Ontrak, Inc. - Quarter Report: 2019 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019

 

Commission File Number 001-31932     

 

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CATASYS, INC.

(Exact name of registrant as specified in its charter)

 

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Delaware	88-0464853
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

 

2120 Colorado Blvd., Suite 230, Santa Monica, CA 90404

(Address of principal executive offices, including zip code)

 

(310) 444-4300

(Registrant's telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.0001 par value	CATS	The NASDAQ Capital Market

 

 

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    ☒          No    ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes    ☒          No    ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,’’ “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒
Emerging growth company	☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

As of August 14, 2019, there were 16,546,992 shares of the registrant's common stock, $0.0001 par value per share, outstanding.

 

 

 

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		June 30,				December 31,
		2019				2018
		(Unaudited)
Assets
Current assets:
Cash and restricted cash		$	7,059			$	3,162
Receivables, net			2,576				1,382
Unbilled receivables			1,055				-
Prepaid expenses and other current assets			724				942
Total current assets			11,414				5,486
Long-term assets:
Property and equipment, net of accumulated depreciation of $1,556 and $1,801, respectively			359				263
Restricted cash, long-term			408				408
Right-of-use assets			2,595				-
Debt issuance costs			1,284				-
Deposits and other assets			-				166
Total assets		$	16,060			$	6,323
Liabilities and stockholders' deficit
Current liabilities:
Current portion of long-term debt		$	1,917			$	-
Accounts payable			1,459				497
Accrued compensation and benefits			1,988				1,537
Deferred revenues			4,033				4,195
Current portion of obligations under operating leases			525				-
Other accrued liabilities			1,953				1,501
Total current liabilities			11,875				7,730
Long-term liabilities:
Long-term debt, net of discount of $365 and $478, respectively		$	13,618			$	7,472
Long-term lease liabilities			1,780				-
Warrant liabilities			842				86
Other long-term liabilities			100				-
Total liabilities			28,215				15,288
Stockholders' deficit:
Preferred stock, $0.0001 par value; 50,000,000 shares authorized; no shares issued and outstanding			-				-
Common stock, $0.0001 par value; 500,000,000 shares authorized; 16,536,992 and 16,185,146 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively			2				2
Additional paid-in capital			301,909				296,688
Accumulated deficit			(314,066	)			(305,655	)
Total stockholders' deficit			(12,155	)			(8,965	)
Total liabilities and stockholders' deficit		$	16,060			$	6,323

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(in thousands)		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2019				2018				2019				2018
Revenue		$	7,681			$	3,273			$	14,492			$	5,184
Cost of revenue			4,365				2,941				7,392				5,228
Gross profit (loss)			3,316				332				7,100				(44	)
Operating expenses			8,223				4,477				14,522				8,348
Operating loss			(4,907	)			(4,145	)			(7,422	)			(8,392	)
Other income			8				-				14				40
Interest expense			(471	)			(36	)			(792	)			(37	)
Change in fair value of warrant liability			(120	)			(19	)			(211	)			(29	)
Net loss		$	(5,490	)		$	(4,200	)		$	(8,411	)		$	(8,418	)
Net loss per share, basic and diluted from operations:		$	(0.34	)		$	(0.26	)		$	(0.51	)		$	(0.53	)
Weighted-average shares used to compute basic and diluted net loss per share			16,315				15,913				16,398				15,906

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										Additional								Total
		Common Stock								Paid-In				Accumulated				Stockholders'
		Shares				Amount				Capital				Deficit				Deficit
Balance at December 31, 2018			16,185,146			$	2			$	296,688			$	(305,655	)		$	(8,965	)
Reclassification of warrant liability to equity upon adoption of ASU 2017-11			-				-				86				-				86
Warrants issued for services			-				-				43				-				43
Warrant exercised for cash			212,461				-				1,028				-				1,028
Stock option exercised for cash			139,385				-				1,473				-				1,473
Stock compensation expense			-				-				2,591				-				2,591
Net loss			-				-				-				(8,411	)			(8,411	)
Balance at June 30, 2019			16,536,992			$	2			$	301,909			$	(314,066	)			(12,155	)

										Additional								Total
		Common Stock								Paid-In				Accumulated				Stockholders'
		Shares				Amount				Capital				Deficit				Deficit
Balance at March 31, 2019			16,205,146			$	2			$	297,898			$	(308,576	)		$	(10,676	)
Warrants issued for services			-				-				43				-				43
Warrant exercised for cash			192,461				-				928				-				928
Stock option exercised for cash			139,385				-				1,473				-				1,473
Stock compensation expense			-				-				1,567				-				1,567
Net loss			-				-				-				(5,490	)			(5,490	)
Balance at June 30, 2019			16,536,992			$	2			$	301,909			$	(314,066	)		$	(12,155	)

										Additional								Total
		Common Stock								Paid-In				Accumulated				Stockholders'
		Shares				Amount				Capital				Deficit				Deficit
Balance at December 31, 2017			15,889,171			$	2			$	294,220				(293,324	)			898
Adoption of accounting standard, ASC 606			-				-				-				1,881				1,881
Balance at January 1, 2018			15,889,171			$	2			$	294,220				(291,443	)			2,779
Common stock issued for outside services			24,000				-				112				-				112
Warrants issued for services			-				-				86				-				86
Warrants issued in connection with A/R facility			-				-				63				-				63
Stock compensation expense			-				-				753				-				753
Net loss			-				-				-				(8,418	)			(8,418	)
Balance at June 30, 2018			15,913,171			$	2			$	295,234				(299,861	)			(4,625	)

										Additional								Total
		Common Stock								Paid-In				Accumulated				Stockholders'
		Shares				Amount				Capital				Deficit				Deficit
Balance at March 31, 2018			15,913,171			$	2			$	294,746			$	(295,661	)		$	(913	)
Warrants issued in connection with A/R facility			-				-				63				-				63
Stock compensation expense			-				-				425				-				425
Net loss			-				-				-				(4,200	)			(4,200	)
Balance at June 30, 2018			15,913,171				2				295,234				(299,861	)			(4,625	)

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		For the Six Months Ended June 30,
		2019				2018
Cash flows used in operating activities
Net loss		$	(8,411	)		$	(8,418	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			72				170
Amortization of debt discount included in interest expense			146				10
Warrant issued for services			-				86
Warrants issued for investor relations			43				-
Loss on disposal of fixed assets			-				68
Deferred rent			(26	)			(25	)
Stock-based compensation expense			2,591				753
Amortization of debt issuance costs			112				-
Change in fair value of warrant liability			211				29
Shares issued for services			-				112
Changes in operating assets and liabilities:
Receivables			(1,194	)			(629	)
Unbilled receivables			(1,055	)			-
Operating leases liability			525				-
Prepaids and other current assets			218				165
Deferred revenue			(162	)			2,379
Accounts payable and other accrued liabilities			975				1,466
Net cash used in operating activities		$	(5,955	)		$	(3,834	)
Cash flows provided by financing activities
Proceeds from secured promissory note		$	-			$	5,000
Proceeds from revolving loan			7,500				-
Proceeds from A/R Facility			1,938				-
Repayment of A/R Facility			(1,938	)			-
Debt issuance costs			(133	)			(324	)
Proceeds from warrant exercise			1,028				-
Proceeds from options exercise			1,473				-
Capital lease obligations			(16	)			(18	)
Net cash provided by financing activities		$	9,852			$	4,658
Net increase in cash and restricted cash		$	3,897			$	824
Cash and restricted cash at beginning of period			3,570				4,779
Cash and restricted cash at end of period		$	7,467			$	5,603
Supplemental disclosure of cash flow information:
Interest paid		$	792			$	37
Non cash financing and investing activities:
Warrant issued in connection with A/R Facility		$	21			$	63
Reclassification of warrant liability to equity upon amendment of the Loan Agreement		$	86			$	-
Warrants issued in connection with revolving loan		$	610			$	-
Property and equipment acquired through capital leases		$	154			$	-

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Note 1.   Basis of Consolidation and Presentation

 

We are a AI and technology-enabled healthcare company whose mission is to help improve the health and save the lives of as many people as possible. Our PRE^TM (Predict-Recommend-Engage) platform predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages people who aren’t getting the care they need. By combining predictive analytics with human engagement, we deliver improved member health and validated outcomes and savings to healthcare payers. 

 

Our integrated, technology-enabled OnTrak solution, a critical component of the Catasys PRE platform, is designed to treat members with behavioral conditions that cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, COPD, and congestive heart failure, which result in high medical costs. We have an ability to engage these members, who do not otherwise seek behavioral healthcare, leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance. OnTrak integrates evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, along with care coaching and in-market Community Care Coordinators who address the social and environmental determinants of health, including loneliness.

 

The accompanying unaudited consolidated financial statements include Catasys, Inc. and its wholly-owned subsidiaries and variable interest entities. All intercompany balances and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements for Catasys, Inc. and its subsidiaries have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and instructions to Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with U.S. GAAP. In our opinion, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included.  Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The accompanying financial information should be read in conjunction with the financial statements and the notes thereto included in our most recent Annual Report on Form 10-K for the year-ended December 31, 2018, from which the balance sheet, as of December 31, 2018, has been derived. Certain prior period amounts reported in consolidated financial statements and notes have been reclassified to conform to current period presentation.

 

As of June 30, 2019, cash and restricted cash was $7.5 million and we had a working capital deficit of approximately $461,000. We could continue to incur negative cash flows and operating losses for the next twelve months. Our average cash burn rate is approximately $1.0 million per month, for the six months ended June 30, 2019. We expect our current cash resources to cover expenses through at least the next twelve months, however, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.

 

Our ability to fund ongoing operations is dependent on several factors. We aim to increase the number of members that are eligible for our solutions by signing new contracts and identifying more eligible members in existing contracts. Additionally, our funding is dependent upon the success of management’s plan to increase revenue and control expenses. We currently operate our OnTrak solutions in twenty-seven states. We provide services to commercial (employer funded), managed Medicare Advantage, and managed Medicaid and dual eligible (Medicare and Medicaid) populations. We have generated fees from our launched programs and expect to increase enrollment and fees throughout 2019.

 

Management’s Plans

 

Historically, we have seen and continue to see net losses, net loss from operations, negative cash flow from operating activities, and historical working capital deficits as we continue through a period of rapid growth. The accompanying financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We have alleviated substantial doubt by both entering into contracts for additional revenue-generating health plan customers and expanding our OnTrak program within existing health plan customers. To support this increased demand for services, we invested and will continue to invest in additional headcount needed to support the anticipated growth. Additional management plans include increasing the outreach pool as well as improving our current enrollment rate. We will continue to explore ways to increase margins on both existing and new members.

 

We have a growing customer base and believe we are able to fully scale our operations to service the contracts and future enrollment providing leverage in these investments that we expect to generate positive cash flow by the end of 2019. We believe we will have enough capital to cover expenses through the foreseeable future and we will continue to monitor liquidity. In the event we add more health plans than budgeted, increase the size of the outreach pool by more than we anticipate, decide to invest in new products or seek out additional growth opportunities, we will seek additional financing.

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

Note 2.   Accounting Standards and Significant Accounting Policies

 

Revenue, Deferred Revenue and Performance Obligations

 

Revenue from contracts with customers is recognized when, or as, we satisfy our performance obligations by transferring the promised goods or services to the customers. A good or service is transferred to a customer when, or as, the customer obtains control of that good or service. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring our progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that we determine the customer obtains control over the promised good or service. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for those promised goods or services (i.e. the “transaction price”). In determining the transaction price, we consider multiple factors, including the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. In determining when to include variable consideration in the transaction price, we consider the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgment and actions of third parties.

 

The following table disaggregates our revenue by business line:

 

 

Our customer contracts are generally designed to provide cash fees to us on a monthly basis, an upfront case rate, or fee for service based on enrolled members. Our performance obligation is satisfied over time as the OnTrak service is provided continuously throughout the service period. Catasys recognizes revenue evenly over the service period using a time-based measure because we are providing a continuous service to our customers. Contracts with minimum performance guarantees or price concessions include variable consideration and are subject to the revenue constraint. Catasys uses an expected value method to estimate variable consideration for these minimum performance guarantees and price concessions. Additionally, Catasys has constrained revenue for expected price concessions for the three and six months ended June 30, 2019.

 

Cost of Revenue

 

Cost of revenue consists primarily of salaries related to our care coaches, outreach specialists and other staff directly involved in member care, healthcare provider claims payments, and fees charged by our third-party administrators for processing these claims. Salaries and fees charged by our third-party administrators for processing claims are expensed when incurred and healthcare provider claims payments are recognized in the period in which an eligible member receives services. We contract with doctors and licensed behavioral healthcare professionals, on a fee-for-service basis. We determine that a member has received services when we receive a claim or in the absence of a claim, by utilizing member data recorded in the OnTrak database within the contracted timeframe, with all required billing elements correctly completed by the service provider. 

  

Concentration of Credit Risk 

  

The following table is a summary of concentration of credit risk by customer revenues and accounts receivables:

 

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

Net loss per share

 

Basic net loss per share is computed by dividing the net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potential shares of common stock, preferred stock and outstanding stock options and warrants, to the extent dilutive. Basic and diluted net loss per share was the same for each period presented as the inclusion of all potential shares of common stock outstanding would have been anti-dilutive.

 

Common equivalent shares, consisting of 5,604,451 and 4,571,912 shares for the six months ended June 30, 2019 and 2018, respectively, issuable upon the exercise of stock options and warrants have been excluded from the diluted earnings per share calculation as their effect is anti-dilutive.

 

Common equivalent shares, that could potentially dilute loss per share in the future that were not included in the computation of diluted loss per share are as follows:

 

 

Leases

 

Effective January 1, 2019, we account for leases under Accounting Standards Codification (“ASC”) Topic 842, Leases. Under this guidance, arrangements meeting the definition of a lease are classified as operating or financing leases and are recorded on the consolidated balance sheet as both a right-of-use asset and lease liability, calculated by discounting fixed lease payments over the lease term at the rate implicit in the lease or our incremental borrowing rate. Lease liabilities are increased by interest and reduced by payments each period, and the right-of-use asset is amortized over the lease term. For operating leases, interest on the lease liability and the amortization of the right-of-use asset result in straight-line rent expense over the lease term. For finance leases, interest on the lease liability and the amortization of the right-of-use asset results in front-loaded expense over the lease term. Variable lease expenses are recorded when incurred.

 

In calculating the right-of-use asset and lease liability, we elected to combine lease and non-lease components. We exclude short-term leases having initial terms of 12 months or less from the new guidance as an accounting policy election and recognizes rent expense on a straight-line basis over the lease term.

 

We accounted for leases in the prior period financial statements under ASC Topic 840.

 

Recently Issued or Newly Adopted Accounting Standards

 

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies that we adopt as of the specified effective date. Unless otherwise discussed, we do not believe that the impact of recently issued standards that are not yet effective will have a material impact on our financial position or results of operations upon adoption.

 

In August 2018, the FASB issued Accounting Standard Update (“ASU”) No. 2018-13, Fair Value Measurement (Topic 820), which modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including, among other changes, the consideration of costs and benefits when evaluating disclosure requirements. For public companies, the amendments are effective for annual reporting periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted. We are currently assessing the impact that adopting this new accounting guidance will have on our financial statements and footnote disclosures.

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which supersedes ASC 505-50 and expands the scope of ASC 718 to include all share-based payments arrangements related to the acquisition of goods and services from both employees and nonemployees. For public companies, the amendments are effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted, but no earlier than a company's adoption date of ASC 606. The adoption of this ASU 2018-07 on January 1, 2019 did not have a material impact on our consolidated financial statements.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). The amendments in this update are intended to simplify the accounting for certain equity linked financial instruments and embedded features with down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the new guidance, a down round feature will no longer need to be considered when determining whether certain financial instruments or embedded features should be classified as liabilities or equity instruments. That is, a down round feature will no longer preclude equity classification when assessing whether an instrument or embedded feature is indexed to an entity's own stock. In addition, the amendments clarify existing disclosure requirements for equity-classified instruments. These amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The adoption of this ASU 2017-11 on January 1, 2019 resulted in the reclassification of our warrant liability in amount of $86,000 into additional paid-in capital.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). The amendment revises the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses on financial instruments, including, but not limited to, available for sale debt securities and accounts receivable. We are required to adopt this standard starting in the first quarter of fiscal year 2021. Early adoption is permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). Under this standard, which applies to both lessors and lessees, lessees will be required to recognize all leases (except for short-term leases) as a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and as a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018 and is to be applied at the beginning of the earliest period presented using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements, with certain practical expedients available. We adopted ASU 2016-02 on January 1, 2019 and recorded right-to-use assets and liabilities for all operating lease obligations with terms of 12 months or greater. Any prior period changes were immaterial and therefore no retrospective adjustments were recorded. 

 

 

Note 3. Accounts Receivable

 

We use the specific identification method for recording the provision for doubtful accounts. There was no allowance for doubtful accounts as of June 30, 2019 and December 31, 2018. 

 

 

Note 4. Property and Equipment

 

Property and equipment consisted of the following as of June 30, 2019 and December 31, 2018:

 

 

Depreciation expense was $34,000 and $72,000 for the three and six months ended June 30, 2019, respectively compared with approximately $85,000 and $170,000 for the same periods in 2018, respectively.

 

 

Note 5. Common Stock

 

In January 2019, there was an exercise of 20,000 warrants at an exercise price of $5.00 per share. We received approximately $100,000 of proceeds and issued 20,000 shares of our common stock.

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

In April 2019, there was an exercise of 9,479 stock options at an exercise price of $7.50 per share. We received approximately $71,000 of proceeds and issued 9,479 shares of our common stock.

 

In May 2019, there was an exercise of 172,461 warrants at an exercise price of $4.80 per share. We received approximately $828,000 of proceeds and issued 172,461 shares of our common stock.

 

In May 2019, there was an exercise of 129,906 stock options at a weighted average exercise price of $10.79 per share. We received approximately $1.4 million of proceeds and issued 129,906 shares of our common stock.

 

In June 2019, there was an exercise of 20,000 warrants at an exercise price of $5.00 per share. We received approximately $100,000 of proceeds and issued 20,000 shares of our common stock.

 

 

Note 6. Stock Compensation

 

Our 2017 Stock Incentive Plan (the “2017 Plan”), provides for the issuance of up to 2,333,334 shares of our common stock and an additional 243,853 shares of our common stock that are represented by awards granted under our 2010 Stock Incentive Plan (the “2010 Plan”). In August 2018, at our Annual Stockholders Meeting, stockholders approved an amendment to the 2017 Plan, among other things, to provide for an additional 1,400,000 shares to be issued in connection with awards granted thereunder (the “2017 Amended Plan”). In February 2019, we increased the number of shares in the 2017 Plan by 552,884 shares as allowed in the 2017 Plan for annual increases to the number of shares available under the 2017 Plan. Incentive stock options (ISOs) under Section 422A of the Internal Revenue Code and non-qualified options (NSOs) are authorized under the 2017 Amended Plan. We have granted stock options to executive officers, employees, members of our board of directors, and certain outside consultants. The terms and conditions upon which options become exercisable vary among grants; however, option rights expire no later than ten years from the date of grant and employee and Board of Director awards generally vest over three to five years on a straight-line basis. As of June 30, 2019, we had 4,156,731 vested and unvested stock options outstanding issued to Employees and Directors and 50,000 vested and unvested stock options outstanding issued to Non-Employees. There are 183,955 shares reserved for future awards.

 

Stock compensation expense attributable to operations was $1.6 million and $2.6 million for the three and six months ended June 30, 2019, respectively, compared with approximately $425,000 and $753,000 for the same periods in 2018, respectively.

 

Stock Options - Employees and Directors

 

A summary of stock option activity for employees and directors is as follows:

 

 

As of June 30, 2019, there was $9.9 million of total unrecognized compensation cost related to non-vested stock compensation arrangements granted to employees and directors under the 2017 Amended Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.89 years.          

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Stock Options and Warrants - Non-Employees

 

A summary of warrants activity for non-employees is as follows:

 

 

There were none and 50,000 options issued to non-employees at a weighted average exercise price of $9.93 for the three and six months ended June 30, 2019, respectively, compared with none for the same periods in 2018.

 

There were 4,167 warrants issued in exchange for services for the three and six months ended June 30, 2019, respectively, compared with none and 24,000 for the same periods in 2018. Generally, the costs associated with shares issued for services are amortized to the related expense on a straight-line basis over the related service periods.

 

As of June 30, 2019, there was approximately $286,000 of total unrecognized compensation cost related to non-vested stock compensation arrangements granted to non-employees under the 2017 Amended Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.58 years 

 

 

Note 7. Leases

 

The operating lease agreement for our Los Angeles, CA office space expired in April 2019, therefore there are no remaining operating lease right-of-use assets or liabilities associated with this office as of June 30, 2019.

 

In September 2018, we signed an operating lease for our new corporate headquarters in Santa Monica, CA (“Santa Monica Headquarters”). The lease agreement includes 7,869 square feet for 60 months commencing in July 2019, which is 30 days following date the premises were ready for occupancy. The base rent is approximately $48,000 subject to annual adjustments.

 

Our lease liability resulted from the lease of our Santa Monica Headquarters which expires in 2024. This lease does not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. Our lease includes renewal options and escalation clauses; renewal options have not been included in the calculation of the lease liability and right-of-use asset as we are not reasonably certain to exercise the options. Variable expenses generally represent our share of the landlord’s operating expenses. We do not act as a lessor or have any leases classified as financing leases.

 

As of June 30, 2019, we have an operating lease liability of approximately $2.3 million and right-of-use asset of approximately $2.6 million, which are included in the consolidated balance sheet.

 

Quantitative information for the operating lease is as follows: 

 

 

 

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

Maturities of the operating lease liabilities are as follows:

 

 

We incurred rent expense of approximately $107,000 and $184,000 for the three and six months ended June 30, 2019, respectively compared with approximately $75,000 and $149,000 for the same periods in 2018, respectively.

 

 

Note 8. Debt

 

In June 2018, we entered into a venture loan and security agreement (the “Loan Agreement”) with Horizon Technology Finance Corporation (“Horizon”), which provides for up to $7.5 million in loans to Catasys, including initial loans in the amount of $5.0 million funded upon signing of the Loan Agreement. An additional $2.5 million loan was subject to our achievement of billings of not less than $5.0 million during any three consecutive month period on or prior to November 30, 2018. In August 2018, we incurred the additional $2.5 million loan as a result of our achievement of the trailing three-month billings exceeding $5.0 million on or prior to November 30, 2018. In addition, in June 2018, we entered into a loan and security agreement (the “A/R Facility”) in connection with a $2.5 million receivables financing facility with Corporate Finance, a division of Heritage Bank of Commerce (“Heritage”). The A/R Facility provides for Catasys to borrow up to 85% of our eligible accounts receivable, as defined in the A/R Facility. In February 2019, we borrowed approximately $1.9 million on the A/R Facility during the month. None of the A/R Facility is outstanding as of June 30, 2019.

 

In March 2019, we entered into an amended and restated venture loan and security agreement (as so amended and restated, the “Amended Loan Agreement”) with Horizon, which provides for up to $15.0 million in loans to us, including initial term loans in the amount of $7.5 million previously funded under the original Loan Agreement entered into in June 2018 and an additional up to $7.5 million loan in three revolving tranches of $2.5 million in availability, subject to our achievement of trailing three month billings exceeding $5.0 million, $7.0 million and $8.0 million, respectively (collectively, the “Billing Requirements”). An initial advance of $2.5 million was funded upon the execution and delivery of the Amended Loan Agreement, subject to repayment if the foregoing $5.0 million threshold is not reached by July 1, 2019.  We concurrently entered into an amendment to the previously disclosed $2.5 million A/R Facility with Heritage intended primarily to reflect the amendment and restatement of the Amended Loan Agreement. We have met all three of the Billing Requirements and as a result have incurred the full $7.5 million under the Amended Loan Agreement.

 

Repayment of the Revolving Loan is on an interest-only basis through September 30, 2020, followed by monthly payments of principal and accrued interest until maturity on the date which is the earliest of: (a) September 30, 2022, (b) the date of acceleration of such loan, following an event of default (c) or the date of prepayment. Until we receive cash proceeds of $10.0 million from the sale of our equity securities, we are required to maintain reserve cash on deposit for Horizon in an amount equal to our net operating loss for the trailing three-month calendar period, plus all amounts required to repaid in respect of all outstanding indebtedness for the following three months, plus $4.0 million. From and after the receipt of $10.0 million in cash proceeds from the sale of our equity securities, we are required to maintain reserve cash on deposit for Horizon in an amount equal to the net operating loss of our trailing three-month calendar period, plus all amounts required to repaid in respect of all outstanding indebtedness for the following three months.

 

The Revolving Loan bears interest at a floating coupon rate of the amount by which one-month LIBOR exceeds 2.00% plus 9.75%. After September 30, 2020, upon the earlier of (i) payment in full of the principal balance of the Revolving Loan, (ii) an event of default and demand by Lender of payment in full of the Revolving Loan or (iii) on the Revolving Loan Maturity Date (September 30, 2022), as applicable, we shall pay to Lender a payment equal to the greater of $150,000 or 6% of the outstanding principal balance of the Revolving Loan on August 31, 2020. 

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The Loan Agreement includes customary affirmative and restrictive covenants, excluding any covenants to attain or maintain certain financial metrics, and also includes customary events of default, including for payment failures, breaches of covenants, change of control and material adverse changes. Upon the occurrence of an event of default and following any applicable cure periods, a default interest rate of an additional 5% may be applied to the outstanding loan balances, certain minimum revenue based payment guarantees become due and Horizon may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Loan Agreement.

 

A summary of our debt activity is as follows:

 

 

During the three and six months ended June 30, 2019 we incurred debt related interest expense of approximately $471,000 and $792,000 respectively compared with $36,000 and $37,000 for the same periods in 2018, respectively. Interest expense for the three and six months ended June 30, 2019 included amortization of debt discount of approximately $33,000 and $65,000 related to the A/R Facility and amortization of debt discount of $70,000 and $81,000 related to the Horizon Loan Agreement.

 

Catasys is in compliance with all debt covenants as of June 30, 2019.

 

 

Note 9. Fair Value Measurements 

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure fair value. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level I) and the lowest priority to unobservable inputs (Level III). The three levels of the fair value hierarchy are described below:

 

Level Input:		Input Definition:
Level I		Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level II		Inputs, other than quoted prices included in Level I, that are observable for the asset or liability through corroboration with market data at the measurement date.
Level III		Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

 

The following tables summarize fair value measurements by level as of June 30, 2019 and December 31, 2018, respectively, for assets and liabilities measured at fair value on a recurring basis:

 

 

(1)	$408,000 is included in restricted cash, long-term on our balance sheet as of June 30, 2019.

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

(2)	$71,000 is included in cash and restricted cash and $408,000 is included in restricted cash, long term on our balance sheet as of December 31, 2018.

 

The following is a rollforward of our warrant liabilities:  

 

 

For the three and six months ended June 30, 2019, we recognized a loss of $120,000 and $211,000, respectively compared with approximately $19,000 and $29,000 for the same periods in 2018, respectively, related to the revaluation of our warrant liabilities.

 

In March 2019, in connection with our entry into the Amended Loan Agreement, we issued Horizon 40,279 seven-year warrants to purchase an aggregate of $600,000 (depending on the level of availability under the Amended Loan Agreement) at the trailing volume weighted average price (“VWAP”) of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants at a per share exercise price equal to the lower of (i) $9.93 or (ii) the price per share of any securities that may be issued by us in an equity financing during the 18 months following the agreement date.

 

In May 2019, we met the $7.0 million Billing Requirement under the Amended Loan Agreement and incurred an additional $2.5 million revolving loan. In connection with the additional revolving loan, we issued Horizon 5,561 seven-year warrants to purchase an aggregate of $100,000 (depending on the level of availability under the Loan Agreement) at the trailing VWAP of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants at a per share exercise price equal to the lower of (i) $17.98 or (ii) the price per share of any securities that may be issued by us in an equity financing during the 18 months following the agreement date.

 

In June 2019, we met the $8.0 million Billing Requirement under the Amended Loan Agreement and incurred the final $2.5 million revolving loan. In connection with the additional revolving loan, we issued Horizon 5,345 seven-year warrants to purchase an aggregate of $100,000 (depending on the level of availability under the Loan Agreement) at the trailing VWAP of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants at a per share exercise price equal to the lower of (i) $18.71 or (ii) the price per share of any securities that may be issued by us in an equity financing during the 18 months following the agreement date (the “Horizon Warrants”).

 

In no event will we be required to issue more than 19.9% of its currently outstanding common stock pursuant to the Horizon Warrants.

 

We adopted ASU 2017-11, as of January 1, 2019. However, given the number of variable features, the Horizon Warrants have been classified as a liability at the time of issuance in accordance with ASC 815. We initially valued the Horizon Warrants using a Monte Carlo model and recorded the fair value of the Horizon Warrants as a discount to the debt obligation. As of June 30, 2019, we have met all Billing Requirements under the Amended Loan Agreement and we will continue to mark-to-market the warrants each month using the Black-Scholes model.

 

 

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The key assumptions used to value the Horizon Warrants are as follows:

 

 

 

Note 10. Variable Interest Entities

 

The amounts and classification of assets and liabilities of the variable interest entities included in our consolidated balance sheets are as follows:

 

 

 

 

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