		-		14,195
Proceeds from stock subscription		-		500,000
Proceeds from sale of Series D preferred stock		200,000		-
Net cash provided by  financing activities		1,356,408		3,525,963
Net (decrease) in cash and cash equivalents		(571,910)		(380,687)
Cash and cash equivalents at beginning of period		584,974		1,386,007
Cash and cash equivalents at end of period	$	13,064	$	1,005,320
Supplemental disclosures of cash flow information:
Taxes paid	$	-	$	-
Interest paid	$	-	$	-
Non cash financing activities:
Fair value of warrants issued for financing	$	17,759	$	3,302,674
See the accompanying notes to these unaudited condensed consolidated financial statements

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

NOTE 1 – SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting policies applied in the presentation of the accompanying unaudited condensed consolidated financial statements follows:

General

The accompanying unaudited condensed consolidated financial statements of NewCardio, Inc., (the “Company”), have been prepared in accordance with the rules and regulations (S-X) of the Securities and Exchange Commission (the "SEC") and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  The results from operations for the nine month period ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated December 31, 2010  financial statements and footnotes thereto included in the Company's SEC Form 10-K.

 

Basis and business presentation

NewCardio, Inc. (the “Company”) was incorporated under the laws of the State of Delaware in September 2004 and was in the development stage through December 31, 2009.  The year 2010 was the first year during which the Company was considered an operating company and no longer in the development stage.

 

The Company is principally devoted to providing cardiac diagnostic technology with its proprietary 3-D ECG software platform technology products and services to significantly improve the non-invasive diagnosis and monitoring of cardiovascular disease, as well as the cardiac safety assessment of drugs under development. The Company’s 3-D ECG software platform’s objective is to reduce the time and expense involved in assessing cardiac status while increasing the ability to diagnose clinically significant conditions which were previously difficult to detect.

The unaudited condensed consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiary NewCardio Technologies, Inc. (“NewCardio Technologies”).  All significant intercompany balances and transactions have been eliminated in consolidation.

Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures.  The most significant estimates are those used in determination of derivative liabilities and stock compensation. Accordingly, actual results could differ from those estimates.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Revenue Recognition

The Company recognizes revenue in accordance with Accounting Standards Codification subtopic 605-10, Revenue Recognition (“ASC 605-10”) which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded.

Revenues consist of Cardiac Safety software licenses provided on a fee for services basis and are recognized as the services are performed, as well as Cardiac Safety consulting services on a time and materials basis. The Company recognizes revenues as it performs the services.

At the time of each transaction, management assesses whether the fee associated with the transaction is fixed or determinable and whether or not collection is reasonably assured. The assessment of whether the fee is fixed or determinable is based upon the payment terms of the transaction. If a significant portion of a fee is due after our normal payment terms or upon implementation or client acceptance, the fee is accounted for as not being fixed or determinable and revenue is recognized as the fees become due or after implementation or client acceptance has occurred. Collectability is assessed based on a number of factors, including past transaction history with the client and the creditworthiness of the client.

 

The Company accounts for Multiple-Element Arrangements under ASC 605-10 which incorporates Accounting Standards Codification subtopic 605-25, Multiple-Element Arrangements (“ASC 605-25”). ASC 605-25 addresses accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets.

Unbilled revenue is revenue that is recognized but is not currently billable to the customer pursuant to contractual terms. In general, such amounts become billable in accordance with predetermined payment schedules, but are recognized as revenue as services are performed. Amounts included in unbilled revenue are expected to be collected within one year and are included within current assets.

Cash

The Company considers cash to consist of cash on hand and temporary investments having an original maturity of 90 days or less that are readily convertible into cash.

Commitment Fees

 

The Company amortizes commitment fees paid in connection with establishment of a credit facility ratably over the term of the credit facility commitment. (See note 4)

Accounts Receivable

 

Trade receivables are carried at their estimated collectible amounts. Trade credit is generally extended on a short-term basis; thus trade receivables do not bear interest. Trade accounts receivable are periodically evaluated for collectability based on past credit history with customers and their current financial condition.

As of December 31, 2010, two customers represented 60% and 40% of the Company’s accounts receivable.  There was no accounts receivable as of September 30, 2011.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Allowance for Doubtful Accounts

Any changes to the allowance for doubtful accounts on accounts receivable are charged to operations in amounts sufficient to maintain the allowance for uncollectible accounts at a level management believes is adequate to cover any probable losses. Management determines the adequacy of the allowance based on historical write-off percentages and the current status of accounts receivable. Accounts receivable are charged off against the allowance when collectability is determined to be permanently impaired. As of September 30, 2011 and December 31, 2010, there was no allowance for doubtful accounts recorded, as all of the Company’s receivables were considered collectible.

Property and Equipment

Property and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings. For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives of 3 to 5 years.

Long-Lived Assets

 

The Company follows Accounting Standards Codification 360-10-15-3, “Impairment or Disposal of Long-lived Assets,” which established a “primary asset” approach to determine the cash flow estimation period for a group of assets and liabilities that represents the unit of accounting for a long-lived asset to be held and used.  Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.  Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell.  

Intangibles

Intangible assets with finite lives are amortized over their estimated useful lives. Intangible assets with indefinite lives are not amortized, but are tested for impairment annually. The Company’s intangible assets with finite lives are patent costs, which are be amortized over their economic or legal life, whichever is shorter. To date, these patent costs are due to legal, filing issuance and maintenance fees associated with patents that have been applied for or are being prosecuted and there is no amortization at this time.

Income Taxes

The Company has adopted Accounting Standards Codification subtopic 740-10, Income Taxes (“ASC 740-10”) which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  Temporary differences between taxable income reported for financial reporting purposes and income tax purposes consist primarily of derivative liability and stock compensation accounting recognized for book basis versus tax recognition.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Comprehensive Income

The Company does not have any items of comprehensive income in any of the periods presented.

Net Loss per Common Share, basic and diluted

The Company has adopted Accounting Standards Codification subtopic 260-10, Earnings Per Share (“ASC 260-10”) specifying the computation, presentation and disclosure requirements of earnings per share information. Basic loss per share has been calculated based upon the weighted average number of common shares outstanding. Preferred stock, stock options and warrants have been excluded as common stock equivalents in the diluted loss per share because their effect is anti-dilutive on the computation. Fully diluted shares outstanding were 52,456,105 and 51,294,164 for the three month periods ended September 30, 2011 and 2010, respectively; and 51,760,792 and 54,208,653 for the nine month periods ended September 30, 2011 and 2010, respectively.

Stock based compensation

The Company follows Accounting Standards Codification subtopic 718-10, Compensation (“ASC 718-10”) which requires that all share-based payments to both employees and non employees be recognized in the income statement based on their fair values.  (See note 8)

As of September 30, 2011, there were outstanding stock options to purchase 11,918,752 shares of common stock, 8,005,303 shares of which were vested.

Concentrations of Credit Risk

Financial instruments and related items, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and trade receivables. The Company places its cash and temporary cash investments with high credit quality institutions.  At times, such investments may be in excess of the FDIC insurance limit.

 

The Company’s revenues earned from sale of products and services for the three months ended September 30, 2011 included 71% and 29% of the Company’s total revenues from two customers; for the three months ended September 30, 2010, 70.6% of the Company’s total revenues was from one customer.

  

The Company’s revenues earned from sale of products and services for the nine months ended September 30, 2011 included 71% and 25% of the Company’s total revenues from two customers; for the nine months ended September 30, 2010, 86.2% of the Company’s total revenues was from one customer.

Reliance on Key Personnel and Consultants

 

The Company has 10 full-time employees and no part-time employees.  Additionally, there are approximately 12 consultants performing various specialized services.  The Company is heavily dependent on the continued active participation of these current executive officers, employees and key consultants. The loss of any of the senior management or key consultants could significantly and negatively impact the business until adequate replacements can be identified and put in place.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Research and Development

The Company accounts for research and development costs in accordance with Accounting Standards Codification subtopic 730-10, Research and Development (“ASC 730-10”). Under ASC 730-10, all research and development costs must be charged to expense as incurred. Accordingly, internal research and development costs are expensed as incurred.  Third-party research and development costs are expensed when the contracted work has been performed or as milestone results have been achieved as defined under the applicable agreement. Company-sponsored research and development costs related to both present and future products are expensed in the period incurred. The Company incurred research and development expenses of $566,350 and $1,983,536 for the three and nine month periods ended September 30, 2011 and  $748,401 and $2,674,089 for the three and nine month period ended September 30, 2010. 

Fair Value

Accounting Standards Codification subtopic 825-10, Financial Instruments (“ASC 825-10”) requires disclosure of the fair value of certain financial instruments. The carrying amount reported in the consolidated condensed balance sheets for accounts receivables, accounts payable and accrued expenses and put liability approximates fair value because of the immediate or short-term maturity of these financial instruments. The carrying amount reported in the accompanying condensed consolidated balance sheets for line of credit approximates fair value because the actual interest rates do not significantly differ from current rates offered for instruments with similar characteristics.

 

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Short term investment and derivative liabilities are recorded at fair value on a recurring basis. In accordance with Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. (See note 9)

Reclassification

Certain reclassifications have been made to prior periods’ data to conform with the current year’s presentation. These reclassifications had no effect on reported income or losses.

Recent Accounting Pronouncements

There are various updates recently issued, most of which represented technical corrections to the accounting literature or application to specific industries and are not expected to a have a material impact on the Company's consolidated financial position, results of operations or cash flows.

NOTE 2 – GOING CONCERN MATTERS

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying unaudited condensed consolidated financial statements during nine months ended September 30, 2011, the Company incurred net losses attributable to common shareholders of $5,628,424 and used $1,895,655 in cash for operating activities during nine months ended September 30, 2011. These factors among others may indicate that the Company will be unable to continue as a going concern for a reasonable period of time.

 

The Company’s existence is dependent upon management’s ability to develop profitable operations and to obtain additional funding sources. Management is devoting substantially all of its efforts to the commercialization of its initial product solution, as well as raising additional debt or equity financing in order to accelerate the development and commercialization of additional products based on the Company’s 3-D ECG software platform technology.  The Company is continuing to explore potential sources to provide capital and other resources for the further development and marketing of its products.  The Company has also implemented expense management measures. There can be no assurance that the Company’s commercialization or financing efforts will result in profitable operations or the resolution of the Company’s liquidity problems. The accompanying statements do not include any adjustments that might result should the Company be unable to continue as a going concern.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

NOTE 3 – RELATED PARTY TRANSACTIONS

Effective July 30, 2009, a greater than 5% shareholder of the Company who also has current representation rights with respect to the Board of Directors entered into a credit facility that the Company utilized in 2010; the Company borrowed $1,900,000 from this investor as of September 30, 2011. On July 29, 2010, the Company entered into a new credit facility that is available in 2011 and this investor committed $500,000 of this facility, of which $300,000 was drawn down during the nine months ended September 30, 2011.  Both the debt and accrued interest were due and payable September 30, 2011 (See Subsequent Events Note 10).  At September 30, 2011 the Company owes this investor $328,017 in accrued interest.   Interest expense in the three and nine months ended September 30, 2011 was $67,467 and $189,000 compared to $51,847 and $79,644 in the three and nine months ended September 30, 2010. (See note 4)

 

The Company has issued a total of 2.6 million warrants in association with both credit facilities and also the draw-downs under the July 2009 facility and these are being amortized as commitment fees over the life of the facilities (i.e. the months in which we can borrow under the facilities) and over the life of the debt (in regards to the draw-down warrants.)

The warrants were valued using Black Scholes and the cost amortized as a commitment fee as follows:

							Three months ended September 30, 2011			Three months ended September 30, 2010
		# of warrants		Total value			Amortization of commitment fees			Amortization  of  commitment fees
2009 commitment fee			475,000		$	592,680			$	-			$	88,172
2010 draw-down warrants			1,900,002		$	1,779,403			$	310,567			$	311,625
2010 commitment fee			250,000		$	165,128			$	24,948			$	-
Totals			2,625,002		$	2,537,211			$	335,515			$	399,797

							Nine months ended September 30, 2011			Nine months ended September 30, 2010
		# of warrants		Total value			Amortization of commitment fees			Amortization of  commitment fees
2009 commitment fee			475,000		$	592,680			$	-			$	352,688
2010 draw-down warrants			1,900,002		$	1,779,403			$	921,574			$	405,519
2010 commitment fee			250,000		$	165,128			$	165,120			$	-
Totals			2,625,002		$	2,537,211			$	1,086,694			$	758,207

During the three months ended September 30, 2011, four of the Company's board of directors, including the Chief Executive Officer, and the 5% shareholder as discussed above advanced a non- interest loan for an aggregate of $138,500 working capital funds. Terms of repayment are immediately following a larger subsequent financing, if any.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

NOTE 4 – CREDIT FACILITIES

On July 30, 2009, the Company entered into a $3 million credit line arrangement (the “Credit Line”), pursuant to a Securities Purchase Agreement (the “SPA”), with purchasers signatory to the SPA, pursuant to which the purchasers will purchase 12% Secured Revolving Debentures Due September 30, 2011(see Subsequent Events Note 10), as amended. In connection therewith, the Company issued 750,000 five-year common stock purchase warrants as commitment warrants with an exercise price of $0.01 per share. Subsequently the Company issued a total of 3,000,006 five-year common stock purchase warrants with an exercise price of $0.85 per share as of September 30, 2011, for the monies advanced under the Credit Line, (the “Draw-down Warrants”). The Draw-down Warrants have full-ratchet price protection (reduction in exercise price and increase in the number of common shares underlying the warrants for potential dilutive equity issuances, as defined) for future issuances of equity securities by the Company (subject to certain specific exceptions.) The warrants have cashless exercise provisions and the Draw-down Warrants are subject to forced cashless exercise in the event that the Company’s common stock is trading at three times the VWAP for the 20 trading days prior to conversion of the warrants.  All interest under the Debentures is accruing and is payable upon maturity.

As indicated above, in connection with the establishment of the Credit Line, the Company issued 750,000 warrants (no ratchet price protection) to purchase the Company’s common stock at $0.01 per share for five years.  The fair value was determined using the Black Scholes Option Pricing Model and included $25,000 paid toward availing the credit facility; it was amortized ratably to ‘amortization of commitment fee’ over the life of the Credit Line through August 2010.  The assumptions for fair value determination were as follows: Dividend yield: 0%; Volatility: 139.04%; Expected life: 5 years; Risk free rate: 2.66%.

During the year ended December 31, 2010, the Company borrowed an aggregate of $3,000,000 from the credit line.  As described above, the Company issued 3,000,006 Draw-down Warrants with exercise prices from $0.85 to $1.45 per share for five years with all warrants subsequently reset to $0.85 per share (see Subsequent Events Note 10). The fair value of the warrants was determined using the Black Scholes Option Pricing Model and amortized ratably to operations over the life of the borrowing.  Assumptions for the fair value determination were as follows: Dividend yield: 0%; Volatility: 103.84% to 136.30%; Expected life: 5 years; Risk free rate: 1.19% to 2.62%.

In July 2010 the Company entered into a new $1.5 million credit line arrangement to issue 12% Revolving Debentures due September 30, 2011 (see Subsequent Events Note 10). The line may be accessed by the Company beginning January 2011.  In connection therewith, the Company issued 750,000 five year common stock purchase warrants with an exercise price of $1.00 per share, a cashless exercise provision and full ratchet price protection (reduction in exercise price and increase in the number of common shares underlying the warrants for potential dilutive equity issuances, as defined) for future issuances of equity securities by the Company (subject to certain specific exceptions.) (see Subsequent Events Note 10) The warrants were valued using the Black Scholes option pricing method with the following assumptions:  dividend yield: $-0-, volatility: 104.134%, expected life: 5 years and risk free rate: 1.75%.   

The warrants, valued using the Black Scholes assumptions above, and the costs amortized as a commitment fee are as follows:

 

								Three months ended September 30, 2011			Three months ended September 30, 2010
		September 30, 2011 # of warrants			September 30, 2011 Total value			Amortization of commitment fees			Amortization of commitment fees
2009 commitment fee			750,000			$	935,860			$	-			$	139,219
2010 draw-down warrants			3,000,006			$	2,807,240			$	493,100			$	487,134
2010 commitment fee			750,000			$	513,193			$	57,811			$	-
Totals			4,500,006			$	4,256,293			$	550,911			$	626,353

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

								Nine months ended September 30, 2011			Nine months ended September 30, 2010
		September 30, 2011 # of warrants			September 30, 2011 Total value			Amortization of commitment fees			Amortization of commitment fees
2009 commitment fee			750,000			$	935,860			$	-			$	556,875
2010 draw-down warrants			3,000,006			$	2,807,240			$	1,463,220			$	850,920
2010 commitment fee			750,000			$	513,193			$	513,193			$	-
Totals			4,500,006			$	4,256,293			$	1,976,413			$	1,407,795

No additional warrants are issuable as the Company draws down on the new credit line arrangement. All interest under the Debentures is accrued interest and is payable upon maturity on September 30, 2011 (See Subsequent Events Note 10).  

In July 2010, in conjunction with the new credit line arrangement, participants in the Credit Line entered into an amendment with the Company pursuant to which, among other things, extended the maturity date of the debentures issued/issuable thereunder from May 31, 2011 to September 30, 2011 and permitted that any debentures issued under the new credit facility will rank pari passu with debentures issued under the Credit Line. The debt issued under the credit facilities is secured by all the assets of the Company.

Both Credit Lines are provided by three stockholders of the Company, one of which has representation rights with respect to the Board of Directors. (See note 3)

During the nine months ended September 30, 2011, the Company canceled 250,000 warrants previously issued under the 2010 commitment fees due to a default of one of the lenders and accordingly wrote off the remaining amortization (included in table above).  Subsequent to the cancelation, the Company re-issued 250,000 replacement warrants once the default conditions were cleared under the same remaining terms and conditions of the previous canceled warrants.  The warrants were valued using the Black Scholes option pricing method with the following assumptions:  dividend yield: $-0-, volatility: 75.44%, expected life: 4.24years and risk free rate: 2.50%.   

During the nine months ended September 30, 2011, the Company Draw-down totaled an aggregate of $900,000 from the new credit line arrangement.

NOTE 5 - WARRANT DERIVATIVE LIABILITY

In connection with issuance of Series C Preferred Stock in September 2009

The Company issued warrants in conjunction with the sale of Series C preferred stock.  These warrants contained certain reset provisions up to the first anniversary of date of the issuance. Therefore, in accordance with ASC 815-40 , the Company reclassified the fair value of the warrant from equity to a liability at the date of issuance.  Subsequent to the initial issuance date, the Company is required to adjust to fair value the warrant as an adjustment to current period operations.

The Company estimated the fair value at date of issue of the warrants issued in connection with the issuance of the Series C preferred stock to be $2,052,181 using the Black-Scholes formula assuming no dividends, a risk-free interest rate of 2.41%, expected volatility of 131.04%, and expected warrant life of two years. Since the warrants have reset provisions for the first year, pursuant to ASC 815-40, the Company has recorded the fair value of the warrants as a derivative liability. The net value of the warrants at the date of issuance was recorded as a warrant liability in the amount of $2,052,181 and a reduction in value of the Series C preferred stock. Until conversion and expiration of the reset provisions of the warrants, changes in fair value were recorded as non-operating, non-cash income or expense at each reporting date. The Company adjusted the recorded fair values of the warrants to market resulting in a non-cash, non-operating loss of $0 and $70,571 for the nine months ended September 30, 2011 and 2010, respectively.

As the warrant reset provisions expired in September 2010, the initial allocated fair value of the warrants of $1,483,201 are included in ‘Permanent Equity’ in the Condensed Consolidated Balance Sheets and charged to current period operations.

13

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

In connection with the Credit Lines

The Company issued (1) warrants in conjunction with the monthly Draw-downs under the Credit Line and (2) warrants as a commitment fee in conjunction with the new $1.5 million credit line arrangement.  These warrants contain certain reset provisions, which expire if the Company lists on a National stock exchange such as NASDAQ. Therefore, in accordance with ASC 815-40 , the Company classifies the fair value of these warrants as a derivative liability at the date of issuance.  Subsequent to the initial issuance date, changes in fair value will be recorded as non-operating, non-cash income or expense at each reporting date. (See note 4).

 

The fair values of all above described warrants of $344,174 at September 30, 2011 were determined using the Black Scholes Option Pricing Model with the following assumptions: Dividend yield: 0%; Volatility: 130.67%; Expected life: 3.4 to 3.9 years and Risk free rate: 0.42%.

As of the date of the financial statements, the Company believes an event under the contract that would create an obligation to settle in cash or other current assets is remote and has classified the obligation as a long term liability.

The Company adjusted the recorded fair values of the warrants to market resulting in a non-operating (loss) gain of $(7,731) and $1,797,697 for the three and nine months ended September 30, 2011 and a non-operating gain of $1,069,128 and $1,619,572 for the three and nine month periods ended September 30, 2010, respectively.

 

NOTE 6 – PREFERRED STOCK DERIVATIVE LIABILITY

In connection with Series C preferred stock

The Series C preferred stock contained certain reset provisions related to common stock conversion during the first anniversary of date of the issuance and therefore, in accordance with ASC 815-40, the Company determined the fair value of the reset provision was $1,647,771 using the Black-Scholes formula assuming no dividends, a risk-free interest rate of 0.39%, expected volatility of 131.04%, and expected life of one year. Pursuant to ASC 815-40, the Company recorded the fair value of the reset provision as a preferred stock derivative liability. The net value of the reset provision at the date of issuance was recorded as a preferred stock derivative liability in the amount of $1,647,771 and a reduction in value of the Series C preferred stock. Until expiration of the reset provisions of the Series C preferred stock, changes in fair value were recorded as gain or loss at each reporting date. The Company adjusted the recorded fair values of the warrants to market resulting in a gain of $0 and $134,361 for the nine months ended September 30, 2011 and 2010, respectively. (See note 7)

As the reset provision contained in the Series C preferred stock expired in September 2010, the initial allocated fair value of the reset provisions of $1,190,916 is included in ‘Permanent Equity’ in the Condensed Consolidated Balance Sheets and charged to current period operations.

In connection with Series D preferred stock

The Series D preferred stock contains certain reset provisions related to common stock conversion subject to subsequent equity financing, therefore in accordance with ASC 815-40, the Company determined the initial allocated fair value of the reset provision using the Binomial Lattice formula at the dates of issuance assuming no dividends, a risk-free interest rate of 0.25%-0.30%, expected volatility of 73.15%-103.23%, and expected life of one year was $211,753 through September 30, 2011. Pursuant to ASC 815-40, the Company reclassified the initial allocated fair value of the reset provision as a reset derivative liability. The net value of the reset provision at the dates of issuance was recorded as a reset derivative liability and a reduction in value of the Series D preferred stock. 

The fair value of the described reset provision of $15,634 at September 30, 2011, determined using the Binomial Lattice Model assuming: Dividend yield: 0%; Volatility: 130.67%; and Risk free rate: 0.13%.

As of the date of the financial statements, the Company believes an event under the contract that would create an obligation to settle in cash or other current assets is remote and has classified the obligation as a long term liability.

The Company adjusted the recorded fair value of the preferred stock derivative liability to market resulting in non-cash, non-operating (loss) gain of $(6,582) and $254,502 for the three and nine months ended September 30, 2011.

14

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

NOTE 7 – STOCKHOLDERS EQUITY

Preferred Stock

The Company is authorized to issue 1,000,000 shares of preferred stock with a par value of $0.001 per share.  The Company's preferred stock may be divided into such series as may be established by the Board of Directors. The Board of Directors may fix and determine the relative rights and preferences of the shares of any series established.

 

Series B – Preferred Stock

In December 2008, the Board of Directors authorized the issuance of up to 18,000 shares of Series B 0% convertible non-voting preferred stock (the “Series B preferred stock”).

The Series B preferred stock is not entitled to preference upon liquidation; not entitled to dividends unless declared by the Board of Directors and are nonvoting except the Corporation shall not, without the affirmative vote of the holders of a majority of the then outstanding shares of the Series B preferred stock, (a) alter or change adversely the powers, preferences or rights given to the Series B preferred stock or alter or amend the Certificate of Designation, (b) amend its certificate of incorporation or other charter documents in any manner that adversely affects any rights of the Series B preferred stockholders, (c) increase the number of authorized shares of Series B preferred stock, or (d) enter into any agreement with respect to any of the foregoing. Each share of Series B preferred stock is convertible, at any time at the option of the holder, into 1000 shares of Common Stock.

During the year ended December 31, 2010 and the nine months ended September 30, 2011, 4,185 and 134 shares of Series B preferred stock was converted into 4,185,000 and 134,000 shares of the Company's common stock, respectively. As of September 30, 2011 and December 31, 2010, 12,116 and 12,250 shares of Series B preferred stock were issued and outstanding, respectively.

Series C - Preferred stock

In September 2009, the Board of Directors authorized the issuance of up to 7,000 shares of 0% convertible non-voting preferred stock (the “Series C preferred stock”) with warrants.

The Company issued an aggregate of 2,920 shares of preferred stock in September 2009 to accredited investors including Company officers, shareholders and directors at $1,000 per share. Each share of Series C preferred stock is convertible, at any time at the option of the holder, into 1,000 shares of common stock (for a total of 2,920,000 shares of common stock or the equivalent of $1.00 per common share.)

 

The Series C preferred stock is not entitled to preference upon liquidation; not entitled to dividends unless declared by the Board of Directors and are nonvoting except the Corporation shall not, without the affirmative vote of the holders of a majority of the then outstanding shares of Series C preferred stock, (a) alter or change adversely the powers, preferences or rights given to the Series C preferred stock or alter or amend the Certificate of Designation, (b) amend its certificate of incorporation or other charter documents in any manner that adversely affects any rights of the Series C preferred stockholders, (c) increase the number of authorized shares of Series C preferred stock, or (d) enter into any agreement with respect of any of the forgoing.

 

Due to certain terms in the September 2009 financing and described below, the proceeds from the financing were allocated among three types of financial instruments. These terms include:

 

Dilutive issuance:   The Preferred C stock contained certain reset provisions relating to conversion of common stock up to the first anniversary of date of the issuance. In connection with the issuance of each share Series C preferred stock, the Company also issued 1,000 warrants to purchase the Company’s common stock at $1.20 per share for five years (2,920,000 warrants in total).  Prior to the first anniversary of the date of issuance, the warrants contained certain proportional reset provisions. The reset provisions expired in September 2010.

Exchange Right:  Each holder of the Series C preferred stock had a one-time right to elect to exchange their Series C preferred stock (and all warrants issued to the holder in connection with the Series C preferred stock) for a debenture and warrants on the same terms and in the same dollar amount, as was issued to the purchasers of the Credit Facility debentures and warrants when the Company first accessed the Credit Line.  No investor exercised this one-time exchange right and in March 2010, the exchange right expired.

15

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Warrant: The warrant is described in note 5, Warrant Liability, ‘In connection with issuance of Series C Preferred Stock in September 2009’.

 

In accordance with ASC 815-40 , the Company was required to bifurcate the fair value of the reset provision from the host contract and mark to market the reset provision each reporting period. The fair value of the reset provision at the date of issuance, determined using the Black Scholes Option Pricing Method, was charged as an allocated debt discount.

In connection with the issuance of the Series C preferred stock, the Company issued 2,920,000 warrants with similar reset provisions.  In accordance with ASC 815-40,   the Company was required to record the fair value of the warrants outside of equity, as warrant liability, and mark to market each reporting period. The fair value of the warrants at the date of issuance, determined using the Black Scholes Option Pricing Method, was charged as an allocated debt discount.

The Company recorded a total debt discount of $2,674,117 from the reset and exchange provisions and related warrants and with the expiration of both the dilutive issuance rights and the exchange right during the year; the entire amount of the Series C preferred stock is now classified in ‘Permanent equity’.  

During the year ended December 31, 2010 and the nine months ended September 30, 2011, 625 and 0 shares of Series C preferred stock was converted into 625,000 and 0 shares of the Company's common stock, respectively. As of September 30, 2011 and December 31, 2010, 2,295 shares of Series C preferred stock were issued and outstanding.

 

Series D - Preferred stock

 

In September 2010, the Board of Directors authorized the issuance of up to 1,000 shares of 0% convertible non-voting preferred stock (the “Series D preferred stock”)

 

The Company issued an aggregate of 800 shares of preferred stock during the year ended December 31, 2010 to accredited investors and additional 200 shares during the nine months ended September 30, 2011, including 60 shares to an officer and a director of the Company. Each share was sold for $1,000 per share. Each share of Series D preferred stock is convertible, at any time at the option of the holder, into 1,000 shares of common stock (for a total of 1,000,000 shares of common stock or the equivalent of $1.00 per common share.)

In connection with the issuance of the Series D preferred stock, the Company issued an aggregate of 1,000,000 warrants to purchase the Company's common stock at $1.10 per share for five years from the date of issuance.

The Series D preferred stock is not entitled to preference upon liquidation; not entitled to dividends unless declared by the Board of Directors and are nonvoting except the Corporation shall not, without the affirmative vote of the holders of a majority of the then outstanding shares of Series D preferred stock, (a) alter or change adversely the powers, preferences or rights given to the Series D preferred stock or alter or amend the Certificate of Designation, (b) amend its certificate of incorporation or other charter documents in any manner that adversely affects any rights of the Series D preferred stockholders, (c) increase the number of authorized shares of Series D preferred stock, or (d) enter into any agreement with respect to any of the foregoing.

The proceeds from the financing were allocated among two types of financial instruments described below. These terms include:

Dilutive issuance:  (see the ‘Preferred stock derivative’ liability in the unaudited Condensed Consolidated Balance Sheets). Each share of Series D preferred stock share shall be convertible, at any time, at the option of the holder into 1,000 shares of common stock.  The Series D preferred stock automatically converts to the Company's common stock with the closing of an equity-based financing of not less than $1 million at a conversion ratio of the lesser of 1,000 shares of common stock for one share of Series D preferred stock or a ratio based on the per share purchase price for the common stock to be issued with subsequent equity financing. (See also note 10.)

Warrant: In connection with the issuance of each share Series D preferred stock, the Company issued 1,000 warrants to purchase the Company’s common stock at $1.10 per share for five years.  

In accordance with ASC 815-40 , the Company was required to bifurcate the fair value of the reset provision from the host contract and mark to market the reset provision each reporting period.

 

The initial allocated fair value of the reset provision at the date of issuance was recorded as a preferred stock derivative liability in the amount of $211,753 and a reduction in value of the Series D preferred stock. 

16

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Common Stock

In September 2010, the Company issued an aggregate of 250,000 shares of common stock for consulting services rendered and to be rendered over the term of the agreement. The valuations of common stock issued for services were based upon the fair value of the common stock. As of September 30, 2011 75% of the shares were earned (i.e. were released); valued at $0.64 per share. The remainder of the shares will be determined with milestones met and are considered issued and not outstanding at September 30, 2011.

NOTE 8 -STOCK OPTIONS AND WARRANTS

 

Warrants

The following table summarizes in warrants outstanding and related prices for the shares of the Company’s common stock issued to shareholders at September 30, 2011:

 

						Warrants Outstanding Weighted Average									Warrants Exercisable
						Remaining			Weighted						Weighted
			Number			Contractual			Average			Number			Average
Exercise Price			Outstanding			Life (years)			Exercise price			Exercisable			Exercise Price
$	0.01				750,000				2.83			$	0.01				750,000			$	0.01
	0.85				3,000,006				3.65				0.85				3,000,006				0.85
	0.95				120,842				1.26				0.95				120,842				0.95
	0.96				203,385				0.75				0.96				203,385				0.96
	1.00				921,000				3.66				1.00				921,000				1.00
	1.10				1,250,000				3.81				1.10				1,187,500				1.10
	1.14				5,178,948				1.26				1.14				5,178,948				1.14
	1.15				162,709				0.75				1.15				162,709				1.15
	1.20				2,920,000				1.95				1.20				2,920,000				1.20
	1.50				350,000				2.45				1.50				350,000				1.50
Total				14,856,890				2.52								14,794,390

 

Transactions involving the Company’s warrant issuance are summarized as follows:

		Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2009			11,247,083			$	1.08
Issued			5,000,006				0.94
Exercised			(915,199	)			0.10
Canceled or expired			(50,000	)			0.10
Outstanding at December 31, 2010			15,281,890				1.10
Issued			450,000				1.04
Expired			(625,000	)			(2.90	)
Canceled			(250,000	)			(1.00	)
Outstanding at September 30, 2011			14,856,890			$	1.03

 

17

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

During the nine months ended September 30, 2011, the warrants totaling 200,000 were issued in connection with the sale of Series D preferred stock.  The warrants are exercisable for five years from the date of issuance at an exercise price of $1.10 per share.

During the nine months ended September 30, 2011, the Company canceled 250,000 warrants previously issued under the 2010 commitment fees due to a default of one of the lenders and accordingly recognized as expense the remaining amortization (included in table above). Subsequent to the cancelation, the Company re-issued 250,000 replacement warrants once the default conditions were cleared under the same remaining terms and conditions of the previous canceled warrants.  The warrants were valued using the Black Scholes option pricing method with the following assumptions:  dividend yield: $-0-, volatility: 75.44%, expected life: 4.24years and risk free rate: 2.50%.   

Stock plans

 

The 2004 Equity Incentive Plan, initially established by NewCardio Technologies, Inc., was adopted by the Company in 2007, as amended, and 10.3 million shares were registered on SEC Form S-8 in the first quarter of 2008. At September 30, 2011 there are approximately 0.5 million shares available for grant.

The 2009 Equity Compensation Plan approved by the Board of Directors on April 15, 2009 and registered on SEC Form S-8 in June 2009, reserved 8.0 million shares of the Corporation’s common stock for the Plan, plus a number of shares annually as of April 15th of each year as initially equal to ten (10%) percent of the issued and outstanding common stock, on a fully diluted basis and effective April 15, 2011 a number equal to 10% of the then outstanding stock on a fully diluted basis (including warrants, options, RSUs, and Convertible Securities) but not less than 1 million over last year’s reserve. At September 30, 2011, the total reserve is approximately 13.6 million shares; approximately 8.5 million shares are available for grant.

 

The 2010 Restricted Equity Compensation Plan approved by the Board of Directors on September 13, 2010 reserved 1 million shares of the Corporation’s common stock for the Plan. At September 30, 2011, there are 750,000 shares available for grant.

 

The Company granted equity based compensation over the years under these equity plans.  The Company granted non-qualified stock options to purchase 2,402,398 and 1,203,000 shares of common stock during the nine months ended September 30, 2011 and 2010, respectively, under the 2004 Equity Incentive Plan and the 2009 Equity Compensation Plan as well as -0- and 116,614 restricted stock units during the nine months ended September 30, 2011 and 2010, respectively, under the 2009 Equity Compensation Plan. The Company granted no restricted shares during the nine months ended September 30, 2011 and 2010 under the 2010 Restricted Equity Compensation Plan.

18

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Non Employee Stock Options

The following table summarizes in options outstanding and the related prices for the shares of the Company's common stock issued to non employees at September 30, 2011:

			Options Outstanding						Options Exercisable
						Weighted Average			Weighted						Weighted
						Remaining			Average						Average
Exercise			Number			Contractual Life			Exercise			Number			Exercise
Prices			Outstanding			(Years)			Price			Exercisable			Price
$	0.01				300,732				5.90			$	0.01				139,815			$	0.01
	0.02				165,826				4.71				0.02				165,826				0.02
	0.22				768,611				6.36				0.22				764,861				0.22
	0.77				200,000				9.00				0.77				60,417				0.77
	0.80				429,000				6.87				0.80				328,817				0.80
	0.85				150,000				9.49				0.85				12,500				0.85
	0.90				3,000				8.81				0.90				877				0.90
	1.16				25,000				6.83				1.16				13,024				1.16
	2.25				150,000				6.43				2.25				131,250				2.25
Total				2,192,169				6.66								1,617,387

Transactions involving stock options issued to non employees are summarized as follows:

		Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2009:			1,405,144			$	1.10
Granted			203,000				0.40
Employment status change			735,000				0.22
Exercised			(85,385	)			(0.14	)
Expired			(400,000	)			(2.00	)
Outstanding December 31, 2010			1,857,759				0.52
Granted			209,000				0.41
Employment status change			151,815				0.79
Exercised			(26,405	)			(0.01	)
Expired			-				-
Outstanding, September 30, 2011			2,192,169			$	0.53

During the nine months  ended September 30, 2011,  the Company granted an aggregate of 209,000 non employee stock options in connection services rendered at the exercise prices from $0.01 to $0.85. 

The fair values of the vesting non employee options for the nine months ended September 30, 2011 were determined using the Black Scholes option pricing model with the following assumptions: Dividend yield: 0%; Volatility: 74.02% to 130.67%; and Risk free rate: 1.43%  to  3.47%.

 

The fair value of all non employee options vesting during the three and nine months ended September 30, 2011 of $11,166 and $66,899, respectively, was charged to current period operations.

   

The fair value of all non-employee options vesting during the three and nine  months ended September 30, 2010 of $27,503 and $137,883, respectively was charged to current period operations.

19

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Employee Stock Options

The following table summarizes the options outstanding and the related prices for the shares of the Company's common stock issued to employees of the Company under a non-qualified employee stock option plan at September 30, 2011:

			Options Outstanding						Options Exercisable
						Weighted Average			Weighted						Weighted
						Remaining			Average						Average
Exercise			Number			Contractual Life			Exercise			Number			Exercise
Prices			Outstanding			(Years)			Price			Exercisable			Price
$	0.001				100,000				2.29			$	0.001				100,000			$	0.001
	0.01				1,776,399				8.49				0.01				683,066				0.01
	0.02				880,000				5.44				0.02				880,000				0.02
	0.22				1,000,000				5.90				0.22				1,000,000				0.22
	0.36				200,000				9.72				0.36				12,500				0.36
	0.69				105,000				9.11				0.69				70,625				0.69
	0.78				40,000				8.13				0.78				18,333				0.78
	0.80				4,090,000				6.82				0.80				3,254,282				0.80
	0.81				185,184				9.26				0.81				34,722				0.81
	0.83				120,000				9.25				0.83				-				-
	0.85				280,000				9.49				0.85				-				-
	0.98				500,000				8.71				0.98				156,250				0.98
	1.32				450,000				8.65				1.32				178,139				1.32
Total				9,726,583				7.33								6,387,917

 

Transactions involving stock options issued to employees are summarized as follows:

		Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2009:			7,365,000			$	0.53
Granted			1,275,000				1.06
Employment status change			(735,000	)			(0.22	)
Exercised			-				-
Forfeitures			(101,256	)			(0.80	)
Outstanding at December 31, 2010			7,803,744				0.63
Granted			2,193,398				0.24
Employment status change			(151,815	)			(0.79	)
Exercised			(92,500	)			(0.80	)
Forfeitures			(26,244	)			(0.80	)
Outstanding at September 30, 2011:			9,726,583			$	0.54

20

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

During the nine months ended September 30, 2011, the Company granted an aggregate of 2,193,398 stock options with an exercise prices of $0.01 to $0.85. The fair values were determined using the Black Scholes option pricing model with the following assumptions: Dividend yield: 0%; Volatility: 72.17% to 91.09%; and Risk free rate: 2.94% to 3.58%.

 

The fair value of all employee options vesting in the three and nine months ended September 30, 2011 of $936,493 and $2,680,523, respectively, was charged to current period operations.

 

The fair value of all employee options vesting in the three and nine months ended September 30, 2010 of $858,702 and $2,487,614, respectively, was charged to current period operations.

Restricted Stock Units (“RSUs”)

The Company has issued RSUs to certain employees and non employees under the 2009 Equity Compensation Plan.  RSUs issued to date vest in up to 24 months with certain acceleration clauses, as defined by the 2009 Equity Compensation Plan.

Employees

 

Transactions involving employee RSUs are summarized as follows: 

		Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2009:			1,470,000			$	0.80
Granted			116,614				1.32
Exercised			(18,183	)			(1.32
Forfeitures			(65,810	)			(0.81	)
Outstanding at December 31, 2010			1,502,621				0.83
Granted			-				-
Exercised			(1,453,812	)			(0.82	)
Forfeitures			-
Outstanding at September 30, 2011:			48,809			$	1.32

 

The fair value of all employees RSUs vesting three and nine months ended September 30, 2011 of $Nil and $187,333, respectively, was charged to current period operations.

The fair value of all employees RSUs vesting three and nine months ended September 30, 2010 of $147,000 and  $594,930, respectively, was charged to current period operations.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Non employees

Transactions involving non employee RSUs are summarized as follows:

		Number of Shares			Weighted Average Price Per Share
Outstanding at December 31, 2009:			105,000			$	0.80
Granted			-				-
Exercised			-				-
Outstanding at December 31, 2010:			105,000				0.80
Granted			-				-
Exercised			(105,000	)			(0.80)
Outstanding at September 30, 2011:			-			$	-

The fair value of all non employees RSUs vesting during the three and nine months ended September 30, 2011 of $Nil and $12,513 respectively was charged to current period operations. The fair value of all non employees RSUs vesting during the three and nine months ended September 30, 2010 of $8,400 and $36,750 respectively was charged to current period operations.

NOTE 9 — FAIR VALUE

ASC 825-10 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of nonperformance. ASC 825-10 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 825-10 establishes three levels of inputs that may be used to measure fair value:

 

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 for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is disclosed is determined based on the lowest level input that is significant to the fair value measurement.

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Items recorded or measured at fair value on a recurring basis in the accompanying consolidated financial statements consisted of the following items as of September 30, 2011:

		Total			Quoted Prices in Active Markets for Identical Instruments Level 1			Significant Other Observable Inputs Level 2			Significant Unobservable Inputs Level 3 (A)
Liabilities
Preferred stock derivative		$	(15,634	)		$	-			$	-			$	(15,634	)
Warrant derivative		$	(344,174	)		$	-			$	-			$	(344,174	)
Total		$	(359,808	)		$	-			$	-			$	(359,808	)

(A)	Fair value is estimated based on internally-developed models or methodologies utilizing significant inputs that are unobservable from objective sources.

Level 3 Liabilities comprised of the fair value of issued warrants with reset provisions and the Series D preferred stock with reset provisions.

The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities as of September 30, 2011:

Nine Months Ended  September 30, 2011:
		Warrant derivative liability			Preferred stock derivative liability
Balance, December 31, 2010		$	2,141,871			$	250,863
Series D preferred stock issuances during the nine months ending September 30, 2011							19,273
Warrants issued in connection with credit facility			17,758
Mark-to-market at September 30, 2011:
-        - Series D preferred stock derivative liability							(254,502)
- Warrants issued with Credit Facility Draw-downs and the new $1.5 million credit facility			(1,815,455	)
Transfers in and/or out of Level 3			-				-
Balance, September 30, 2011		$	344,174			$	15,634
Total gain for the period included in earnings relating to the liabilities held at September 30, 2011 of $2,069,957		$	1,815,455			$	254,502

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NEWCARDIO, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

NOTE 10 — SUBSEQUENT EVENTS

Subsequent events have been evaluated through November 14, 2011, a date that the financial statements were issued.

On October 5, 2011, the Company entered into a letter agreement with the purchasers of the Company’s 12% Secured Revolving Debentures, amending the Debentures to change their maturity from a stated maturity date of September 30, 2011, to payment on demand.  Any demand for payment of the Debentures must be in writing, given at least five (5) business days prior to the specified payment date, and must be signed by the holders of at least sixty percent (60%) of the aggregate principal amount of Debentures then outstanding. The Debentures, in the aggregate principal amount of $3.9 million, were issued under a Securities Purchase Agreement, dated as of July 30, 2009 (the “2009 SPA”), and a Securities Purchase Agreement, dated as of July 28, 2010 (the “2010 SPA”), between the Company and the Purchasers.  

In October 2011, the Company voluntarily reduced the price of warrants issued with the 2009 SPA and 2010 SPA. 3,000,006 warrants issued with $3 million in borrowings under the 2009 SPA are now exercisable at $0.01 per underlying common share, down from $0.85 per underlying common share. 750,000 warrants issued as a commitment fee under the 2010 SPA are now exercisable at $0.01 per underlying common share, down from $1.00 per underlying common share.

In October 2011, in conjunction with the exercise of 25 shares of Series C Preferred Stock, the Company issued 25,000 shares of its common stock.

In October 2011, Dr. Vajdic resigned from the Board of Directors of the Corporation.

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

Forward-Looking Statements

This Management’s Discussion and Analysis contains forward-looking statements regarding our business development plans, clinical trials, regulatory reviews, timing, strategies, expectations, anticipated expense levels, projected profits, business prospects and positioning with respect to market, demographic and pricing trends, business outlook, technology spending and various other matters (including contingent liabilities and obligations and changes in accounting policies, standards and interpretations) and express our current intentions, beliefs, expectations, strategies or predictions.  These forward-looking statements are based on a number of assumptions and currently available information and are subject to a number of risks and uncertainties.

Forward-looking statements are generally identifiable by the use of terms such as “anticipate,” “will,” “expect,” “believe,” “should” or similar expressions. Although we believe that the assumptions on which the forward-looking statements contained herein are based are reasonable, any of those assumptions could prove to be inaccurate given the inherent uncertainties as to the occurrence or nonoccurrence of future events. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict.  Therefore, actual outcomes and results may, and are likely to, differ materially from what is expressed or forecasted in the forward-looking statements due to numerous factors, including the potential risks and uncertainties set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 and Item 1A below and relate to our business plan, our business strategy, development of our proprietary technology platform and our products, timing of such development, timing and results of clinical trials, level and timing of FDA regulatory clearance or review, market acceptance of our products, protection of our intellectual property, implementation of our strategic, operating and people initiatives, benefits to be derived from personnel and directors, ability to commercialize our products, our assumptions regarding cash flow from operations and cash on-hand, the amount and timing of operating costs and capital expenditures relating to the expansion of our business, operations and infrastructure, implementation of marketing programs, our key agreements and strategic alliances, our ability to obtain additional capital as, and when, needed, and on acceptable terms and general economic conditions specific to our industry, any of which could impact sales, costs and expenses and/or planned strategies and timing.   Until we are able to generate sufficient liquidity from operations, if we are not able to raise sufficient additional capital, it could have a material adverse affect on our business, results of operations, liquidity and financial condition. We assume no obligation to, and do not currently intend to, update these forward-looking statements.

Overview

 

Significant highlights for the third quarter of 2011 were as follows: 

Overview

 

In the third quarter of 2011 we continued to limit discretionary spending as we focused on completing a financing. Our operating expenses decreased 21% from a year ago, and net cash used in operations for the 9 months ended September 30, 2011 decreased 51% from 2010. Our sales continue to be small as the market for early stage cardiac safety studies remains low at this time. Revenues represented residual business and there were no new studies started in the quarter ended September 30, 2011, although we have begun on a new study in the fourth quarter, and have been awarded two additional studies which are scheduled to start in the fourth quarter as well..

We did not borrow the final $600,000 under the credit facility that matured September 30, 2011. The outstanding debt of $3.9 million plus interest is due on demand.  We are however working closely with our creditors, who are the investors that funded the company in 2007 as NewCardio was going public.  They advanced $150,000 of the $256,000 in short term advances this quarter, modified the due date on the outstanding debt so that it is a demand note and they currently are working with the Company while we look at various strategic financing options. While we are exploring other sources of financing to meet our working capital requirements, there is no guarantee that such financing will become available or, if it does, that it will become available on acceptable terms, or that any additional capital we may obtain will be sufficient to meet our long-term needs. See further discussions in the ‘Liquidity and Capital Resources’ section below.

During this transition, Accounts Payable and Accrued Expenses (not associated with the debt) have grown from $404,000 at year end to $718,000, an increase of $314,000. We were unable to pay salaries beginning September 1, 2011 and in October, four of our R&D personnel, including the CTO and Fellow have either converted to a consulting status or were furloughed. They are continuing to support the in process prosecution of our intellectual property patent filings and the sales process as needed.  All others have taken further salary reductions or have been furloughed.  We have 5 active employees at this time including the Chief Executive and Chief Financial Officer. And while we have curtailed development efforts on CardioBip ™ , our telemedicine monitoring product, as well as the early research on my3KG ™ , we have consulting agreements in place that we expect will permit us to move forward, by leveraging the resources that have driven the development to date,  when finances permit.

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The lease to our Santa Clara headquarters expired September 30, 2011 and we did not renew it.  We switched our Corporate Offices to our Princeton, New Jersey location.

In October 2011 our founder and vice chairman resigned from the Board of Directors. He continues in his role as Fellow, although that position is currently on furlough.

 

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2011 and September 30, 2010

 

Selected results of operations for the three and nine months ended September 30, 2011 and September 30, 2010 were as follows:

 

Financial Condition and Results of Operations