Ontrak, Inc. - Quarter Report: 2022 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2022
Commission File Number 001-31932
____________________________
Ontrak, Inc.
(Exact name of registrant as specified in its charter)
____________________________
Delaware | 88-0464853 | ||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
2200 Paseo Verde Parkway, Suite 280, Henderson, NV 89052
(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 | OTRK | The NASDAQ Global Market | ||||||
| 9.50% Series A Cumulative Perpetual Preferred Stock, $0.0001 par value | OTRKP | The NASDAQ Global 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 x No o
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 x No o
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 x
As of May 5, 2022, there were 20,862,648 shares of the registrant's common stock, $0.0001 par value per share, outstanding.
TABLE OF CONTENTS
| Signatures | |||||||||||
In this Quarterly Report on Form 10-Q, all references to “Ontrak,” “Ontrak, Inc.,” “we,” “us,” “our” or the “Company” mean Ontrak, Inc., its wholly-owned subsidiaries and variable interest entities, except where it is made clear that the term means only the parent company. The Company’s common stock, par value $0.0001 per share, is referred to as “common stock" and the Company’s 9.50% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share, is referred to as “Series A Preferred Stock.”
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
ONTRAK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
| March 31, 2022 | December 31, 2021 | ||||||||||
Assets | (unaudited) | ||||||||||
Current assets: | |||||||||||
| Cash and cash equivalents | $ | 27,248 | $ | 58,824 | |||||||
| Restricted cash - current | 4,477 | 6,716 | |||||||||
Receivables, net | 5,775 | 5,938 | |||||||||
Unbilled receivables | 4,168 | 3,235 | |||||||||
| Deferred costs - current | 398 | 600 | |||||||||
Prepaid expenses and other current assets | 4,565 | 5,019 | |||||||||
Total current assets | 46,631 | 80,332 | |||||||||
Long-term assets: | |||||||||||
Property and equipment, net | 3,546 | 3,785 | |||||||||
| Restricted cash - long-term | 406 | 406 | |||||||||
| Goodwill | 5,713 | 5,713 | |||||||||
| Intangible assets, net | 2,041 | 2,346 | |||||||||
| Other assets | 485 | 444 | |||||||||
| Operating lease right-of-use assets | 861 | 656 | |||||||||
Total assets | $ | 59,683 | $ | 93,682 | |||||||
| Liabilities and stockholders' equity | |||||||||||
Current liabilities: | |||||||||||
Accounts payable | $ | 1,933 | $ | 1,001 | |||||||
Accrued compensation and benefits | 2,521 | 2,343 | |||||||||
Deferred revenue | 488 | 441 | |||||||||
| Current portion of operating lease liabilities | 617 | 595 | |||||||||
| Other accrued liabilities | 4,881 | 5,953 | |||||||||
Total current liabilities | 10,440 | 10,333 | |||||||||
Long-term liabilities: | |||||||||||
| Long-term debt, net | 16,040 | 35,792 | |||||||||
| Long-term operating lease liabilities | 1,034 | 932 | |||||||||
| Long-term finance lease liabilities | 86 | 136 | |||||||||
| Other liabilities | — | 934 | |||||||||
Total liabilities | 27,600 | 48,127 | |||||||||
| Commitments and contingencies | |||||||||||
| Stockholders' equity: | |||||||||||
Preferred stock, $0.0001 par value; 50,000,000 shares authorized; 3,770,265 shares issued and outstanding at each of March 31, 2022 and December 31, 2021 | — | — | |||||||||
Common stock, $0.0001 par value; 500,000,000 shares authorized; 20,831,320 and 20,680,186 shares issued and outstanding at March 31, 2022 and December 31, 2021, respectively | 2 | 2 | |||||||||
| Additional paid-in capital | 437,894 | 436,721 | |||||||||
| Accumulated deficit | (405,813) | (391,168) | |||||||||
| Total stockholders' equity | 32,083 | 45,555 | |||||||||
| Total liabilities and stockholders' equity | $ | 59,683 | $ | 93,682 | |||||||
3
See notes to condensed consolidated financial statements.
4
ONTRAK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share data)
| Three Months Ended March 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Revenue | $ | 5,258 | $ | 28,722 | ||||||||||
| Cost of revenue | 2,846 | 12,750 | ||||||||||||
| Gross profit | 2,412 | 15,972 | ||||||||||||
| Operating expenses: | ||||||||||||||
| Research and development | 3,428 | 4,569 | ||||||||||||
| Sales and marketing | 1,436 | 1,942 | ||||||||||||
| General and administrative | 10,693 | 12,341 | ||||||||||||
| Total operating expenses | 15,557 | 18,852 | ||||||||||||
| Operating loss | (13,145) | (2,880) | ||||||||||||
| Other expense, net | — | (606) | ||||||||||||
| Interest expense, net | (1,400) | (2,007) | ||||||||||||
| Loss before income taxes | (14,545) | (5,493) | ||||||||||||
| Income tax expense | (100) | — | ||||||||||||
| Net loss | (14,645) | (5,493) | ||||||||||||
| Dividends on preferred stock - declared and undeclared | (2,239) | (2,239) | ||||||||||||
| Net loss attributable to common stockholders | $ | (16,884) | $ | (7,732) | ||||||||||
| Net loss per common share, basic and diluted | $ | (0.81) | $ | (0.44) | ||||||||||
| Weighted-average common shares outstanding, basic and diluted | 20,723 | 17,622 | ||||||||||||
See notes to condensed consolidated financial statements.
5
ONTRAK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited, in thousands, except share and per share data)
| Preferred Stock | Common Stock | Additional Paid-In Capital | Accumulated Deficit | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | 3,770,265 | $ | — | 20,680,186 | $ | 2 | $ | 436,721 | $ | (391,168) | $ | 45,555 | ||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | (2,239) | — | (2,239) | |||||||||||||||||||||||||||||||
| Common stock issued relating to settlement of contingent consideration | — | — | 24,333 | — | 213 | — | 213 | |||||||||||||||||||||||||||||||
| Common stock issued for consulting services | — | — | 55,555 | — | 102 | — | 102 | |||||||||||||||||||||||||||||||
| Restricted stock units vested | — | — | 1,259 | — | (2) | — | (2) | |||||||||||||||||||||||||||||||
| 401(k) employer match | — | — | 69,987 | — | 188 | — | 188 | |||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 2,911 | — | 2,911 | |||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (14,645) | (14,645) | |||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | 3,770,265 | $ | — | 20,831,320 | $ | 2 | $ | 437,894 | $ | (405,813) | $ | 32,083 | ||||||||||||||||||||||||||
| Balance at December 31, 2020 | 3,770,265 | $ | — | 17,543,218 | $ | 2 | $ | 414,773 | $ | (354,024) | $ | 60,751 | ||||||||||||||||||||||||||
| Preferred dividends declared | — | — | — | — | (2,200) | — | (2,200) | |||||||||||||||||||||||||||||||
| Warrants exercised | — | — | 124,717 | — | 58 | — | 58 | |||||||||||||||||||||||||||||||
| Stock options exercised | — | — | 56,923 | — | 726 | — | 726 | |||||||||||||||||||||||||||||||
| 401(k) employer match | — | — | 4,882 | — | 251 | — | 251 | |||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 2,574 | — | 2,574 | |||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | (5,493) | (5,493) | |||||||||||||||||||||||||||||||
| Balance at March 31, 2021 | 3,770,265 | $ | — | 17,729,740 | $ | 2 | $ | 416,182 | $ | (359,517) | $ | 56,667 | ||||||||||||||||||||||||||
See notes to condensed consolidated financial statements.
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ONTRAK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
| For the Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash flows from operating activities | |||||||||||
| Net loss | $ | (14,645) | $ | (5,493) | |||||||
| Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | |||||||||||
| Stock-based compensation expense | 2,911 | 2,574 | |||||||||
| Depreciation expense | 651 | 162 | |||||||||
| Amortization expense | 637 | 701 | |||||||||
| Change in fair value of contingent consideration | — | 635 | |||||||||
| 401(k) employer match in common shares | 202 | 257 | |||||||||
| Common stock issued for consulting services | 102 | — | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Receivables | 163 | 2,129 | |||||||||
| Unbilled receivables | (933) | 756 | |||||||||
| Prepaid expenses and other current assets | 351 | 640 | |||||||||
| Accounts payable | 789 | (117) | |||||||||
| Deferred revenue | 47 | 3,985 | |||||||||
| Leases liabilities | 124 | 29 | |||||||||
| Other accrued liabilities | (890) | 174 | |||||||||
| Net cash (used in) provided by operating activities | (10,491) | 6,432 | |||||||||
| Cash flows from investing activities | |||||||||||
| Purchase of property and equipment | (255) | (827) | |||||||||
| Net cash used in investing activities | (255) | (827) | |||||||||
| Cash flows from financing activities | |||||||||||
| Dividends paid | (2,239) | (2,200) | |||||||||
| Repayments of 2024 Notes | (19,994) | — | |||||||||
| Proceeds from warrant exercise | — | 58 | |||||||||
| Proceeds from options exercise | — | 726 | |||||||||
| Finance lease obligations | (84) | (78) | |||||||||
| Financed insurance premium payments | (750) | (740) | |||||||||
| Payment of taxes related to net-settled stock awards | (2) | — | |||||||||
| Net cash used in financing activities | (23,069) | (2,234) | |||||||||
| Net change in cash and restricted cash | (33,815) | 3,371 | |||||||||
| Cash and restricted cash at beginning of period | 65,946 | 103,210 | |||||||||
| Cash and restricted cash at end of period | $ | 32,131 | $ | 106,581 | |||||||
| Supplemental disclosure of cash flow information: | |||||||||||
| Interest paid | $ | 1,181 | $ | 1,820 | |||||||
| Non-cash financing and investing activities: | |||||||||||
| Finance lease and accrued purchases of property and equipment | $ | 187 | $ | 226 | |||||||
| Common stock issued to settle contingent consideration | 213 | — | |||||||||
See notes to condensed consolidated financial statements.
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Note 1. Organization
Company Overview
Ontrak, Inc. (“Ontrak,” “Company,” “we,” “us” or “our”) is an AI-powered and telehealth-enabled, virtualized healthcare company, whose mission is to help improve the health and save the lives of as many people as possible. The Company's technology-enabled platform provides claim based analytics and predictive modeling to provide analytic insights throughout the delivery of our personalized treatment program. The Company's program predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages and guides them to and through the care they need. By combining predictive analytics with human engagement, we deliver improved member health and validated outcomes and savings to healthcare payors.
The Company's integrated, technology-enabled OntrakTM programs are designed to provide healthcare solutions to members with behavioral conditions that cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, chronic obstructive pulmonary disease, and congestive heart failure, which result in high medical costs. Ontrak has a unique 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 Ontrak program seek to improve member health and deliver validated cost savings to healthcare payors.
Basis of Presentation
The accompanying condensed consolidated financial statements include Ontrak, Inc. and its wholly-owned subsidiaries and variable interest entities (VIEs). The accompanying condensed consolidated financial statements for Ontrak, Inc. have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and instructions to Form 10-Q and Article 10 of Regulation S-X. All intercompany balances and transactions have been eliminated in consolidation. Certain information and note disclosures normally included in the annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the condensed financial statements included all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the interim periods presented. Interim results are not necessarily indicative of the results that may be expected for any other interim period or for the entire fiscal year. The accompanying unaudited financial information should be read in conjunction with the audited financial statements and the notes thereto included in the most recent Annual Report on Form 10-K for the year-ended December 31, 2021, filed with the Securities and Exchange Commission ("SEC"), from which the consolidated balance sheet as of December 31, 2021 has been derived. The Company operates as one segment.
The Company’s ability to fund ongoing operations is dependent on several factors. The Company aims to increase the number of members that are eligible for its solutions by signing new contracts and identifying more eligible members in existing contracts. Additionally, the Company’s funding is dependent upon the success of management’s plan to increase revenue and control expenses. The Company provides services to commercial (employer funded), managed Medicare Advantage, managed Medicaid and duel eligible (Medicare and Medicaid) populations. The Company also provides mental health and wellbeing support to members of employer customers under our LifeDojo wellbeing solution.
We have incurred significant net losses and negative operating cash flows since our inception, and we expect to continue to incur net losses and negative operating cash flow, in part due to the negative impact on our operations by customer terminations. As of March 31, 2022, our cash and restricted cash was $32.1 million and we had working capital of approximately $36.2 million. For the three months ended March 31, 2022, average monthly cash burn rate was $3.5 million. Based on our cash and restricted cash levels, expected revenue from business operations, and after taking into account the amount available to borrow under a master note purchase agreement the Company entered into with Acuitas Capital LLC ("Acuitas"), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder, on April 15, 2022 (the "Keep Well Agreement"), we expect to have sufficient cash to cover our operating expenses through at least the next twelve months following the date our financial statements in this report are issued. See Note 13 below for more information about the Keep Well Agreement. However, delays in cash collections, lower revenue than anticipated, unforeseen expenditures, or our inability to satisfy the conditions precedent to borrowing funds under the Keep Well Agreement could impact our expectations.
8
In addition to revenue from business operations, our primary source of capital is the amount available under the Keep Well Agreement. We may also be able to raise capital through equity financing, however, when we can effect such sales and the amount of shares we can sell depends on a variety of factors to be determined by us from time to time, including, among others, market conditions, the trading price of our common stock and our determination as to the appropriate sources of funding for our operations.
Management plans to continue to execute on its strategy by (i) exploring other sources of capital with either debt or equity financing for on-going liquidity needs; (ii) continuing to manage operating costs by strategically pursuing cost optimization initiatives; and (iii) continuing to pursue executing our growth strategy by improving our marketing techniques and implementing new features to increase customer engagement, adding new members and securing new customer contracts. There can be no assurance that capital will be available when needed or that, if available, it will be obtained on terms favorable to us and our stockholders, that we will be successful in implementing cost optimization initiatives, or that we will be successful in executing our growth strategy. In addition, our Goldman debt agreement contains various financial covenants, and any unanticipated non-compliance with those covenants could result in an acceleration of the repayment of the outstanding loan balance, and our ability to borrow funds under the Keep Well Agreement is subject to conditions precedent being satisfied, and we may not satisfy such conditions precedent if and when we need to borrow funds thereunder. Furthermore, equity or debt financings may have a dilutive effect on the holdings of our existing stockholders, and debt financings may subject us to, and if we borrow funds under the Keep Well Agreement, we will be subject to, restrictive covenants, operational restrictions and security interests in our assets.
Recently Adopted Accounting Standards
In May 2021, the FASB issued ASU No. 2021-04, "Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options ("ASU 2021-04"), to clarify and reduce diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. The amendments in ASU 2021-04 are effective for fiscal years beginning after December 15, 2021, and interim periods with fiscal years beginning after December 15, 2021. The adoption of ASU 2021-04 on January 1, 2022 did not have a material effect on our condensed consolidated financial statements.
In August 2020, the FASB issued ASU No. 2020-06, “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40) ("ASU 2020-06").” ASU 2020-06 modifies and simplifies accounting for convertible instruments, and eliminates certain separation models that require separating embedded conversion features from convertible instruments. ASU 2020-06 also addresses how convertible instruments are accounted for in the diluted earnings per share calculation. ASU 2020-06 is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. The adoption of ASU 2020-06 on January 1, 2022 did not have a material effect on our condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
In the time since the Company filed its most recent Annual Report on Form 10-K for the year ended December 31, 2021, there were no new accounting standards issued, but not yet adopted by the Company, which are expected to materially affect the Company's condensed consolidated financial statements.
9
Note 2. Restricted Cash
The following table provides a reconciliation of cash, cash equivalents and restricted cash total as presented in the condensed consolidated statement of cash flows for the periods presented (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Cash and cash equivalents | $ | 27,248 | $ | 58,824 | |||||||
| Restricted cash - current: | |||||||||||
| Dividend payments on preferred stock | 4,477 | 6,716 | |||||||||
| Subtotal - Restricted cash - current | 4,477 | 6,716 | |||||||||
| Restricted cash - long term: | |||||||||||
| Letter of credit (1) | 306 | 306 | |||||||||
| Cash required per note agreement (2) | 100 | 100 | |||||||||
| Subtotal - Restricted cash - long term | 406 | 406 | |||||||||
| Cash, cash equivalents and restricted cash | $ | 32,131 | $ | 65,946 | |||||||
____________
(1) LOC required as part of our Santa Monica, CA office lease.
(2) Cash required to be maintained in our accounts per the 2024 Note agreement.
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Note 3. Accounts Receivable and Revenue Concentration
The following table is a summary of concentration of credit risk by customer revenues as a percentage of our total revenue:
Three Months Ended March 31, | ||||||||||||||||||||||||||
| Percentage of Revenue | 2022 | 2021 | ||||||||||||||||||||||||
| Customer A | 48.3 | % | 7.0 | % | ||||||||||||||||||||||
| Customer B | 24.0 | 4.0 | ||||||||||||||||||||||||
| Customer C | 18.5 | 2.2 | ||||||||||||||||||||||||
| Customer D | 4.4 | 45.8 | ||||||||||||||||||||||||
| Customer E | — | 38.4 | ||||||||||||||||||||||||
| Remaining customers | 4.8 | 2.6 | ||||||||||||||||||||||||
| 100.0 | % | 100.0 | % | |||||||||||||||||||||||
The following table is a summary of concentration of credit risk by customer accounts receivables as a percentage of our total accounts receivable:
| Percentage of Accounts Receivable | March 31, 2022 | December 31, 2021 | |||||||||
| Customer D (1) | 85.0 | % | 94.0 | % | |||||||
| Customer A | 14.1 | — | |||||||||
| Remaining customers | 0.9 | 6.0 | |||||||||
| 100.0 | % | 100.0 | % | ||||||||
(1) Approximately 95% of the outstanding accounts receivable balance for this customer at March 31, 2022 has been received as of the date of this Form 10-Q. We continue to expect full payment of the remaining uncollected portion.
The Company applies the specific identification method for assessing provision for doubtful accounts. There was no bad debt expense in each of the three months ended March 31, 2022 and 2021.
On February 26, 2021, the Company received a termination notice from Customer D and working with this customer on a transition plan, we completed the participation of this customer's members in the program as of December 31, 2021. In addition, on August 18, 2021, the Company received a termination notice from Customer E of their intent not to continue the program past December 31, 2021. All members relating to Customers D and E have completed their participation in the program as of December 31, 2021. As a result of these termination notices, in March and November 2021, the Company’s management assessed various options and deemed it prudent to initiate workforce reduction plans to effectively align its resources and manage its operating costs. As of December 31, 2021, $0.4 million of accrued termination related costs related to these workforce reduction plans remained outstanding as part of "Other accrued liabilities" on our condensed consolidated balance sheet. As of March 31, 2022, there was no amount outstanding relating to such accrued termination related costs.
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Note 4. Property and Equipment
Property and equipment consisted of the following (in thousands):
| March 31, | December 31, | ||||||||||
| 2022 | 2021 | ||||||||||
| Software | $ | 5,993 | $ | 4,051 | |||||||
| Computers and equipment | 461 | 456 | |||||||||
| ROU assets - finance lease | 375 | 375 | |||||||||
| Leasehold improvements | 17 | 17 | |||||||||
| Software development in progress | 10 | 1,514 | |||||||||
| Subtotal | 6,856 | 6,413 | |||||||||
| Less: Accumulated depreciation and amortization | (3,310) | (2,628) | |||||||||
| Property and equipment, net | $ | 3,546 | $ | 3,785 | |||||||
Total depreciation and amortization expense relating to property and equipment presented above was $0.7 million and $0.2 million for the three months ended March 31, 2022 and 2021, respectively.
Capitalized Internal Use Software Costs
During the three months ended March 31, 2022 and 2021, we capitalized $0.4 million and $1.0 million, respectively, of costs relating to development of internal use software, and recorded $0.6 million and $0.1 million, respectively, of amortization expense relating to capitalized internal use software, which was included in total depreciation and amortization expense as described above.
Note 5. Goodwill and Intangible Assets
Goodwill
The carrying amount of indefinite-lived goodwill was $5.7 million as of March 31, 2022 and December 31, 2021.
Intangible Assets
The following table sets forth amounts recorded for intangible assets subject to amortization (in thousands):
At March 31, 2022 | At December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||
| Weighted Average Estimated Useful Life (years) | Gross Value | Accumulated Amortization | Net Carrying Value | Gross Value | Accumulated Amortization | Net Carrying Value | ||||||||||||||||||||||||||||||||||||||
| Acquired software technology | 3 | $ | 3,500 | $ | (1,653) | $ | 1,847 | $ | 3,500 | $ | (1,361) | $ | 2,139 | |||||||||||||||||||||||||||||||
| Customer relationships | 5 | 270 | (76) | 194 | 270 | (63) | 207 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 3,770 | $ | (1,729) | $ | 2,041 | $ | 3,770 | $ | (1,424) | $ | 2,346 | ||||||||||||||||||||||||||||||||
Amortization expense for intangible assets presented above was $0.3 million for each of the three months ended March 31, 2022 and 2021.
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At March 31, 2022, estimated amortization expense for intangible assets for each of the five years thereafter was as follows (in thousands):
| Remainder of 2022 | $ | 916 | |||
| 2023 | 1,026 | ||||
| 2024 | 54 | ||||
| 2025 | 45 | ||||
| Total | $ | 2,041 | |||
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Note 6. Common Stock and Preferred Stock
Net Loss Per Common Share
Basic net loss per common share is computed by dividing net loss attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per common 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 common share was the same for each period presented below as the inclusion of any such potential shares of common stock would have been anti-dilutive.
Basic and diluted net loss per common share (in thousands, except per share amounts) was as follows:
| Three Months Ended March 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Net loss | $ | (14,645) | $ | (5,493) | ||||||||||
| Dividends on preferred stock - declared and undeclared | (2,239) | (2,239) | ||||||||||||
| Net loss attributable to common stockholders | $ | (16,884) | $ | (7,732) | ||||||||||
| Weighted-average shares of common stock outstanding | 20,723 | 17,622 | ||||||||||||
| Net loss per common share - basic and diluted | $ | (0.81) | $ | (0.44) | ||||||||||
The following common equivalent shares as of March 31, 2022 and 2021, issuable upon exercise of stock options and warrants, have been excluded from the diluted earnings per share calculation as their effect was anti-dilutive:
| March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Warrants to purchase common stock | 167,496 | 1,312,250 | |||||||||
| Options to purchase common stock | 3,505,469 | 3,507,395 | |||||||||
| Total | 3,672,965 | 4,819,645 | |||||||||
Preferred Stock
In 2020, the Company completed the issuance of a total of 3,770,265 shares of 9.50% Series A Cumulative Perpetual Preferred Stock (the "Series A Preferred Stock"), which is listed on the Nasdaq Global Market under the symbol "OTRKP." The Company, generally, may not redeem the Series A Preferred Stock until August 25, 2025, except upon the occurrence of a Delisting Event or Change of Control (as defined in the Certificate of Designations establishing the Series A Preferred Stock), and on and after August 25, 2025, the Company may, at its option, redeem the Series A Preferred Stock, in whole, at any time, or in part, from time to time, for cash at a redemption price of $25.00 per share, plus any accrued and unpaid dividends. The Series A Preferred Stock has no maturity date and will remain outstanding indefinitely unless redeemed by the Company or exchanged for shares of common stock in connection with a Delisting Event or Change of Control. Holders of Series A Preferred Stock generally have no voting rights, but will have limited voting rights if the Company fails to pay dividends for six or more quarters, whether or not declared or consecutive) and in certain other events.
Holders of Series A Preferred Stock of record at the close of business of each respective record date (February 15, May 15, August 15 and November 15) are entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available for the payment of dividends, cumulative cash dividends at the rate of 9.50% per annum of the $25.00 per share liquidation preference (equivalent to $2.375 per annum per share or $0.593750 per quarter per share). Dividends, if and when declared by our Board of Directors, are payable quarterly in arrears, every February 28, May 30, August 31, and November 30, as applicable. Our Board of Directors approved and the Company paid cash dividends of $2.2 million in each of the three months ended March 31, 2022 and 2021. At March 31, 2022, we had undeclared dividends of $0.7 million. See Note 9 below for
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discussion regarding the Eighth Amendment to the Note Purchase Agreement with Goldman Sachs Specialty Lending Group, L.P., which placed a restriction on the Company's ability to make declaration and payment of dividends on the Company's Series A Preferred Stock until after December 31, 2022.
Note 7. Stock-Based Compensation
The Company's 2017 Stock Incentive Plan (the “2017 Plan”) and 2010 Stock Incentive Plan (the “2010 Plan”) provide for the issuance of 5,359,397 shares of the Company's common stock. The Company has granted stock options to executive officers, employees, members of the Company's board of directors, and certain outside consultants and restricted stock units ("RSUs") to employees. 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 to four years on a straight-line basis. The terms and conditions upon which RSUs vest vary among grants; however, RSUs generally vest over to five years on a straight-line basis. As of March 31, 2022, the Company had 3,602,468 stock options and RSUs outstanding and 390,186 shares reserved for future awards.
Stock-based compensation expense was $3.0 million and $2.6 million for the three months ended March 31, 2022 and 2021, respectively.
The assumptions used in the Black-Scholes option-pricing model were as follows:
| Three Months Ended March 31, 2022 | |||||
| Volatility | 100.0% | ||||
| Risk-free interest rate | 1.04% | ||||
| Expected life (in years) | 2.81 | ||||
| Dividend yield | 0 | % | |||
The expected volatility assumptions have been based on the historical and expected volatility of our stock and comparable companies, measured over a period generally commensurate with the expected term or acceptable period to determine reasonable volatility. The weighted average expected option term for the three months ended March 31, 2022 reflects the application of the simplified method prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 107 (as amended by SAB 110), which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.
Stock Options - Employees and Directors
A summary of stock option activity for employees, directors and consultants is as follows:
Number of Shares | Weighted Average Exercise Price | ||||||||||
| Outstanding as of December 31, 2021 | 3,618,145 | $ | 13.55 | ||||||||
| Granted | 332,296 | 8.72 | |||||||||
| Forfeited | (444,972) | 16.28 | |||||||||
| Outstanding as of March 31, 2022 | 3,505,469 | 12.74 | |||||||||
| Options vested and exercisable as of March 31, 2022 | 1,089,599 | $ | 14.19 | ||||||||
As of March 31, 2022, there was $13.2 million of total unrecognized compensation cost related to non-vested stock compensation arrangements granted to employees, directors and consultants under the 2017 Amended Plan, which is expected to be recognized over a weighted-average period of approximately 1.77 years.
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Restricted Stock Units - Employees
The Company estimates the fair value of RSUs based on the closing price of our common stock on the date of grant. The following table summarizes our RSU award activity issued under the 2017 Plan:
| Restricted Stock Units | Weighted- Average Grant Date Fair Value | ||||||||||
| Non-vested at December 31, 2021 | 111,874 | $ | 33.27 | ||||||||
| Forfeited | (13,000) | 28.60 | |||||||||
| Vested and distributed | (1,875) | 51.98 | |||||||||
Non-vested at March 31, 2022 | 96,999 | 33.53 | |||||||||
As of March 31, 2022, there was $2.9 million of unrecognized compensation cost related to unvested outstanding RSUs. We expect to recognize these costs over a weighted average period of 3.46 years.
Warrants - Non-employees
The Company has also granted warrants to purchase common stock that have been approved by our Board of Directors. A summary of warrants activity was as follows:
Number of Warrants | Weighted Average Exercise Price | ||||||||||
| Outstanding as of December 31, 2021 | 35,832 | $ | 16.75 | ||||||||
| Granted | 131,664 | 0.01 | |||||||||
| Outstanding as of March 31, 2022 | 167,496 | 3.59 | |||||||||
| Warrants exercisable as of March 31, 2022 | 167,496 | 3.59 | |||||||||
In connection with entering into the Eighth Amendment of our note purchase agreement for our 2024 Notes on March 8, 2022, as discussed in Note 9 below, the Company issued to Special Situations Investing Group II, LLC (the “Holder”), a Purchase Warrant for Common Shares (the “Amendment Warrant”) pursuant to which the Holder may purchase shares of the Company’s common stock in an aggregate amount of up 111,680 shares. Also, on March 31, 2022, the Company issued additional warrants (a “Ticking Warrant” and together with the Amendment Warrant, the “Warrants”), as discussed in Note 9 below, having the same terms as the Amendment Warrant, to purchase 19,984 shares of the Company's common stock, which was based on a stated value of $47,500 and the number of common stock calculated based on the volume weighted average trading price of the Company’s common stock during the five (5) trading day period immediately preceding the date such Ticking Warrant was issued, not to exceed 7% of the outstanding shares of the Company's common stock on the date of the Eighth Amendment. The Warrants were offered and sold to the Holder in a private placement exempt from registration under the Securities Act. The Warrants may be exercised by the Holder at an exercise price equal to $0.01 per share and will expire on September 24, 2026. The Company assessed and separated the Warrants into liability and equity components, wherein the Amendment Warrant qualified for equity classification and the Ticking Warrant qualified for liability classification. The fair values of the Warrants were determined at grant date using the Black-Scholes pricing model. The equity component is not re-measured as long as it continues to meet the conditions for equity classification. The fair value of liability component is remeasured at each reporting period until it is completely settled or expire. See Note 10 below for more information.
Performance-Based and Market-Based Awards
The Company’s Compensation Committee designed a compensation structure to align the compensation level of the Executive Chairman to the performance of the Company through the issuance of market-based stock options. The market-based options vest upon the Company’s stock price reaching a certain price at a specific performance period and the total amount of compensation
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expense recognized is based on a Monte Carlo simulation that factors in the probability of the award vesting. The following table summarizes the Company’s outstanding awards under this structure:
| Grant Date | Performance Measures | Vesting Term | Performance Period | # of Shares | Exercise Price | |||||||||||||||||||||||||||
| December 2017 | Weighted Average Price of our common stock is $15.00 for at least twenty trading days within a period of thirty consecutive trading days ending on the trading day prior to January 1, 2023. | Fully vest on January 1, 2023 | January 1, 2023 | 642,307 | $ | 7.50 | ||||||||||||||||||||||||||
| August 2018 | Weighted Average Price of our common stock is $15.00 for at least twenty trading days within a period of thirty consecutive trading days ending on the trading day prior to January 1, 2023. | Fully vest on January 1, 2023 | January 1, 2023 | 397,693 | $ | 7.50 | ||||||||||||||||||||||||||
Note 8. Leases
The Company determines whether an arrangement is a lease, or contains a lease, at inception and recognizes right-of-use assets and lease liabilities, initially measured at present value of the lease payments, on our balance sheet and classifies the leases as either operating or financing leases. The Company leases office space in Henderson, Nevada, which lease was entered into with an effective date of March 24, 2022 and serves as the Company's new headquarters, as well as in Santa Monica, California and in Rosemont, Illinois, which are accounted for as operating leases and various computer equipment used in the operation of our business, which are accounted for as finance leases. The operating lease agreements include a total of 13,166 square feet of office space for lease terms ranging from 26 months to 60 months. The finance leases are generally for 36 month terms.
The Company’s operating leases do not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. The lease includes renewal options and escalation clauses. The renewal options have not been included in the calculation of the operating lease liability and right-of-use asset as the Company is not reasonably certain to exercise the options. Variable expenses generally represent the Company’s share of the landlord’s operating expenses.
Quantitative information for our leases is as follows (in thousands):
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| Condensed Consolidated Balance Sheets | Balance Sheet Classification | March 31, 2022 | December 31, 2021 | |||||||||||
| Assets | ||||||||||||||
| Operating lease assets | "Operating lease right-of-use-assets" | $ | 861 | $ | 656 | |||||||||
| Finance lease assets | 155 | 186 | ||||||||||||
| Total lease assets | $ | 1,016 | $ | 842 | ||||||||||
| Liabilities | ||||||||||||||
| Current | ||||||||||||||
| Operating lease liabilities | "Current portion of operating lease liabilities" | $ | 617 | $ | 595 | |||||||||
| Finance lease liabilities | 248 | 282 | ||||||||||||
| Non-current | ||||||||||||||
| Operating lease liabilities | "Long-term operating lease liabilities" | 1,034 | 932 | |||||||||||
| Finance lease liabilities | "Long-term finance lease liabilities" | 86 | 136 | |||||||||||
| Total lease liabilities | $ | 1,985 | $ | 1,945 | ||||||||||
| Three Months Ended March 31, | ||||||||||||||
Condensed Consolidated Statements of Operations | 2022 | 2021 | ||||||||||||
| Operating lease expense | $ | 98 | $ | 171 | ||||||||||
| Short-term lease rent expense | 4 | 23 | ||||||||||||
| Variable lease expense | 15 | 12 | ||||||||||||
| Total rent expense | $ | 117 | $ | 206 | ||||||||||
| Finance lease expense | ||||||||||||||
| Amortization of leased assets | $ | 31 | $ | 79 | ||||||||||
| Interest on lease liabilities | 7 | 12 | ||||||||||||
| Total | $ | 38 | $ | 91 | ||||||||||
| Three Months Ended March 31, | |||||||||||
| Condensed Consolidated Statements of Cash Flows | 2022 | 2021 | |||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | |||||||||||
| Operating cash flows from operating leases | $ | 179 | $ | 148 | |||||||
| Financing cash flows from finance leases | 84 | 78 | |||||||||
| Other Information | March 31, 2022 | December 31, 2021 | |||||||||
| Weighted-average remaining lease term (years) | |||||||||||
| Operating leases | 2.9 | 2.3 | |||||||||
| Financing leases | 1.3 | 1.5 | |||||||||
| Weighted-average discount rate | |||||||||||
| Operating leases | 12.46 | % | 10.73 | % | |||||||
| Finance leases | 11.79 | % | 11.46 | % | |||||||
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The following table sets forth maturities of our lease liabilities (in thousands):
| March 31, 2022 | |||||||||||
| Operating Leases | Financing Leases | Total | |||||||||
| Remainder of 2022 | $ | 578 | $ | 211 | $ | 789 | |||||
| 2023 | 760 | 139 | 899 | ||||||||
| 2024 | 420 | — | 420 | ||||||||
| 2025 | 90 | — | 90 | ||||||||
| 2026 and thereafter | 109 | — | 109 | ||||||||
| Total lease payments | 1,957 | 350 | 2,307 | ||||||||
| Less: imputed interest | (306) | (16) | (322) | ||||||||
| Present value of lease liabilities | 1,651 | 334 | 1,985 | ||||||||
| Less: current portion | (617) | (248) | (865) | ||||||||
| Lease liabilities, non-current | $ | 1,034 | $ | 86 | $ | 1,120 | |||||
Note 9. Debt
2024 Notes
The Company is party to a Note Purchase Agreement dated September 24, 2019 (the “Note Agreement”) with Goldman Sachs Specialty Lending Group, L.P. and any other purchasers party thereto from time to time (collectively, the “Holders”), as amended, pursuant to which the Company initially issued $35.0 million aggregate principal amount of senior secured notes (the "Initial 2024 Notes"). In August 2020, the Company issued an additional $10.0 million principal amount of senior secured notes as provided under the additional note purchase commitment of the Note Agreement (together with the Initial 2024 Notes, the "2024 Notes"). The 2024 Notes, as amended, permits the Company to issue Series A Preferred Stock in an amount not to exceed $125 million, to pay dividends thereon under specified conditions, including a waiver of the mandatory prepayment of the 2024 Notes with the proceeds of the Series A Preferred Stock offering, and permits the Company's issuance of common shares up to a market value of $70 million through an at-the-market ("ATM") offering, provided that proceeds from any such ATM offering are solely used to repay the 2024 Notes. The 2024 Notes, as amended, also included changes to redefine certain definitions and financial covenants, including changes to Minimum Consolidated Liquidity, Consolidated Adjusted EBITDA, the Leverage Ratio, the Fixed Charge Coverage Ratio, the addition of Minimum Monthly Cash Flow and elimination of Minimum Revenue, primarily intended to increase the Company’s financial flexibility. The 2024 Notes, as amended, also contains customary covenants that restrict the Company’s ability to incur debt, grant liens, make certain investments and acquisitions, pay certain dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into affiliate transactions and asset sales or make certain equity issuances, and covenants that require the Company to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, weekly cash flow forecasts, maintain its property in good repair, maintain insurance, comply with applicable laws, and customary events of default, including, among others, payment default, bankruptcy events, cross-default, breaches of covenants and representations and warranties, change of control, judgment defaults and an ownership change within the meaning of Section 382 of the Internal Revenue Code. In the case of an event of default, the Holder may, among other remedies, accelerate the payment of all obligations under the 2024 Notes and all assets of the Company serves as collateral. The Company was in compliance with all of its debt covenants as of March 31, 2022, except for the Minimum Consolidated Liquidity covenant and certain non-financial compliance requirements, which the Company expects to cure with the collection of $4.8 million received on May 9, 2022 from one of the terminated customers and submission of the non-financial compliance requirements.
On February 14, 2022, the Company repaid $9.0 million of the outstanding balance of the 2024 Notes. This prepayment met the requirements as prescribed in the terms of the note agreement such that no yield maintenance premium and no prepayment fee were applicable. On March 8, 2022, the Company entered into an Eight Amendment to Note Purchase Agreement with the Holders (the "Eighth Amendment"), which among other things, amended certain financial covenants intended to increase the Company's financial flexibility, a required prepayment of $11.0 million of the outstanding loan balance without the incurrence of
19
a yield maintenance premium or prepayment fee, which prepayment was made by the Company on March 8, 2022, restrictions on the declaration and payment of dividends on the Company's Series A Preferred Stock until after December 31, 2022, and elimination of LIBOR as a reference rate such that the 2024 Notes only bear interest at the Base Rate, as defined in the Note Agreement, going forward. At March 31, 2022, the effective weighted average annual interest rate applicable to the outstanding 2024 Notes was 15.60%. The entire principal amount of the remaining outstanding balance under the 2024 Notes is due and payable on the fifth anniversary of the Note Agreement (September 24, 2024) unless earlier redeemed upon the occurrence of certain mandatory prepayment events, including 50% of excess cash flow, asset sales and the amount by which total debt exceeds an applicable leverage multiple.
In connection with entering into the Eighth Amendment, the Company issued to Special Situations Investing Group II, LLC (the “Holder”), a Purchase Warrant for Common Shares (the “Amendment Warrant”) pursuant to which the Holder may purchase shares of the Company’s common stock in an aggregate amount of up 111,680 shares. Also, the Company agreed to issue to the Holder, beginning March 31, 2022 and until the earlier of (i) date the 2024 Notes have been paid in full and (ii) October 31, 2022, additional warrants (each a “Ticking Warrant” and together with the Amendment Warrant, the “Warrants”), having the same terms as the Amendment Warrant, to purchase a number of shares of the Company's common stock equal to $47,500, to be calculated based on the volume weighted average trading price of the Company’s common stock during the five (5) trading day period immediately preceding the date such Ticking Warrant is issued, not to exceed 7% of the outstanding shares of the Company's common stock on the date of the Eighth Amendment. The Warrants were offered and sold to the Holder in a private placement exempt from registration under the Securities Act. The Warrants may be exercised by the Holder at an exercise price equal to $0.01 per share and will expire on September 24, 2026. As of March 31, 2022, a Ticking Warrant to purchase 19,984 shares of the Company's common stock was issued to the Holder. The Company assessed and separated the Warrants into liability and equity components, wherein the Amendment Warrant qualified for equity classification and the Ticking Warrant qualified for liability classification. See Notes 7 and 10 for more information.
In accounting for the issuance of the 2024 Notes, the Company separated the 2024 Notes into liability and equity components. The fair value of the liability component was estimated using an interest rate for debt with terms similar to the 2024 Notes. The carrying amount of the equity component was calculated by measuring the fair value based on the Black-Scholes model. The gross proceeds from the transaction was allocated between liability and equity based on the proportionate value. The debt discount is accreted to interest expense over the term of the 2024 Notes using the interest method. The equity component is not re-measured as long as it continues to meet the conditions for equity classification.
The assumptions used in the Black-Scholes option-pricing model at inception remain unchanged and were determined as follows:
| Volatility | 98.01 | % | |||
| Risk-free interest rate | 1.58 | % | |||
| Expected life (in years) | 7 | ||||
| Dividend yield | 0 % | ||||
The net carrying amounts of the liability components consists of the following (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Principal | $ | 19,200 | $ | 39,194 | |||||||
| Less: debt discount | (3,160) | (3,402) | |||||||||
Net carrying amount | $ | 16,040 | $ | 35,792 | |||||||
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The following table presents the interest expense recognized related to the 2024 Notes (in thousands):
| Three Months Ended March 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Contractual interest expense | $ | 1,160 | $ | 1,781 | ||||||||||
| Accretion of debt discount | 242 | 199 | ||||||||||||
| Total interest expense | $ | 1,402 | $ | 1,980 | ||||||||||
Other
In November 2021, the Company financed a portion of its insurance premiums for the new term totaling $3.1 million at an annual effective rate of 2%, payable in ten equal monthly installments beginning on December 8, 2021 and a down payment of $0.6 million at inception. At March 31, 2022 and December 31, 2021, there was $1.5 million and $2.3 million, respectively, relating to this financed insurance premium outstanding, which was included as part of "Other accrued liabilities" on our condensed consolidated balance sheet as of each respective period.
Note 10. 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 condensed 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 for assets and liabilities measured at fair value on a recurring basis as of the periods presented (in thousands):
| Balance as of March 31, 2022 | |||||||||||||||||||||||
| Level I | Level II | Level III | Total | ||||||||||||||||||||
| Letter of credit (1) | $ | 306 | $ | — | $ | — | $ | 306 | |||||||||||||||
| Total assets | $ | 306 | $ | — | $ | — | $ | 306 | |||||||||||||||
| Contingent consideration (2) | $ | — | $ | — | $ | 144 | $ | 144 | |||||||||||||||
| Warrant liability (3) | — | — | 45 | 45 | |||||||||||||||||||
| Total liabilities | $ | — | $ | — | $ | 189 | $ | 189 | |||||||||||||||
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| Balance as of December 31, 2021 | |||||||||||||||||||||||
| Level I | Level II | Level III | Total | ||||||||||||||||||||
| Letter of credit (1) | $ | 306 | $ | — | $ | — | $ | 306 | |||||||||||||||
| Total assets | $ | 306 | $ | — | $ | — | $ | 306 | |||||||||||||||
| Contingent consideration (2) | $ | — | $ | — | $ | 357 | $ | 357 | |||||||||||||||
| Total liabilities | $ | — | $ | — | $ | 357 | $ | 357 | |||||||||||||||
___________________
(1) $0.3 million was included in "Restricted cash - long term" on our condensed consolidated balance sheets as of March 31, 2022 and December 31, 2021.
(2) Contingent consideration was included in "Other accrued liabilities" on our condensed consolidated balance sheets as of March 31, 2022 and December 31, 2021.
(3) Relates to Ticking Warrant issued on March 31, 2022 in connection with the Eight Amendment executed on March 8, 2022, as discussed in Notes 7 and 9 above, and included in "Other accrued liabilities" on our condensed consolidated balance sheet as of March 31, 2022.
Financial instruments classified as Level III in the fair value hierarchy as of March 31, 2022 and December 31, 2021 represent liabilities measured at market value on a recurring basis and include warrant liabilities relating to Ticking Warrant issued in connection with an amendment to our debt agreement, as discussed in Note 9, and contingent consideration relating to a stock price guarantee provided in an acquisition (see further discussion below regarding this contingent consideration). In accordance with current accounting rules, the warrant liability and contingent consideration liability are being marked-to-market each quarter-end until they are completely settled or expire. The fair value of the warrant liability is valued using the Black-Scholes pricing model, using both observable and unobservable inputs and assumptions consistent with those used in the estimate of fair value of employee stock options. The fair value of the contingent consideration liability is valued using the Monte Carlo simulation model, using both observable and unobservable inputs and assumptions.
The carrying value of the 2024 Notes is estimated to approximate their fair value as the variable interest rate of the Senior Secured Notes approximates the market rate for debt with similar terms and risk characteristics.
The fair value measurements using significant Level III inputs, and changes therein, was as follows (in thousands):
| Level III Contingent Consideration | |||||
| Balance as of December 31, 2021 | $ | 357 | |||
| Settlement of contingent consideration | (213) | ||||
| Balance as of March 31, 2022 | $ | 144 | |||
The $0.1 million of contingent consideration, which resulted from a stock price guarantee provided as a part of our acquisition of LifeDojo, Inc. in October 2020, remaining as of March 31, 2022 relates to 16,510 shares of common stock remaining to be issued, pending response for stockholder information.
Warrant Liabilities
| Level III Warrant Liabilities | |||||
| Balance as of December 31, 2021 | $ | — | |||
| Warrant issued - Ticking Warrant | 45 | ||||
| Balance as of March 31, 2022 | $ | 45 | |||
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The assumptions used in the Black-Scholes warrant-pricing model were determined as follows:
| March 31, 2022 | ||||||||
| Volatility | 100.0 | % | ||||||
| Risk-free interest rate | 2.45 | % | ||||||
| Weighted average expected life (in years) | 4.55 | |||||||
| Dividend yield | 0 | % | ||||||
Note 11. Variable Interest Entities
Generally, an entity is defined as a Variable Interest Entity (“VIE”) under current accounting rules if it either lacks sufficient equity to finance its activities without additional subordinated financial support, or it is structured such that the holders of the voting rights do not substantively participate in the gains and losses of the entity. When determining whether an entity that meets the definition of a business, qualifies for a scope exception from applying VIE guidance, the Company considers whether: (i) it has participated significantly in the design of the entity, (ii) it has provided more than half of the total financial support to the entity, and (iii) substantially all of the activities of the VIE are conducted on its behalf. A VIE is consolidated by its primary beneficiary, the party that has the power to direct the activities that most significantly affect the economics of the VIE and has the right to receive benefits or the obligation to absorb losses of the entity that could be potentially significant to the VIE. The primary beneficiary assessment must be re-evaluated on an ongoing basis.
As discussed under the heading Management Services Agreements (“MSA”) below, the Company has an MSA with a Texas nonprofit health organization (“TIH”) and a California Professional Corporation (“CIH”). Under the MSAs, the equity owners of TIH and CIH have only a nominal equity investment at risk, and the Company absorbs or receives a majority of the entity’s expected losses or benefits. The Company participates significantly in the design of these MSAs. The Company also agrees to provide working capital loans to allow for TIH and CIH to fund their day to day obligations. Substantially all of the activities of TIH and CIH, including its decision making and approvals are conducted for its benefit, as evidenced by the fact that (i) the operations of TIH and CIH are conducted primarily using the Company's licensed network of providers and (ii) under the MSA, the Company agrees to provide and perform all non-medical management and administrative services for the entities. Payment of the Company's management fee by TIH and CIH is subordinate to payments of the other obligations of TIH and CIH, and repayment of the working capital loans is not guaranteed by the equity owner of the affiliated medical group or other third party. Creditors of TIH and CIH do not have recourse to the Company's general credit.
Based on the design of the entity and the lack of sufficient equity to finance its activities without additional working capital loans, the Company has determined that TIH and CIH are VIEs. The Company, as the primary beneficiary, is required to consolidate the VIE entities as it has power and potentially significant interests in the entities. Accordingly, the Company is required to consolidate the assets, liabilities, revenues and expenses of the managed treatment centers.
Management Services Agreements
In April 2018, the Company executed an MSA with TIH and in July 2018, the Company executed an MSA with CIH. Under the MSAs, the Company licenses to TIH and CIH the right to use its proprietary treatment programs and related trademarks, and provides all required day-to-day business management services, including, but not limited to:
•general administrative support services;
•information systems;
•recordkeeping;
•billing and collection; and
•obtaining and maintaining all federal, state and local licenses, certifications and regulatory permits.
All clinical matters relating to the operation of TIH and CIH and the performance of clinical services through the network of providers shall be the sole and exclusive responsibility of the TIH and CIH Board free of any control or direction from the Company.
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TIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the medical group, provided that any capitalized costs will be amortized over a five-year period), (b) 10%-15% of the foregoing costs, and (c) any performance bonus amount, as determined by TIH at its sole discretion.
CIH pays the Company a monthly fee equal to the aggregate amount of (a) its costs of providing management services (including reasonable overhead allocated to the delivery of its services and including salaries, rent, equipment, and tenant improvements incurred for the benefit of the entity, provided that any capitalized costs will be amortized over a five-year period), and (b) any performance bonus amount, as determined by CIH at its sole discretion.
The Company's condensed consolidated balance sheets include the following assets and liabilities from its TIH and CIH VIEs (in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Cash and cash equivalents | $ | 1,358 | $ | 1,356 | |||||||
| Unbilled receivables | 54 | 80 | |||||||||
| Prepaid and other current assets | 32 | 48 | |||||||||
| Total assets | $ | 1,444 | $ | 1,484 | |||||||
| Accounts payable | $ | 5 | $ | 10 | |||||||
| Accrued liabilities | 103 | 11 | |||||||||
| Deferred revenue | 48 | 40 | |||||||||
| Payables to Ontrak | 1,680 | 1,841 | |||||||||
| Total liabilities | $ | 1,836 | $ | 1,902 | |||||||
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Note 12. Commitments and Contingencies
From time to time, we are subject to various legal proceedings that arise in the normal course of our business activities. As of the date of this Quarterly Report on Form 10-Q, we were not party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our results of operations or financial position except for the following:
Loss Contingencies
On March 3, 2021, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Farhar v. Ontrak, Inc., Case No. 2:21-cv-01987. On March 19, 2021, another similar lawsuit was filed in the same court, entitled Yildrim v. Ontrak, Inc., Case No. 2:21-cv-02460. On July 14, 2021, the Court consolidated the two actions under the Farhar case (“Consolidated Class Action”), appointed Ibinabo Dick as lead plaintiff, and the Rosen Law Firm as lead counsel. On August 13, 2021, lead plaintiff filed a consolidated amended complaint. In the Consolidated Amended Complaint, lead plaintiff, purportedly on behalf of a putative class of purchasers of Ontrak securities from August 5, 2020 through February 26, 2021, alleges that the Company and Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and misleading statements and omissions in various press releases, SEC filings and conference calls with investors on August 5, 2020 and November 5, 2020. Specifically, the Consolidated Amended Complaint alleges that the Company was inappropriately billing its largest customer, Aetna, causing Aetna to, in May 2020, shut off its data feed to Ontrak, and, in July 2020, require Ontrak to complete a Corrective Action Plan (“CAP”). Lead plaintiff alleges that defendants: (1) misrepresented to investors that the data feed was shut off in July 2020, and that it was part of Aetna’s standard compliance review of all of its vendors; (2) failed to disclose to investors that Aetna had issued the CAP; and (3) failed to disclose to investors that Ontrak was engaging in inappropriate billing practices. Lead plaintiff seeks certification of a class and monetary damages in an indeterminate amount. On September 13, 2021, defendants filed a motion to dismiss the Consolidated Amended Complaint for failure to state a claim under Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. §§ 78u-4, et seq. The motion is fully briefed and has been taken under submission, with no oral argument. The Company believes that the allegations lack merit and intends to defend against the action vigorously.
On August 6, 2021, a purported stockholder derivative complaint was filed in the United States District Court for the Central District of California, entitled Aptor v. Peizer, Case No. 2:21-cv-06371, alleging breach of fiduciary duty on behalf of the Company against Terren S. Peizer, Brandon H. LaVerne, Richard A. Berman, Michael Sherman, Diane Seloff, Robert Rebak, Gustavo Giraldo and Katherine Quinn, and contribution against Terren S. Peizer and Brandon H. LaVerne. On October 6, 2021, a similar shareholder derivative action was filed in the same Court, entitled Anderson v. Peizer, Case No. 2:21-cv-07998, for breach of fiduciary duty, abuse of control, unjust enrichment, gross mismanagement and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn, and contribution against Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros. On December 1, 2021, a similar shareholder derivative action was filed in the United States District Court for the District of Delaware, entitled Vega v. Peizer, Case No. 1:21-cv-01701, for violation of Section 20(a) of the Exchange Act, breach of fiduciary duty, unjust enrichment and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn. In these actions, plaintiffs allege that the defendants breached their fiduciary duties by allowing or causing the Company to violate the federal securities laws as alleged in the Consolidated Class Action discussed above. The plaintiffs seek damages (and contribution from the officers) in an indeterminate amount. On December 7, 2021, the Court in the Central District of California consolidated the two Central District of California actions under the Aptor case caption and number (the "Consolidated Derivative Action"), stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to file a consolidated amended complaint within fourteen (14) days of a ruling on the Motion to Dismiss in the Consolidated Class Action. On February 7, 2022, the Court in the District of Delaware extended the deadline for defendants to respond to the complaint in the Vega action to April 8, 2022. On March 21, 2022 the Court in the District of Delaware granted plaintiff’s unopposed motion to transfer the case to the United States District Court for Central District of California in the interest of judicial efficiency due to the Consolidated Class Action and Consolidated Derivative Action already pending in that district, and that same day the case was transferred into the United States District Court for Central District of California and given the new Case No. 2:22-cv-01873-CAS-AS. On April 11, 2022, the Court stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to inform defendants regarding their intention to amend their initial
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complaint withing thirty (30) days of said ruling. Although all of the claims asserted in these actions purport to seek recovery on behalf of the Company, the Company will incur certain expenses due to indemnification and advancement obligations with respect to the defendants. The Company understands that defendants believe these actions are without merit and intend to defend themselves vigorously.
On February 28, 2022, a purported securities class action was filed in the Superior Court of California for Los Angeles County, entitled Braun v. Ontrak, Inc., et al., Case No. 22STCV07174. The plaintiff filed this action purportedly on behalf of a putative class of all purchasers of the 9.50% Series A Cumulative Perpetual Preferred Stock (the “Preferred stock”) of Ontrak pursuant to Registration Statements and Prospectuses issued in connection with Ontrak’s August 21, 2020 initial public stock offering, its September 2020 through December 2020 “at market” offering, and its December 16, 2020 follow-on stock offering (collectively, the “Offerings”). The plaintiff brings this action against the Company; its officers: Terren S. Peizer, Brandon H. LaVerne, and Christopher Shirley; its board members: Richard A. Berman, Sharon Gabrielson, Gustavo Giraldo, Katherine B. Quinn, Robert Rebak, Diane Seloff, Michael Sherman, and Edward Zecchini; and the investment banking firms that acted as underwriters for the Offerings: B. Riley Securities, Inc., Ladenburg Thalmann & Co., Inc., William Blair & Company, LLC, Aegis Capital Corp., Insperex LLC (f/k/a Incapital LLC), The Benchmark Company, LLC, Boenning & Scatteredgood, Inc., Colliers Securities, LLC, Kingswood Capital Markets, and ThinkEquity. The plaintiff asserts violations of § 11, § 12(a)(2), and § 15 of the Securities Act of 1933, alleging that these filings failed to disclose and misrepresented that (1) Ontrak’s relationships with two of its largest customers, Aetna and Cigna, were materially impaired due to a lack of confidence in Ontrak’s value proposition and billing practices; (2) Aetna had turned off the data feed of customer records to Ontrak by May 2020, citing dissatisfaction with the Company’s value proposition and billing practices and thus submitted a CAP which Ontrak’s senior executives were unable to effectively respond to; and (3) the alleged failures in Ontrak’s ability to ensure insurance coverage and resulting billing problems affected all of its relationships with large health insurance provider clients weakening its business metrics and financial prospects. The plaintiff seeks damages in an indeterminate amount. On April 4, 2022, the parties filed a joint stipulation extending defendants time to respond to the initial complaint until May 6, 2022. On April 6, 2022, the Court stayed the case pending an initial status conference, which is scheduled for June 7, 2022 at 10:00am. That order stayed the entire case, including the May 6, 2022 response deadline. The Company believes that the allegations lack merit and intends to defend against the action vigorously.
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Note 13. Subsequent Events
On April 12, 2022, the Company entered into a sublease agreement with a subtenant for 100% of the leased office space located at Santa Monica, California. The sublease agreement commences 30 days following the execution of a consent agreement by the prime landlord, which was executed on May 3, 2022. As such, the sublease will commence on June 3, 2022 and expire on July 17, 2024, unless sooner terminated.
On April 15, 2022, the Company entered into a Master Note Purchase Agreement (the “Keep Well Agreement”) with Acuitas Capital LLC ("Acuitas"), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder, pursuant to which, subject to specified conditions, the Company may borrow up to $25.0 million (the “Available Amount”) from time to time through the earlier of (a) the date on which the Company files a report with the SEC that states there is substantial doubt regarding the Company’s ability to continue as a going concern during the twelve month period following such filing and (b) September 1, 2023. In connection with each borrowing under the Keep Well Agreement, the Company will issue senior secured notes (each, a "Keep Well Note") to Acuitas, or an entity affiliated with it ("Purchaser"), in return for the specified face amount of such senior secured note. The Keep Well Notes will accrue interest based on the Secured Overnight Financing Rate plus a corresponding applicable margin, for an all-in interest rate equating to 16.25% as of the closing date of the Keep Well Agreement. The Keep Well Notes will be due on September 1, 2023, subject to acceleration for certain customary events of default. In addition to customary conditions precedent, Purchaser's obligation to purchase Keep Well Notes is subject to the condition that (x) the Company used best efforts to obtain sufficient financing from a third party for the Company to pay and discharge, when due and payable, its obligations, (y) the Company was unable despite its best efforts to obtain such financing from a third party on reasonably acceptable terms, as determined by a majority of the independent directors of the Company (such determination to be made as if the financing contemplated by the Keep Well Agreement were not available to the Company; and (z) (1) absent obtaining the funds requested by the Company, the Company will not have sufficient unrestricted cash to pay and discharge all its obligations then due or scheduled to become due within the 30 days following the date of the request, and (2) there are no conditions or events that, when considered in the aggregate, raise substantial doubt about the Company’s ability to continue as a going concern through August 15, 2023, after giving effect to the receipt of the funds requested and the remaining Available Amount.
As of the date hereof, the Company has borrowed no funds under the Keep Well Agreement. If a Keep Well Note is issued, the Company’s obligations under the Keep Well Agreement will be unconditionally guaranteed by certain of the Company’s subsidiaries and will be secured by a first priority lien on substantially all of the present and future property and assets of the Company and such subsidiaries, in each case, subject to customary exceptions and exclusions.
The Keep Well Agreement was evaluated by, and negotiated at the direction of, a special committee of independent and disinterested directors of the Company’s board of directors. The Company’s board of directors approved the Keep Well Agreement upon the recommendation for such approval by the special committee.
The Keep Well Agreement contains customary covenants that must be complied with by the Company, including, among other covenants, restrictions on the Company’s ability to incur debt, grant liens, make certain investments and acquisitions, pay dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into certain asset sale transactions, and covenants that require the Company to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, maintain its property in good repair, maintain insurance and comply with applicable laws. The Keep Well Agreement also includes the following financial covenants: a requirement that annualized consolidated recurring revenue for 2022, and during 2023, consolidated recurring revenue for the preceding twelve months be at least $15.0 million tested monthly; and a requirement that consolidated liquidity must be greater than $5.0 million at all times.
The Keep Well Agreement contains customary events of default, including, among others, a payment default, bankruptcy events, cross-default provisions, breaches of covenants and representations and warranties, change of control, and judgment defaults. In the case of an event of default, Purchaser may, among other remedies, accelerate the payment of all obligations under the Keep Well Notes.
The Company has the right terminate the Keep Well Agreement at any time prior to borrowing funds thereunder (such date on which such funds are borrowed, the "Initial Keep Well Note Date"). Any Commitment Shares (as defined below) that would have been earned prior to such termination, subject to obtaining the Commitment Shares Stockholder Approval (as defined below), will
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be earned and issued upon Commitment Shares Stockholder Approval, and the Company’s obligation to seek Commitment Shares Stockholder Approval shall survive any such termination.
In connection with entering into the Keep Well Agreement, subject to obtaining approval of the Company’s stockholders as required by applicable Nasdaq listing rules (the “Commitment Shares Stockholder Approval”), the Company will issue up to 739,645 shares of its common stock to Purchaser (or any entity affiliated with Purchaser, as designated by Purchaser) (the “Commitment Shares”), (a) 50% of which will be issued upon obtaining Commitment Shares Stockholder Approval, (b) 25% of which will be issued upon the later of June 1, 2022 and obtaining Commitment Shares Stockholder Approval, unless on or before June 1, 2022, the Company has secured sufficient capital to replace the Available Amount pursuant to an alternative financing approved by the Company’s board of directors; and (c) 25% of which will be issued on the later of the Initial Keep Well Note Date and obtaining the Commitment Shares Stockholder Approval.
In connection with the each Keep Well Note sold by Company, subject to obtaining approval of the Company’s stockholders as required by applicable Nasdaq listing rules (the “Keep Well Warrant Stockholder Approval”), the Company will issue to Purchaser (or an entity affiliated with Purchaser, as designated by Purchaser) a warrant to purchase shares of the Company’s common stock (each, a “Keep Well Warrant”). The number of shares of the Company’s common stock underlying each Keep Well Warrant will be equal to (y) the product of the principal amount of the applicable Keep Well Note and 20% divided by (z) the exercise price of the applicable Keep Well Warrant. Each Keep Well Warrant will have a term of five years and an exercise price equal to $1.69, which was the consolidated closing bid price of the Company’s common stock as reported by Nasdaq immediately preceding the time the parties entered into the Keep Well Agreement. Each Keep Well Warrant will contain customary adjustment provisions in the event of stock splits, combinations, and similar transactions, and will provide specified information, registration and indemnification rights to the holder of such Keep Well Warrant.
The Company agreed to seek the Commitment Shares Stockholder Approval and the Keep Well Warrant Stockholder Approval at a stockholders meeting to be held on or on or before September 9, 2022.
If Acuitas' beneficial ownership of the Company’s capital stock equals at least a majority of the voting power of the Company’s outstanding capital stock following the issuance of any of the Commitment Shares, a Keep Well Warrant or any shares of common stock issuable upon exercise of a Keep Well Warrant, Acuitas agreed to enter into a stockholders agreement with the Company (the “Stockholders Agreement”) pursuant to which Acuitas would agree to vote the shares of the Company’s common stock it beneficially owns (a) in favor of an amendment to the certificate of incorporation or bylaws of the Company that would require the Company’s board of directors to include not fewer than three independent directors at all times, (b) in favor of the election or re-election of independent directors nominated for election by the Company’s board of directors or by the nominating committee thereof unless the failure of a nominee to be elected or re-elected to the Company’s board of directors would not result in the Company having fewer than three independent directors following such election, and (c) against any proposal or action that would result in the Company’s board of directors having fewer than three independent directors at all times. In addition, under the Stockholders Agreement, the parties will agree that the Company will not enter into any transaction between the Company or any of its affiliates, on the one hand, and Acuitas or any of its affiliates (excluding the Company and its affiliates), on the other hand, unless it is approved by a majority of the independent directors then serving on the Company’s board of directors.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements, including the related notes, and the other financial information included elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission.
FORWARD-LOOKING STATEMENTS
This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, business strategies, operating efficiencies or synergies, competitive positions, growth opportunities for existing products, plans and objectives of management, markets for our stock and other matters. Statements in this report that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Exchange Act of 1934, as amended (the “Exchange Act”) and Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements, including, without limitation, those relating to the future business prospects, our revenue and income, wherever they occur, are necessarily estimates reflecting the best judgment of our senior management as of the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to a variety of risks, uncertainties and assumptions, including those described in the “Risk Factors” in Item 1A of Part I of our most recent Annual Report on Form 10-K (“Form 10-K”) for the fiscal year ended December 31, 2021 and other reports we filed with the Securities and Exchange Commission (“SEC”), that may affect the operations, performance, development and results of our business. Because the factors discussed in this report could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any such forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.
All references to “Ontrak,” “Ontrak, Inc.,” “we,” “us,” “our” or the “Company” mean Ontrak, Inc., its wholly-owned subsidiaries and variable interest entities, except where it is made clear that the term means only the parent company.
OVERVIEW
General
Ontrak, Inc. (“Ontrak,” “Company,” “we,” “us” or “our”) is an AI-powered and telehealth-enabled, virtualized healthcare company, whose mission is to help improve the health and save the lives of as many people as possible. Our technology-enabled platform provides claim based analytics and predictive modeling to provide analytic insights throughout the delivery of our personalized treatment program. Our program predicts people whose chronic disease will improve with behavior change, recommends effective care pathways that people are willing to follow, and engages and guides them to and through the care they need. By combining predictive analytics with human engagement, we deliver improved member health and validated outcomes and savings to healthcare payors.
Our integrated, technology-enabled OntrakTM programs are designed to provide healthcare solutions to members with behavioral conditions that cause or exacerbate chronic medical conditions such as diabetes, hypertension, coronary artery disease, chronic obstructive pulmonary disease, and congestive heart failure, which result in high medical costs. Ontrak has a unique 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. Our programs seek to improve member health and deliver validated cost savings to healthcare payors.
We operate as one segment in the United States and we have contracted with leading national and regional health plans to make the Ontrak program available to eligible members.
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Recent Developments
Keep Well Agreement
On April 15, 2022, we entered into a Master Note Purchase Agreement with Acuitas Capital, LLC ("Acuitas"), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder (the “Keep Well Agreement”), pursuant to which, subject to specified conditions, we may borrow up to $25.0 million (the “Available Amount”) from time to time through the earlier of (a) the date on which we file a report with the SEC that states there is substantial doubt regarding our ability to continue as a going concern during the twelve month period following such filing and (b) September 1, 2023. In connection with each borrowing under the Keep Well Agreement, we will issue a senior secured note for the amount borrowed (each such note a "Keep Well Note") to Acuitas or an entity affiliated with it, which will accrue interest based on the Secured Overnight Financing Rate plus a corresponding applicable margin, for an all-in interest rate equating to 16.25% as of the closing date of the Keep Well Agreement, and will be due on September 1, 2023, subject to acceleration for customary events of default (each such note, a “Keep Well Note”). In addition to customary conditions precedent, Acuitas' obligation to loan funds to us and to purchase a Keep Well Note is subject to the condition that (x) we used best efforts to obtain sufficient financing from a third party for us to pay our obligations, (y) we were unable despite our best efforts to obtain such financing from a third party on reasonably acceptable terms, as determined by a majority of our independent directors, such determination to be made as if the financing available to us under Keep Well Agreement was not available; and (z) (1) absent obtaining the funds requested, we will not have sufficient unrestricted cash to pay all our obligations then due or scheduled to become due within the 30 days following the date of the request, and (2) there are no conditions or events that, when considered in the aggregate, raise substantial doubt about our ability to continue as a going concern through August 15, 2023, after giving effect to the receipt of the funds requested and the remaining Available Amount. As of March 31, 2022, we have borrowed no funds under the Keep Well Agreement.
For additional information regarding the Keep Well Agreement and the transactions related thereto, please see the discussion under “Keep Well Agreement” in Note 13 of the Notes to Condensed Consolidated Financial Statements in Item 1, Part I of this Form 10-Q.
Amendment to the 2024 Note Agreement
On March 8, 2022, the Company entered into an Eight Amendment to Note Purchase Agreement with the Holders (the "Eighth Amendment"), which among other things, amended certain financial covenants intended to increase the Company's financial flexibility, a required prepayment of $11.0 million of the outstanding loan balance without the incurrence of a yield maintenance premium or prepayment fee, which prepayment was made by the Company on March 8, 2022, restrictions on the declaration and payment of dividends on the Company's Series A Preferred Stock until after December 31, 2022, and elimination of LIBOR as a reference rate such that the 2024 Notes only bear interest at the Base Rate, as defined in the Note Agreement, going forward.
In connection with entering into the Eighth Amendment, the Company issued to Special Situations Investing Group II, LLC (the “Holder”), a Purchase Warrant for Common Shares (the “Amendment Warrant”) pursuant to which the Holder may purchase shares of the Company’s common stock, par value $0.0001 per share (the “Common Shares”) in an aggregate amount of up 111,680 shares. Also, the Company agreed to issue to the Holder, beginning March 31, 2022 and until the earlier of (i) date the 2024 Notes have been paid in full and (ii) October 31, 2022, additional warrants (the “Ticking Warrants” and together with the Amendment Warrant, the “Warrants”), having the same terms as the Amendment Warrant, to purchase a number of Common Shares of the Company equal to $47,500, to be calculated based on the volume weighted average trading price of the Company’s shares during the five (5) trading day period immediately preceding the date such Ticking Warrants are issued, not to exceed 7% of the outstanding Common Shares on the date of the Eighth Amendment. The Warrants were offered and sold to the Holder in a private placement exempt from registration under the Securities Act. The Warrants may be exercised by the Holder at an exercise price equal to $0.01 per share and will expire on September 24, 2026. As of March 31, 2022, Ticking Warrant for 19,984 shares of the Company's common stock was issued to the Holder.
Metrics
The following table sets forth our key metrics that we use to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions:
•Revenue. Our revenues are mostly generated from fees charged to health plan customers related to health plan members enrolled in our Ontrak program. Our 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 and achievement of certain member specified metrics that
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drive clinical engagement. Our performance obligation is satisfied over the length of the Ontrak program as our services our delivered.
•Cash flow from operations. Our business activities generally have resulted in an outflow of cash flow from operations as we invest strategically into our business to help the growth of our operations.
•Effective Outreach Pool. Our Effective Outreach Pool represents individuals insured by our health plan customers who have been identified through our advanced data analytics and predictive modeling with untreated behavioral health conditions that may be impacted through enrollment in the Ontrak program.
| Three Months Ended March 31, | |||||||||||||||||||||||
| (In thousands, except outreach pool and percentages) | 2022 | 2021 | Change $ | Change % | |||||||||||||||||||
| Revenue | $ | 5,258 | $ | 28,722 | $ | (23,464) | (82) | % | |||||||||||||||
| Cash flow from operations | (10,491) | 6,432 | (16,923) | (263) | |||||||||||||||||||
At March 31, | ||||||||||||||||||||||||||
| 2022 | 2021 | Change | Change % | |||||||||||||||||||||||
| Effective Outreach Pool | 3,950 | 24,709 | (20,759) | (84) | % | |||||||||||||||||||||
Our revenue for the three months ended March 31, 2022 was $5.3 million compared to $28.7 million for the same period in 2021. The decrease in our revenue in the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to the loss of two of our largest customers as previously announced and a decrease in total average enrolled members during the three months ended March 31, 2022 compared to the same period in 2021.
Our cash flow from operations for the three months ended March 31, 2022 was $(10.5) million compared to $6.4 million for the same period in 2021. The year over year decrease in our cash flow from operations during the three months ended March 31, 2022 as compared to the three ended March 31, 2021 was primarily due to a decrease in our revenue related to the customer terminations previously announced and an increase in unbilled receivables, as well as the timing of collection of receivable from a terminated customer subsequent to March 31, 2022.
Our effective outreach pool at March 31, 2022 was 3,950 compared to 24,709 for the same period in 2021. The decrease was primarily due to reduced outreach pool associated with the loss of one of our customers, as well as smaller decreases associated with the loss of a second customer and budgetary constraints limiting our enrollment at certain other customers. As we work with our remaining customers in maximizing return on their investment, optimizing our enrollment process, and enhancing our offering, the effective outreach pool could continue to fluctuate in the near term.
Key Components of Our Results of Operations
Revenue
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. 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 related to health plan customers whose health plan members are enrolled in our program is recognized over the enrollment period of the program.
Cost of Revenue
Cost of healthcare services consists primarily of salaries related to our care coaches, member engagement specialists and other staff directly involved in member care, healthcare provider claims payments and related processing fees, and other direct costs incurred to serve our health plan customers. All costs are recognized in the period in which an eligible member receives services.
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Operating Expenses
Our operating expenses consist of our sales and marketing, research and development and general and administrative expenses. Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including salaries, benefits, bonuses, stock-based compensation and commissions, and costs of marketing and promotional events, corporate communications, online marketing, product marketing and other brand-building activities. All advertising related costs are expensed as incurred. Research and development expenses consist primarily of personnel and related expenses for our engineers and software development staff, including salaries, benefits, bonuses and stock-based compensation, and the cost of certain third-party service providers. Research and development costs are expensed as incurred. General and administrative expenses consist primarily of personnel and related expenses for administrative, legal, finance, compliance and human resource staff, including salaries, benefits, bonuses and stock-based compensation, professional fees, insurance premiums, and other corporate expenses.
Interest Expense, net
Interest expense consists primarily of interest expense from our note agreements, accretion of debt discount, amortization of debt issuance costs and finance leases.
Other Expense, net
Other income (expense) consists of gains (losses) associated with changes in fair value of contingent consideration and warrant liabilities and other miscellaneous income (expense) items.
RESULTS OF OPERATIONS
The table below and the discussion that follows summarize our results of operations for each of the periods presented (in thousands):
| Three Months Ended March 31, | ||||||||||||||
| 2022 | 2021 | |||||||||||||
| Revenue | $ | 5,258 | $ | 28,722 | ||||||||||
| Cost of revenue | 2,846 | 12,750 | ||||||||||||
| Gross profit | 2,412 | 15,972 | ||||||||||||
| Operating expenses: | ||||||||||||||
| Research and development | 3,428 | 4,569 | ||||||||||||
| Sales and marketing | 1,436 | 1,942 | ||||||||||||
| General and administrative | 10,693 | 12,341 | ||||||||||||
| Total operating expenses | 15,557 | 18,852 | ||||||||||||
| Operating loss | (13,145) | (2,880) | ||||||||||||
| Other expense, net | — | (606) | ||||||||||||
| Interest expense, net | (1,400) | (2,007) | ||||||||||||
| Loss before income taxes | (14,545) | (5,493) | ||||||||||||
| Income tax expense | (100) | — | ||||||||||||
| Net loss | $ | (14,645) | $ | (5,493) | ||||||||||
Revenue
The mix of our revenue between commercial and government insured members can fluctuate quarter over quarter. The following table sets forth our sources of revenue for each of the periods indicated:
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| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change | Change % | ||||||||||||||||||||||
| Commercial revenue | $ | 2,452 | $ | 11,351 | $ | (8,899) | (78) | % | ||||||||||||||||||
| Percentage of commercial revenue to total revenue | 47 | % | 40 | % | 7 | % | ||||||||||||||||||||
| Government revenue | $ | 2,806 | $ | 17,371 | $ | (14,565) | (84) | % | ||||||||||||||||||
| Percentage of government revenue to total revenue | 53 | % | 60 | % | (7) | % | ||||||||||||||||||||
| Total revenue | $ | 5,258 | $ | 28,722 | $ | (23,464) | (82) | % | ||||||||||||||||||
Total revenue decreased $23.5 million, or 82% in the three months ended March 31, 2022 compared to the same period of 2021. The decrease in revenue during the three months ended March 31, 2022 compared to the same period in 2021 was primarily attributable to the loss of our two largest customers as previously announced and a decrease in total average enrolled members.
The mix of our revenues from commercial customers increased to 47% in the three months ended March 31, 2022 compared to 40% in the three months ended March 31, 2021. The mix of our revenues from government customers decreased to 53% in the three months ended March 31, 2022 compared to 60% in the three months ended March 31, 2021. This shift in mix of revenues from commercial and government customers was mainly due to the loss of our two largest customers as previously announced, partially offset by our expansion of health plan customers with Medicare and Medicaid members.
We currently expect our revenues in the remainder of 2022 to decline year over year primarily as a result of the lost customers as previously announced and pricing and volume updates with certain other customers.
Cost of Revenue, Gross Profit and Gross Profit Margin
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change | Change % | ||||||||||||||||||||||
| Cost of revenue | $ | 2,846 | $ | 12,750 | $ | (9,904) | (78) | % | ||||||||||||||||||
| Gross profit | 2,412 | 15,972 | (13,560) | (85) | ||||||||||||||||||||||
| Gross profit margin | 46 | % | 56 | % | (10) | % | ||||||||||||||||||||
Cost of revenue decreased $9.9 million, or 78% in the three months ended March 31, 2022 compared to the same period of 2021. The decrease in cost of revenue during the three months ended March 31, 2022 was primarily due to the decrease in revenues, as well as additional headcount efficiencies gained and cost optimization initiatives as we improve the operations for our member facing organization.
Gross profit and gross profit margin decreased by $13.6 million and 10%, respectively, in the three months ended March 31, 2022 compared to the same period of 2021. The decrease in both gross profit and gross profit margin in the three months ended March 31, 2022 was primarily due to the decrease in our revenue discussed above, partially offset by headcount efficiencies gained and cost optimization initiatives as we improve the operations for our member facing organization.
We expect our cost of revenue to decline year over year in line with the decrease in revenue and as we optimize the efficiency of our operations and continue to scale our business.
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Operating Expenses
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change | Change % | ||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||
| Research and development | $ | 3,428 | $ | 4,569 | $ | (1,141) | (25) | % | ||||||||||||||||||
| Sales and marketing | 1,436 | 1,942 | (506) | (26) | ||||||||||||||||||||||
| General and administrative | 10,693 | 12,341 | (1,648) | (13) | ||||||||||||||||||||||
| Total operating expenses | $ | 15,557 | $ | 18,852 | $ | (3,295) | (17) | |||||||||||||||||||
| Operating loss | $ | (13,145) | $ | (2,880) | $ | (10,265) | 356 | % | ||||||||||||||||||
| Operating loss margin | (250) | % | (10) | % | (240) | % | ||||||||||||||||||||
Total operating expense decreased by $3.3 million, or 17%, in the three months ended March 31, 2022 compared to the same period in 2021. The decrease in operating expenses was primarily due to the following:
•$1.1 million decrease in our research and development costs, which was primarily related to $1.6 million decrease in employee-related costs, partially offset by a $0.5 million increase in depreciation expense.
•$0.5 million decrease in our sales and marketing costs, which was primarily related to $0.6 million decrease in professional service and promotional costs related to marketing initiatives.
•$1.6 million decrease in our general and administrative costs, which was primarily related to $1.1 million decrease in employee-related costs and a $0.3 million decrease in professional service costs.
Our operating expenses may fluctuate as a percentage of our total revenue from period to period due to the timing and extent of our operating and strategic initiatives.
Other Expense, net
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change $ | Change % | ||||||||||||||||||||||
| Other expense, net | $ | — | $ | (606) | $ | 606 | 100 | % | ||||||||||||||||||
The decrease in other expense, net for the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to a $0.6 million loss in the three months ended March 31, 2021 attributable to a change in fair value of the contingent liability relating to an acquisition.
Interest Expense, net
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change $ | Change % | ||||||||||||||||||||||
| Interest expense, net | $ | (1,400) | $ | (2,007) | $ | 607 | 30 | % | ||||||||||||||||||
The decrease in interest expense for the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to lower average total outstanding loan balance during the three months ended March 31, 2022.
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Income Tax Expense
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (In thousands, except percentages) | 2022 | 2021 | Change $ | Change % | ||||||||||||||||||||||
| Income tax expense | $ | (100) | $ | — | $ | (100) | 100 | % | ||||||||||||||||||
Income tax expense for the three months ended March 31, 2022 was $0.1 million, which was primarily related to state income taxes. There was no income tax expense for the three months ended March 31, 2021.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s ability to fund ongoing operations is dependent on several factors. The Company aims to increase the number of members that are eligible for its solutions by signing new contracts and identifying more eligible members in existing contracts. Additionally, the Company’s funding is dependent upon the success of management’s plan to increase revenue and control expenses. The Company provides services to commercial (employer funded), managed Medicare Advantage, managed Medicaid and duel eligible (Medicare and Medicaid) populations. The Company also provides mental health and wellbeing support to members of employer customers under our LifeDojo wellbeing solution.
We have incurred significant net losses and negative operating cash flows since our inception, and we expect to continue to incur net losses and negative operating cash flow, in part due to the negative impact on our operations by customer terminations. As of March 31, 2022, our cash and restricted cash was $32.1 million and we had working capital of approximately $36.2 million. For the three months ended March 31, 2022, average monthly cash burn rate was $3.5 million. Based on our cash and restricted cash levels, expected revenue from business operations, and after taking into account the amount available to borrow under a master note purchase agreement the Company entered into with Acuitas Capital LLC ("Acuitas"), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder, on April 15, 2022 (the "Keep Well Agreement"), we expect to have sufficient cash to cover our operating expenses through at least the next twelve months following the date our financial statements in this report are issued. See Note 13 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information about the Keep Well Agreement. However, delays in cash collections, lower revenue than anticipated, unforeseen expenditures, or our inability to satisfy the conditions precedent to borrowing funds under the Keep Well Agreement could impact our expectation.
In addition to revenue from business operations, our primary source of capital is the amount available under the Keep Well Agreement. We may also be able to raise capital through equity financing, however, when we can effect such sales and the amount of shares we can sell depends on a variety of factors to be determined by us from time to time, including, among others, market conditions, the trading price of our common stock and our determination as to the appropriate sources of funding for our operations.
Management plans to continue to execute on its strategy by (i) exploring other sources of capital with either debt or equity financing for on-going liquidity needs; (ii) continuing to manage operating costs by strategically pursuing cost optimization initiatives; and (iii) continuing to pursue executing our growth strategy by improving our marketing techniques and implementing new features to increase customer engagement, adding new members and securing new customer contracts. There can be no assurance that capital will be available when needed or that, if available, it will be obtained on terms favorable to us and our stockholders, that we will be successful in implementing cost optimization initiatives, or that we will be successful in executing our growth strategy. In addition, our Goldman debt agreement contains various financial covenants, and any unanticipated non-compliance with those covenants could result in an acceleration of the repayment of the outstanding loan balance, and our ability to borrow funds under the Keep Well Agreement is subject to conditions precedent being satisfied, and we may not satisfy such conditions precedent if and when we need to borrow funds thereunder. Furthermore, equity or debt financings may have a dilutive
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effect on the holdings of our existing stockholders, and debt financings may subject us to, and if we borrow funds under the Keep Well Agreement, we will be subject to, restrictive covenants, operational restrictions and security interests in our assets.
Cash Flows
The following table sets forth a summary of our cash flows for the periods indicated (in thousands):
| Three Months Ended March 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Net cash (used in) provided by operating activities | $ | (10,491) | $ | 6,432 | |||||||
| Net cash used in investing activities | (255) | (827) | |||||||||
| Net cash used in financing activities | (23,069) | (2,234) | |||||||||
| Net (decrease) increase in cash and restricted cash | $ | (33,815) | $ | 3,371 | |||||||
Net cash used in operating activities during the three months ended March 31, 2022 was $10.5 million compared with net cash provided by operating activities of $6.4 million during the same period in 2021. The $16.9 million decrease in net cash provided by operating activities during the three months ended March 31, 2022 compared to the same period in 2021 was primarily due to a decrease in our revenue related to the customer terminations previously announced and an increase in unbilled receivables, as well as the timing of collection of receivable from a terminated customer subsequent to March 31, 2022.
Net cash used in investing activities was $0.3 million for the three months ended March 31, 2022 compared with $0.8 million in the same period of 2021. The $0.3 million and $0.8 million of net cash used in investing activities for the three months ended March 31, 2022 and 2021, respectively, was primarily related to capitalized software development costs. We anticipate that software development costs and capital expenditures will decrease in the near future.
Our net cash used in financing activities was $23.1 million for the three months ended March 31, 2022 compared with $2.2 million for the three months ended March 31, 2021. The $23.1 million of net cash used in financing activities for the three months ended March 31, 2022 was primarily related to $20.0 million of repayments made on our 2024 Notes and $2.2 million of dividend payments made on our Series A Preferred Stock. Net cash used in financing activities for the three months ended March 31, 2021 was primarily related to a $2.2 million dividend payment made on our Series A Preferred Stock and $0.7 million of payments made on our financed insurance premiums, partially offset by $0.7 million of proceeds received from stock option exercises.
As a result of the above, our total cash and cash equivalents, including restricted cash of $4.9 million, was $32.1 million as of March 31, 2022.
Debt
See Note 9 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed discussion about our debt.
Preferred Stock Offering
See Note 6 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed discussion about our preferred stock offering.
OFF BALANCE SHEET ARRANGEMENTS
During the periods presented, we did not have, nor do we currently have, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are therefore not exposed to the financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
See Note 2 of the Notes to the Consolidated Financial Statements in Part II, Item 8 of our 2021 Form 10-K, and “Critical Accounting Policy and Estimates” in Part II, Item 7 of our 2021 Form 10-K for a discussion of the significant accounting policies and methods used in the preparation of the Company’s condensed consolidated financial statements. There have been no material changes to the Company’s critical accounting policies and estimates since the 2021 Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We have evaluated, with the participation of our principal executive officer and our principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2022. Based on this evaluation, our principal executive officer and our principal financial officer have concluded that, as of March 31, 2022, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the three months ended March 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we are subject to various legal proceedings that arise in the normal course of our business activities. As of the date of this Quarterly Report on Form 10-Q, we were not a party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our results of operations or financial position, except for the following:
Loss Contingencies
On March 3, 2021, a purported securities class action was filed in the United States District Court for the Central District of California, entitled Farhar v. Ontrak, Inc., Case No. 2:21-cv-01987. On March 19, 2021, another similar lawsuit was filed in the same court, entitled Yildrim v. Ontrak, Inc., Case No. 2:21-cv-02460. On July 14, 2021, the Court consolidated the two actions under the Farhar case (“Consolidated Class Action”), appointed Ibinabo Dick as lead plaintiff, and the Rosen Law Firm as lead counsel. On August 13, 2021, lead plaintiff filed a consolidated amended complaint. In the Consolidated Amended Complaint, lead plaintiff, purportedly on behalf of a putative class of purchasers of Ontrak securities from August 5, 2020 through February 26, 2021, alleges that the Company and Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by intentionally or recklessly making false and misleading statements and omissions in various press releases, SEC filings and conference calls with investors on August 5, 2020 and November 5, 2020. Specifically, the Consolidated Amended Complaint alleges that the Company was inappropriately billing its largest customer, Aetna, causing Aetna to, in May 2020, shut off its data feed to Ontrak, and, in July 2020, require Ontrak to complete a Corrective Action Plan (“CAP”). Lead plaintiff alleges that defendants: (1) misrepresented to investors that the data feed was shut off in July 2020, and that it was part of Aetna’s
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standard compliance review of all of its vendors; (2) failed to disclose to investors that Aetna had issued the CAP; and (3) failed to disclose to investors that Ontrak was engaging in inappropriate billing practices. Lead plaintiff seeks certification of a class and monetary damages in an indeterminate amount. On September 13, 2021, defendants filed a motion to dismiss the Consolidated Amended Complaint for failure to state a claim under Federal Rules of Civil Procedure 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. §§ 78u-4, et seq. The motion is fully briefed and has been taken under submission, with no oral argument. The Company believes that the allegations lack merit and intends to defend against the action vigorously.
On August 6, 2021, a purported stockholder derivative complaint was filed in the United States District Court for the Central District of California, entitled Aptor v. Peizer, Case No. 2:21-cv-06371, alleging breach of fiduciary duty on behalf of the Company against Terren S. Peizer, Brandon H. LaVerne, Richard A. Berman, Michael Sherman, Diane Seloff, Robert Rebak, Gustavo Giraldo and Katherine Quinn, and contribution against Terren S. Peizer and Brandon H. LaVerne. On October 6, 2021, a similar shareholder derivative action was filed in the same Court, entitled Anderson v. Peizer, Case No. 2:21-cv-07998, for breach of fiduciary duty, abuse of control, unjust enrichment, gross mismanagement and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn, and contribution against Terren S. Peizer, Brandon H. LaVerne and Curtis Medeiros. On December 1, 2021, a similar shareholder derivative action was filed in the United States District Court for the District of Delaware, entitled Vega v. Peizer, Case No. 1:21-cv-01701, for violation of Section 20(a) of the Exchange Act, breach of fiduciary duty, unjust enrichment and waste of corporate assets against Terren S. Peizer, Brandon H. LaVerne, Curtis Medeiros, Richard A. Berman, Michael Sherman, Edward Zecchini, Diane Seloff, Robert Rebak, Gustavo Giraldo, and Katherine Quinn. In these actions, plaintiffs allege that the defendants breached their fiduciary duties by allowing or causing the Company to violate the federal securities laws as alleged in the Consolidated Class Action discussed above. The plaintiffs seek damages (and contribution from the officers) in an indeterminate amount. On December 7, 2021, the Court in the Central District of California consolidated the two Central District of California actions under the Aptor case caption and number (the "Consolidated Derivative Action"), stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to file a consolidated amended complaint within fourteen (14) days of a ruling on the Motion to Dismiss in the Consolidated Class Action. On February 7, 2022, the Court in the District of Delaware extended the deadline for defendants to respond to the complaint in the Vega action to April 8, 2022. On March 21, 2022 the Court in the District of Delaware granted plaintiff’s unopposed motion to transfer the case to the United States District Court for Central District of California in the interest of judicial efficiency due to the Consolidated Class Action and Consolidated Derivative Action already pending in that district, and that same day the case was transferred into the United States District Court for Central District of California and given the new Case No. 2:22-cv-01873-CAS-AS. On April 11, 2022, the Court stayed the action pending a ruling on the Motion to Dismiss in the Consolidated Class Action and ordered plaintiffs to inform defendants regarding their intention to amend their initial complaint withing thirty (30) days of said ruling. Although all of the claims asserted in these actions purport to seek recovery on behalf of the Company, the Company will incur certain expenses due to indemnification and advancement obligations with respect to the defendants. The Company understands that defendants believe these actions are without merit and intend to defend themselves vigorously.
On February 28, 2022, a purported securities class action was filed in the Superior Court of California for Los Angeles County, entitled Braun v. Ontrak, Inc., et al., Case No. 22STCV07174. The plaintiff filed this action purportedly on behalf of a putative class of all purchasers of the 9.50% Series A Cumulative Perpetual Preferred Stock (the “Preferred stock”) of Ontrak pursuant to Registration Statements and Prospectuses issued in connection with Ontrak’s August 21, 2020 initial public stock offering, its September 2020 through December 2020 “at market” offering, and its December 16, 2020 follow-on stock offering (collectively, the “Offerings”). The plaintiff brings this action against the Company; its officers: Terren S. Peizer, Brandon H. LaVerne, and Christopher Shirley; its board members: Richard A. Berman, Sharon Gabrielson, Gustavo Giraldo, Katherine B. Quinn, Robert Rebak, Diane Seloff, Michael Sherman, and Edward Zecchini; and the investment banking firms that acted as underwriters for the Offerings: B. Riley Securities, Inc., Ladenburg Thalmann & Co., Inc., William Blair & Company, LLC, Aegis Capital Corp., Insperex LLC (f/k/a Incapital LLC), The Benchmark Company, LLC, Boenning & Scatteredgood, Inc., Colliers Securities, LLC, Kingswood Capital Markets, and ThinkEquity. The plaintiff asserts violations of § 11, § 12(a)(2), and § 15 of the Securities Act of 1933, alleging that these filings failed to disclose and misrepresented that (1) Ontrak’s relationships with two of its largest customers, Aetna and Cigna, were materially impaired due to a lack of confidence in Ontrak’s value proposition and billing practices; (2) Aetna had turned off the data feed of customer records to Ontrak by May 2020, citing dissatisfaction with the Company’s value proposition and billing practices and thus submitted a CAP which Ontrak’s senior executives were unable to effectively respond to; and (3) the alleged failures in Ontrak’s ability to ensure insurance coverage and resulting billing problems affected all of its relationships with large health insurance provider clients weakening its business metrics and financial prospects. The plaintiff seeks damages in an indeterminate amount. On April 4, 2022, the parties filed a joint stipulation extending defendants time to respond to the initial complaint until May 6, 2022. On April 6, 2022, the Court stayed the case pending an
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initial status conference, which is scheduled for June 7, 2022 at 10:00am. That order stayed the entire case, including the May 6, 2022 response deadline. The Company believes that the allegations lack merit and intends to defend against the action vigorously.
Item 1A. Risk Factors
In evaluating us and our securities, we urge you to carefully consider the risks, uncertainties and other information in this Quarterly Report on Form 10-Q, as well as the risk factors disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, which we filed with the SEC on April 15, 2022. Any of the risks discussed in this Quarterly Report on Form 10-Q or any of the risks disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as well as additional risks and uncertainties not currently known to us or that we currently deem immaterial, could materially and adversely affect our results of operations or financial condition. If any of these risks occur, our business, results of operations and financial condition could be harmed, the price of our common stock could decline, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this Quarterly Report on Form 10-Q.
Summary of Risk Factors
Below is a summary of the principal factors that make an investment in our securities speculative or risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” and should be carefully considered, together with other information in this Form 10-K and our other filings with the SEC, before making an investment decision regarding our securities.
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| ● | We have incurred significant losses since our inception and may be unable to obtain additional funds before we achieve positive cash flows. | |||||||
| ● | Our programs and solutions may not be as effective as we believe and may not achieve broad market acceptance and announcements of disappointing results may lead to declines in the market prices of our securities. | |||||||
| ● | Our business currently depends upon a few large customers; we have recently lost two of such customers and any further loss would have a material adverse effect on us. | |||||||
| ● | The agreement with our lenders regarding our outstanding senior secured indebtedness contains significant restrictions on our business and operations and requires ongoing compliance with detailed financial covenants. Any failure to comply with the terms of such indebtedness would have a material adverse effect on our business and our securities. | |||||||
| ● | The $25.0 million available to us under the master note purchase agreement we entered into in April 2022 may not be available to us if we do not satisfy the conditions to borrow funds thereunder. | |||||||
| ● | We may not be able to generate sufficient cash flow or raise adequate financing to grow or scale our business or to fund our operations. | |||||||
| ● | We depend upon our senior management and key consultants and their loss or unavailability could put us at a competitive disadvantage. | |||||||
| ● | We need to attract and retain highly skilled personnel; we may be unable to effectively manage growth with our limited resources. | |||||||
| ● | Customers may not achieve the savings we expect are created by our programs and solutions, which could adversely impact our business. | |||||||
| ● | Market acceptance of our programs and solutions depends in large part on the willingness of third party payors to cover them, which is beyond our control. | |||||||
| ● | We may fail to manage our growing business and may not be successful in identifying or completing any acquisitions necessary to continue such growth. Any such acquisition completed may not be successfully integrated with our operations or yield additional value for stockholders. | |||||||
| ● | We may be unable to protect our intellectual property rights and we may be liable for infringing the intellectual property rights of others. | |||||||
| ● | Ongoing healthcare legislative and regulatory reform measures may have a material adverse effect on our business and results of operations. | |||||||
| ● | We must comply with significant government regulations, including with respect to licensure and privacy matters. | |||||||
| ● | Our Series A Preferred Stock has no fixed maturity date, ranks junior to our currently outstanding indebtedness, is entitled to the payment of dividends only to the extent we may do so under Delaware corporate law, is subject to restrictions on transfer contained in our charter and has limited voting rights. | |||||||
| ● | Our Executive Chairman controls approximately 44% of the outstanding common stock and may determine all matters presented for stockholder approval, including the election of directors, significant corporate transactions and our dissolution. | |||||||
| ● | The price of our common stock and preferred stock may be volatile. | |||||||
| ● | The market prices for our common stock and preferred stock may be adversely impacted by future events. | |||||||
| ● | Our certificate of incorporation, bylaws and Delaware law have anti-takeover provisions that could discourage, delay or prevent a change in control, which may cause our stock price to decline. | |||||||
Risk Factors
Risks related to our business
We expect to continue to incur substantial operating losses and may be unable to obtain additional financing.
We have been unprofitable since our inception in 2003. Historically, we have seen and continue to see net losses, net loss from operations and negative cash flow from operating activities as we experienced a period of rapid growth, and more recently our results have been negatively impacted by customer terminations. At March 31, 2022, our cash and restricted cash was $32.1
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million and we had a working capital of approximately $36.2 million. We had an average monthly cash burn rate of approximately $3.5 million for the three months ended March 31, 2022 and could continue to incur negative cash flows and operating losses for the next twelve months. As of March 31, 2022, there was approximately $19.2 million of principal outstanding under secured promissory notes we issued pursuant to the note purchase agreement dated September 24, 2019, by and among us, certain of our subsidiaries as guarantors, Goldman Sachs Specialty Lending Holdings, Inc., and Goldman Sachs Specialty Lending Group, L.P., as collateral agent (as the same has been amended from time to time, the “Goldman debt agreement”). The Goldman debt agreement contains various financial covenants, and any non-compliance with such covenants could result in an acceleration of repayment of the outstanding loan balance.
We will continue to monitor liquidity, however, if we are unable to make sufficient new sales or expand existing customer contracts, we may not continue to have sufficient capital to continue to scale our operations, service our contracts and future enrollments or cover our operating expenses. Additionally, if 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, or in order to provide liquidity for an extended period of losses, we would consider financing these options with either a debt or equity financing for which there can be no assurance that any such financing will be available on acceptable terms or at all.
We may need additional funding, and we cannot guarantee that we will satisfy the conditions precedent for borrowing funds under the Keep Well Agreement or find adequate sources of capital in the future.
We have incurred negative cash flows from operations since inception and have expended, and expect to continue to expend, substantial funds to support and grow our business. We may require additional funds before we are able to generate enough cash flows to fund our operations and meet our obligations.
On April 15, 2022, we entered into a Master Note Purchase Agreement with Acuitas Capital LLC ("Acuitas"), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder (the “Keep Well Agreement”), pursuant to which, subject to specified conditions, we may borrow up to $25.0 million (the “Available Amount”) from time to time through the earlier of (a) the date on which we file a report with the SEC that states there is substantial doubt regarding our ability to continue as a going concern during the twelve month period following such filing and (b) September 1, 2023. In connection with each borrowing under the Keep Well Agreement, we will issue a senior secured note for the amount borrowed (each such note, a “Keep Well Note”) to Acuitas or an entity affiliated with it. In addition to customary conditions precedent, Acuitas' obligation to loan funds to us and to purchase a Keep Well Note is subject to the condition that (x) we used best efforts to obtain sufficient financing from a third party for us to pay our obligations, (y) we were unable despite our best efforts to obtain such financing from a third party on reasonably acceptable terms, as determined by a majority of our independent directors, such determination to be made as if the financing available to us under Keep Well Agreement was not available; and (z) (1) absent obtaining the funds requested, we will not have sufficient unrestricted cash to pay all our obligations then due or scheduled to become due within the 30 days following the date of the request, and (2) there are no conditions or events that, when considered in the aggregate, raise substantial doubt about our ability to continue as a going concern through August 15, 2023, after giving effect to the receipt of the funds requested and the remaining Available Amount. As of March 31, 2022, we have borrowed no funds under the Keep Well Agreement. There are no assurances that we will satisfy the conditions precedent for borrowing funds under the Keep Well Agreement, and if we do not, we will not be able to borrow funds under the Keep Well Agreement.
If we do borrow funds under the Keep Well Agreement, we will be subject to certain negative and affirmative covenants and will be subject to other restrictions on our business operations. For additional information regarding the Keep Well Agreement and the transactions related thereto, please see the discussion regarding Keep Well Agreement in Note 13 of the Notes to Condensed Consolidated Financial Statements in Item 1, Part I of this Form 10-Q.
If we raise additional funds by issuing equity securities, such financing will result in further dilution to our stockholders. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise funds by issuing debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations in addition to those referenced above.
We do not know whether additional financing will be available on commercially acceptable terms, or at all. If adequate funds are not available or are not available on commercially acceptable terms, we may need to downsize, curtail program development efforts or halt our operations altogether.
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We may fail to successfully manage and grow our business, which could adversely affect our results of operations, financial condition and business.
Continued expansion could put significant strain on our management, operational and financial resources. The need to comply with the rules and regulations of the SEC will continue to place significant demands on our financial and accounting staff, financial, accounting and information systems, and our internal controls and procedures, any of which may not be adequate to support our anticipated growth. The need to comply with the state and federal healthcare, security and privacy regulation will continue to place significant demands on our staff and our policies and procedures, any of which may not be adequate to support our anticipated growth. We may not be able to effectively hire, train, retain, motivate and manage required personnel. Our failure to manage growth effectively could limit our ability to satisfy our reporting obligations, or achieve our marketing, commercialization and financial goals.
We may be unable to successfully execute on our growth initiatives, business strategies or operating plans.
We are continually executing a number of growth initiatives, strategies and operating plans designed to enhance our business. The anticipated benefits from these efforts are based on several assumptions that may prove to be inaccurate. Moreover, we may not be able to successfully complete these growth initiatives, strategies and operating plans and realize all of the benefits, including growth targets and cost savings, that we expect to achieve or it may be more costly to do so than we anticipate. A variety of risks could cause us not to realize some or all of the expected benefits. These risks include, among others, delays in the anticipated timing of activities related to such growth initiatives, strategies and operating plans, increased difficulty and cost in implementing these efforts, including difficulties in complying with new regulatory requirements and the incurrence of other unexpected costs associated with operating the business, failure of our products to receive sufficient market acceptance and a highly competitive, rapidly evolving marketplace. Moreover, our continued implementation of our programs may disrupt our operations and performance. As a result, we cannot assure you that we will realize the intended benefits. If, for any reason, the benefits we realize are less than our estimates or the implementation of our growth initiatives, strategies and operating plans adversely affect our operations or cost more or take longer to effectuate than we expect, or if our assumptions prove inaccurate, our business, financial condition and results of operations may be materially adversely affected.
Our programs may not be as effective as we believe them to be, which could limit our potential revenue growth.
Our belief in the efficacy of our Ontrak solution is based on a limited experience with a relatively small number of members in comparison to the total addressable members. Such results may not be indicative of the long-term future performance of treatment with our programs. If the initially indicated results cannot be successfully replicated or maintained over time, utilization of our programs could decline substantially. There are no standardized methods for measuring efficacy of programs such as ours. Even if we believe our solutions are effective, our customers could determine they are not effective by utilizing different outcome measures. In addition, even if our customers determine our solutions are effective they may discontinue them because they determine that the aggregate cost savings are not sufficient, our programs do not have a high enough return on investment, they prefer other competitive or strategic solutions or do not believe our programs deliver other desired benefits such as clinical outcomes. Our success is dependent on our ability to enroll third-party payor members in our Ontrak solutions. Large scale outreach and enrollment efforts have not been conducted and only for limited time periods and we may not be able to achieve the anticipated enrollment rates.
Our Ontrak solution may not become widely accepted, which could limit our growth.
Our ability to achieve further marketplace acceptance for our Ontrak solution is dependent on our ability to demonstrate financial and clinical outcomes from our agreements. If we are unable to secure sufficient contracts to achieve recognition or acceptance of our Ontrak solution or if our program does not demonstrate the expected level of clinical improvement and cost savings, it is unlikely that we will be able to achieve widespread market acceptance.
Disappointing results for our solutions or failure to attain our publicly disclosed milestones could adversely affect market acceptance and have a material adverse effect on our stock price.
Disappointing results, later-than-expected press release announcements or termination of evaluations, pilot programs or commercial Ontrak solutions could have a material adverse effect on the commercial acceptance of our solutions, our stock price and on our results of operations. In addition, announcements regarding results, or anticipation of results, may increase volatility in our stock price. In addition to numerous upcoming milestones, from time to time we provide financial guidance and other forecasts to the market. While we believe that the assumptions underlying projections and forecasts we make publicly available are reasonable, projections and forecasts are inherently subject to numerous risks and uncertainties. Any failure to achieve
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milestones, or to do so in a timely manner, or to achieve publicly announced guidance and forecasts, could have a material adverse effect on our results of operations and the price of our common stock.
We face business disruption and related risks resulting from the novel coronavirus 2019 (COVID-19) pandemic, which could have a material adverse effect on our business and results of operations.
Our business could be disrupted and materially adversely affected by the COVID-19 pandemic, including as a result of mutations of such virus and the global spread of viral variants that may be more contagious or resistant to currently known treatments. As a result of measures imposed by the governments in affected regions, businesses and schools have been from time to time suspended due to quarantines intended to contain this outbreak and many people have been forced to work from home in those areas. As a result of the global pandemic, trade and business activities around the world have been adversely affected, international stock and commodity markets have fluctuated widely and many regions are exhibiting signs of economic recession. Several programs were enacted in different countries in efforts to alleviate rising levels of unemployment and economic dislocation created by significantly reduced levels of social and business activity, although their longer term effectiveness is still uncertain particularly in view of the spread of the contagion and related variants. We are continuously assessing our business operations and system supports and the impact COVID-19 may have on our results and financial condition, but there can be no assurance that this analysis will enable us to avoid part or all of any impact from the spread of COVID-19 or its consequences, including downturns in business sentiment generally or in our sector in particular, or its effects on our members or outreach pool.
Our industry is highly competitive, and we may not be able to compete successfully.
The healthcare business in general, and the behavioral health treatment business in particular, are highly competitive and rapidly evolving. While we believe our products and services are in many aspects unique, we operate in highly competitive markets. We compete with other healthcare management service organizations, care management and disease management companies, including Managed Behavioral Healthcare Organizations (MBHOs), other specialty healthcare and managed care companies, and healthcare technology companies that are offering treatment and support of behavioral health on-line and on mobile devices. Most of our competitors are significantly larger and have greater financial, marketing and other resources than us. We believe that our ability to offer customers a comprehensive and integrated behavioral health solution, including the utilization of our analytical models and innovative member engagement methodologies, will enable us to compete effectively. However, there can be no assurance that we will not encounter more effective or more strategically desirable competition in the future, that we will have financial resources to continue to improve our offerings or that we will be successful improving them, which would limit our ability to maintain or increase our business.
Our competitors may develop and introduce new processes and products that are equal or superior to our programs in treating behavioral health conditions. Accordingly, we may be adversely affected by any new processes and products developed by our competitors.
A substantial percentage of our revenues are attributable to a few large customers, any or all of which may terminate our services at any time.
Three customers accounted for an aggregate of approximately 91% of our total revenue for each of the three months ended March 31, 2022 and 2021. Also, two customers represented an aggregate of approximately 99% and 100% of our total accounts receivable as of March 31, 2022 and December 31, 2021, respectively.
On February 26, 2021, we received a termination notice from our then largest customer and working with this customer on a transition plan, we completed the participation of this customer's members in the program as of December 31, 2021. On August 18, 2021, we received a termination notice from another large customer of their intent not to continue the program past December 31, 2021. As of December 31, 2021, members from these two customers have completed their participation in the program.
We expect that revenues from a limited number of customers will continue for the foreseeable future. Sales to these customers are made pursuant to agreements with flexible termination provisions, generally entitling the customer to terminate with or without cause on limited notice to us, as we have recently experienced during fiscal year 2021 as described above, and which have adversely affected our business and financial condition and results. We may not be able to keep our key customers, or these customers may decrease their enrollment levels. Any substantial decrease or delay in revenues relating to one or more of our key customers would harm our business and financial condition and results. If revenues relating to current key customers cease or are reduced, we may not obtain sufficient enrollments from other customers necessary to offset any such losses or reductions.
We depend on key personnel, the loss of which could impact the ability to manage our business.
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We are highly dependent on our senior management and key operating and technical personnel. The loss of the services of any member of our senior management and key operating and technical personnel could have a material adverse effect on our business, operating results and financial condition. We also rely on consultants and advisors to assist us in formulating our strategy.
As our company grows, we will need to hire additional employees in order to achieve our objectives. There is currently intense competition for skilled executives and employees with relevant expertise, and this competition is likely to continue. The inability to attract and retain sufficient personnel could adversely affect our business, operating results and financial condition.
Our success depends largely upon the continued services of our key executive officers. These executive officers are at-will employees and therefore they may terminate employment with us at any time with no advance notice. We also rely on our leadership team in the areas of research and development, marketing, services and general and administrative functions. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. The replacement of one or more of our executive officers or other key employees would likely involve significant time and costs and may significantly delay or prevent the achievement of our business objectives.
To continue to execute our growth strategy, we also must attract and retain highly skilled personnel. Competition is intense for qualified professionals. We may not be successful in continuing to attract and retain qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled personnel with appropriate qualifications. The pool of qualified personnel with experience working in the healthcare market is limited overall. In addition, many of the companies with which we compete for experienced personnel have greater resources than we have.
In addition, in making employment decisions, particularly in high-technology industries, job candidates often consider the value of the stock options or other equity instruments they are to receive in connection with their employment. Volatility in the price of our stock may, therefore, adversely affect our ability to attract or retain highly skilled personnel. Further, the requirement to expense stock options and other equity instruments may discourage us from granting the size or type of stock option or equity awards that job candidates require to join our company. Failure to attract new personnel or failure to retain and motivate our current personnel, could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on our ability to recruit, retain and develop a very large and diverse workforce. We must transform our culture in order to successfully grow our business.
Our products and services and our operations require a large number of employees. A significant number of employees have joined us in recent years as we continue to grow and expand our business. Our success is dependent on our ability to transform our culture, align our talent with our business needs, engage our employees and inspire our employees to be open to change, to innovate and to maintain member- and client-focus when delivering our services. Our business would be adversely affected if we fail to adequately plan for succession of our executives and senior management; or if we fail to effectively recruit, integrate, retain and develop key talent and/or align our talent with our business needs, in light of the current rapidly changing environment. While we have succession plans in place and we have employment arrangements with a limited number of key executives, these do not guarantee that the services of these or suitable successor executives will continue to be available to us.
Our business and growth strategy depend on our ability to maintain and expand a network of qualified healthcare providers. If we are unable to do so, our future growth and our business, financial condition and results of operations would be negatively impacted.
The success of our business is dependent upon our continued ability to maintain a network of qualified healthcare providers. In any particular market that we operate in, providers could demand higher payments or take other actions that could result in higher medical costs, less attractive service for our members or difficulty meeting regulatory or accreditation requirements. The failure to maintain or to secure new cost-effective provider contracts may result in a loss of or inability to grow our member base, higher costs, healthcare provider network disruptions, and less attractive service for our members, any of which could have a material adverse effect on our business, growth strategy, financial condition and results of operations.
We may be subject to future litigation, which could result in substantial liabilities that may exceed our insurance coverage.
All significant medical treatments and procedures, including treatment utilizing our programs, involve the risk of serious injury or death. While we have not been the subject of any such claims, our business entails an inherent risk of claims for personal injuries and substantial damage awards. We cannot control whether individual physicians and therapists will apply the appropriate standard of care in determining how to treat their patients. While our agreements typically require physicians to indemnify us for
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their negligence, there can be no assurance they will be willing and financially able to do so if claims are made. In addition, our license agreements require us to indemnify physicians, hospitals or their affiliates for losses resulting from our negligence.
We currently have insurance coverage for personal injury claims, directors’ and officers’ liability insurance coverage, and errors and omissions insurance. We may not be able to maintain adequate liability insurance at acceptable costs or on favorable terms. We expect that liability insurance will be more difficult to obtain and that premiums will increase over time and as the volume of patients treated with our programs increases. In the event of litigation, we may sustain significant damages or settlement expense (regardless of a claim's merit), litigation expense and significant harm to our reputation.
If third-party payors fail to provide coverage and adequate payment rates for our solutions, our revenue and prospects for profitability will be harmed.
Our future revenue growth will depend in part upon our ability to contract with health plans and other insurance payors for our Ontrak solutions. In addition, insurance payors are increasingly attempting to contain healthcare costs, and may not cover or provide adequate payment for our programs. Adequate insurance reimbursement might not be available to enable us to realize an appropriate return on investment in research and product development, and the lack of such reimbursement could have a material adverse effect on our operations and could adversely affect our revenues and earnings.
We may not be able to achieve promised savings for our Ontrak contracts, which could result in pricing levels insufficient to cover our costs or ensure profitability.
Many of our Ontrak contracts are based upon anticipated or guaranteed levels of savings for our customers and achieving other operational metrics resulting in incentive fees based on savings. If we are unable to meet or exceed promised savings, achieve agreed upon operational metrics, or favorably resolve contract billing and interpretation issues with our customers, we may be required to refund from the amount of fees paid to us any difference between savings that were guaranteed and the savings, if any, which were actually achieved; or we may fail to earn incentive fees based on savings. Accordingly, during or at the end of the contract terms, we may be required to refund some or all of the fees paid for our services. This exposes us to significant risk that contracts negotiated and entered into may ultimately be unprofitable. In addition, managed care operations are at risk for costs incurred to provide agreed upon services under our solution. Therefore, failure to anticipate or control costs could have a materially adverse effect on our business.
Our ability to use our net operating losses to offset future taxable income has been limited in certain cases and may be subject to certain limitations in the future.
Our net operating loss carryforwards ("NOLs") will begin to expire in 2023. These NOLs may be used to offset future taxable income, to the extent we generate any taxable income, and thereby reduce or eliminate our future federal income taxes otherwise payable. Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize NOLs if it experiences an ownership change as defined in Section 382. In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50% over a three-year period. In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in the Internal Revenue Code. Any unused annual limitation may be carried over to later years. We have experienced ownership changes in the past and can continue to experience ownership changes under Section 382 as a result of events in the past or the issuance of shares of common or preferred stock, or a combination thereof. As a result of such ownership changes, the use of our NOLs, or a portion thereof, against our future taxable income may be subject to an annual limitation under Section 382, which may result in expiration of a portion of our NOLs before utilization.
In order to protect the Company’s significant NOLs, we filed an Amended and Restated Certificate of Incorporation of the Company containing an amendment (the “Protective Amendment”) with the Delaware Secretary of State on October 28, 2019. The Protective Amendment was approved by the Company’s stockholders by written consent dated September 24, 2019.
The Protective Amendment is designed to assist in protecting the long-term value of our accumulated NOLs by limiting certain transfers of our stock. The Protective Amendment’s transfer restrictions generally restrict any direct or indirect transfers of stock if the effect would be to increase the direct or indirect ownership of the stock by any person from less than 4.99% to 4.99% or more of the stock, or increase the percentage of the stock owned directly or indirectly by a person owning or deemed to own 4.99% or more of the stock. Any direct or indirect transfer attempted in violation of the Protective Amendment will be void as of the date of the prohibited transfer as to the purported transferee.
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The Protective Amendment also requires any person attempting to become a holder of 4.99% or more of our common stock to seek the approval of our Board. This may have an unintended “anti-takeover” effect because our Board may be able to prevent any future takeover. Similarly, any limits on the amount of stock that a shareholder may own could have the effect of making it more difficult for shareholders to replace current management. Additionally, because the Protective Amendment may have the effect of restricting a shareholder’s ability to dispose of or acquire our common stock, the liquidity and market value of our common stock might suffer.
The Protective Amendment is not binding with respect to shares of stock issued prior to its adoption unless the holder of such shares has voted in favor of the Protective Amendment and the resulting transfer restriction is noted conspicuously on the certificate representing such shares, or, in the case of uncertificated shares, the registered owners are notified of the Protective Amendment, or such registered owner has actual knowledge of the Protective Amendment. Therefore, even after the effectiveness of the Protective Amendment, we cannot assure you that we will not experience an ownership change as defined in Section 382, including as a result of a waiver or modification by our Board as permitted by the Protective Amendment.
On March 1, 2022, our stockholders approved the removal of the Protective Amendment provisions in in the discretion of our Board of Directors (the “Protective Amendment Removal”). As of the date hereof, the Board of Directors has not determined whether to proceed with the Protective Amendment Removal or any timing thereof should it be deemed appropriate.
We may periodically consummate opportunistic acquisitions of other companies, and we may not realize expected benefits or such acquisitions or we may have difficulties integrating acquired companies into our operations in a cost-effective manner, if at all.
We may periodically consummate opportunistic acquisitions of businesses, assets, personnel or technologies that allow us to complement our existing operations, expand our market coverage, enter new geographic markets, or add new business capabilities. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic partnerships, and the purchase or sale of assets. In October 2020, we completed a strategic acquisition and have integrated this acquisition into our operations. No assurance can be given that the benefits or synergies we may expect from an acquisition will be realized to the extent or in the time frame we anticipate. We may lose key employees, customers, vendors and other business partners of a company we acquire after announcement of acquisition plans. In addition, an acquisition may involve a number of risks and difficulties, including expansion into new geographic markets and business areas in which our management has limited prior experience, the diversion of management’s attention to the operations and personnel of the acquired company, the integration of the acquired company’s personnel, operations and technology systems and applications, changing relationships with customers, vendors or strategic partners, differing regulatory requirements including in new geographic markets and new business areas, and potential short-term adverse effects on our operating results. These challenges can be magnified as the size of the acquisition increases. Any delays or unexpected costs incurred in connection with the integration of an acquired company or otherwise related to an acquisition could have a material adverse effect on our business, financial condition and results of operations.
An acquisition may require significant expenses and can result in increased debt or other contingent liabilities, adverse tax consequences, deferred compensation charges, the recording and later amortization of amounts related to deferred compensation and certain purchased intangible assets, and the refinement or revision of fair value acquisition estimates following the completion of an acquisition, any of which items could negatively impact our business, financial condition and results of operations. In addition, we may record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline. An acquisition also could absorb substantial cash resources, require us to incur or assume debt obligations, or involve our issuance of additional equity securities. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company. An acquired entity also may be leveraged or dilutive to our earnings per share, or may have unknown liabilities. In addition, the combined entity may have lower than expected revenues or higher expenses and therefore may not achieve the anticipated results. Any of these factors relating to an acquisition could have a material adverse impact on our business, financial condition and results of operations.
Risks related to our Note Agreement
The terms of our Note Agreement place restrictions on our operating and financial flexibility, and failure to comply with covenants or to satisfy certain conditions of the agreement may result in acceleration of our repayment obligations, which could significantly harm our liquidity, financial condition, operating results, business and prospects and cause the price of our securities to decline.
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On September 24, 2019 (the “Closing Date”), we entered into the Note Agreement (as amended to date, the "Note Agreement"), by and among us, certain of our subsidiaries as guarantors, Goldman Sachs Specialty Lending Holdings, Inc. (with any other purchasers party thereto from time to time, collectively the “Holder”) and Goldman Sachs Specialty Lending Group, L.P., as collateral agent, in connection with the sale of up to $45.0 million aggregate principal amount of senior secured notes (the “2024 Notes”). On the Closing Date, we issued an aggregate of $35.0 million in principal amount of 2024 Notes and, on August 25, 2020, we issued an additional $10.0 million in principal amount of 2024 Notes.
The Note Agreement, as amended, contains customary covenants, including, among others, covenants that restrict the our ability to incur debt, grant liens, make certain investments and acquisitions, pay dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into affiliate transactions and asset sales or make certain equity issuances, and covenants that require the us to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, maintain its property in good repair, maintain insurance and comply with applicable laws. The Note Agreement also includes covenants with respect to our maintenance of certain financial ratios, including a fixed charge coverage ratio, leverage ratio and consolidated liquidity as well as minimum levels of consolidated adjusted EBITDA and monthly cash flow, as defined in the Note Agreement. Any non-compliance with such covenants in the Note Agreement, as amended, could result in an acceleration of repayment of the outstanding loan balance.
The Note Agreement, as amended, and the 2024 Notes could have important consequences for us and our stockholders. For example, the Notes require a balloon payment at maturity in September 2024, which may require us to dedicate a substantial portion of our uncommitted cash flow from operations to this future payment if we feel we cannot be successful in our ability to refinance in the future, thereby further reducing the availability of our cash flow to fund working capital, capital expenditures, and acquisitions, and for other general corporate purposes. In addition, our indebtedness could:
•increase our vulnerability to adverse economic and competitive pressures in our industry;
•place us at a competitive disadvantage compared to our competitors that have less debt;
•limit our flexibility in planning for, or reacting to, changes in our business and our industry; and
•limit our ability to borrow additional funds on terms that are acceptable to us or at all.
The Note Agreement contains restrictive covenants that will restrict our operational flexibility and require that we maintain specified financial ratios. If we cannot comply with these covenants, we may be in default under the Note Agreement.
The Note Agreement contains restrictions and limitations on our ability to engage in activities that may be in our long-term best interests. The Note Agreement contains affirmative and negative covenants that limit and restrict, among other things, our ability to:
•incur additional debt;
•sell assets;
•issue equity securities;
•pay dividends or repurchase equity securities;
•incur liens or other encumbrances;
•make certain restricted payments and investments;
•acquire other businesses; and
•merge or consolidate.
The Note Agreement contains a fixed charge coverage ratio covenant, a leverage ratio covenant and minimum liquidity covenant as well as minimum levels of consolidated adjusted EBITDA. Events beyond our control could affect our ability to meet these and other covenants under the Note Agreement. We have in the past required waivers to or modifications of such covenant requirements which the lender has granted. There can be no assurance that we will not require additional such waivers or modifications or on what terms the lender will be willing to provide them, if at all. The Note Agreement also contains customary events of default, including, among others, payment default, bankruptcy events, cross-default, breaches of covenants and representations and warranties, change of control, judgment defaults and an ownership change within the meaning of Section 382 of the Code. Our failure to comply with our covenants and other obligations under the Note Agreement may result in an event of default thereunder. A default, if not cured or waived, may permit acceleration of the Notes. If the indebtedness represented by the Notes is accelerated, we cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness (together with accrued interest and fees), or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all. This could have serious consequences to our financial condition, operating results, and business, and
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could cause us to become insolvent or enter bankruptcy proceedings, and shareholders may lose all or a portion of their investment because of the priority of the claims of our creditors on our assets.
If we are unable to generate, borrow or raise sufficient cash to make payments on our indebtedness, our financial condition would be materially harmed, our business could fail, and shareholders may lose all of their investment.
Our ability to make scheduled payments on or to refinance our obligations will depend on our financial and operating performance, which will be affected by economic, financial, competitive, business, and other factors, some of which are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations to service our indebtedness or to fund our other liquidity needs. If we are unable to meet our debt obligations or fund our other liquidity needs, we may need to restructure or refinance all or a portion of our indebtedness on or before maturity or sell certain of our assets. We cannot assure you that we will be able to restructure or refinance any of our indebtedness on commercially reasonable terms, if at all, which could cause us to default on our debt obligations and impair our liquidity. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations.
Increases in interest rates could adversely affect our results from operations and financial condition.
The Notes bear interest at either a floating rate plus an applicable margin in the case of Notes subject to cash interest payments or a floating rate plus a slightly higher applicable margin in the case of Notes as to which current interest has been capitalized during the first twelve months following the Closing Date, at the Company’s option. The applicable margins are subject to stepdowns, in each case, following the achievement of certain financial ratios. As a result, an increase in prevailing interest rates would have an effect on the interest rates charged on the Notes, which rise and fall upon changes in interest rates. If prevailing interest rates or other factors result in higher interest rates, the increased interest expense would adversely affect our cash flow and our ability to service our indebtedness.
Risks related to our intellectual property
Confidentiality agreements with employees, treating physicians and others may not adequately prevent disclosure of trade secrets and other proprietary information.
In order to protect our proprietary technology and processes, we rely in part on confidentiality provisions in our agreements with employees, treating physicians, and others. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our business.
Our future operations may be subject to claims, and potential litigation, arising from our alleged infringement of patents, trade secrets, trademarks or copyrights owned by other third parties. Within the healthcare, drug and bio-technology industry, many companies actively pursue infringement claims and litigation, which makes the entry of competitive products more difficult. We may experience claims or litigation initiated by existing, better-funded competitors and by other third parties. Court-ordered injunctions may prevent us from continuing to market existing products or from bringing new products to market and the outcome of litigation and any resulting loss of revenues and expenses of litigation may substantially affect our ability to meet our expenses and continue operations.
Risks related to our healthcare industry
Recent changes in insurance and health care laws have created uncertainty in the health care industry.
The Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act, each enacted in March 2010, generally known as the Health Care Reform Law, significantly expanded health insurance coverage to uninsured Americans and changed the way health care is financed by both governmental and private payors. Following the 2016 federal elections, which resulted in the election of the Republican presidential nominee and Republican majorities in both houses of Congress, there were renewed legislative efforts to significantly modify or repeal the Health Care Reform Law and certain executive policy changes designed to modify its impact, including the enactment of the Tax Cuts and Jobs Act in December 2017 which repealed the penalties under the Health Care Reform Law for uninsured persons. In light of the recent Supreme Court
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ruling in California et al. v. Texas et al. in June 2021 generally supporting the Health Care Reform Law, we cannot predict what further reform proposals, if any, will be adopted, when they may be adopted, or what impact they may have on our business. There may also be other risks and uncertainties associated with the Health Care Reform Law. If we fail to comply or are unable to effectively manage such risks and uncertainties, our financial condition and results of operations could be adversely affected.
Our policies and procedures may not fully comply with complex and increasing regulation by state and federal authorities, which could negatively impact our business operations.
The healthcare industry is highly regulated and continues to undergo significant changes as third-party payors, such as Medicare and Medicaid, traditional indemnity insurers, managed care organizations and other private payors, increase efforts to control cost, utilization and delivery of healthcare services. Healthcare companies are subject to extensive and complex federal, state and local laws, regulations and judicial decisions. Our failure or the failure of our treating physicians, to comply with applicable healthcare laws and regulations may result in the imposition of civil or criminal sanctions that we cannot afford, or require redesign or withdrawal of our programs from the market.
We may become subject to medical liability claims, which could cause us to incur significant expenses and may require us to pay significant damages if not covered by insurance.
Our business entails the risk of medical liability claims against both our providers and us. Although we carry insurance covering medical malpractice claims in amounts that we believe are appropriate in light of the risks attendant to our business, successful medical liability claims could result in substantial damage awards that exceed the limits of our insurance coverage. We carry professional liability insurance for ourselves, and we separately carry a general insurance policy, which covers medical malpractice claims. In addition, professional liability insurance is expensive and insurance premiums may increase significantly in the future, particularly as we expand our services. As a result, adequate professional liability insurance may not be available to us in the future at acceptable costs or at all.
Any claims made against us that are not fully covered by insurance could be costly to defend against, result in substantial damage awards against us and divert the attention of our management and our providers from our operations, which could have a material adverse effect on our business, financial condition and results of operations. In addition, any claims may adversely affect our business or reputation.
Our business practices may be found to constitute illegal fee-splitting or corporate practice of medicine, which may lead to penalties and adversely affect our business.
Many states, including California where our principal executive offices are located, have laws that prohibit business corporations, such as us, from practicing medicine, exercising control over medical judgments or decisions of physicians or other health care professionals (such as nurses or nurse practitioners), or engaging in certain business arrangements with physicians or other health care professionals, such as employment of physicians and other health care professionals or fee-splitting. The state laws and regulations and administrative and judicial decisions that enumerate the specific corporate practice and fee-splitting rules vary considerably from state to state and are enforced by both the courts and government agencies, each with broad discretion. Courts, government agencies or other parties, including physicians, may assert that we are engaged in the unlawful corporate practice of medicine, fee-splitting, or payment for referrals by providing administrative and other services in connection with our treatment programs. As a result of such allegations, we could be subject to civil and criminal penalties, our contracts could be found invalid and unenforceable, in whole or in part, or we could be required to restructure our contractual arrangements. If so, we may be unable to restructure our contractual arrangements on favorable terms, which would adversely affect our business and operations.
Our business practices may be found to violate anti-kickback, physician self-referral or false claims laws, which may lead to penalties and adversely affect our business.
The healthcare industry is subject to extensive federal and state regulation with respect to kickbacks, physician self-referral arrangements, false claims and other fraud and abuse issues.
The federal anti-kickback law (the “Anti-Kickback Law”) prohibits, among other things, knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for, or recommending of an item or service that is reimbursable, in whole or in part, by a federal health care program. “Remuneration” is broadly defined to include anything of value, such as, for example, cash payments, gifts or gift certificates, discounts, or the furnishing of services, supplies, or equipment. The Anti-Kickback Law is broad, and it prohibits many arrangements and practices that are lawful in businesses outside of the health care industry.
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Recognizing the breadth of the Anti-Kickback Law and the fact that it may technically prohibit many innocuous or beneficial arrangements within the health care industry, the Office of Inspector General (“OIG”) has issued a series of regulations, known as the “safe harbors.” Compliance with all requirements of a safe harbor immunizes the parties to the business arrangement from prosecution under the Anti-Kickback Law. The failure of a business arrangement to fit within a safe harbor does not necessarily mean that the arrangement is illegal or that the OIG will pursue prosecution. Still, in the absence of an applicable safe harbor, a violation of the Anti-Kickback Law may occur even if only one purpose of an arrangement is to induce referrals. The penalties for violating the Anti-Kickback Law can be severe. These sanctions include criminal and civil penalties, imprisonment, and possible exclusion from the federal health care programs. Many states have adopted laws similar to the Anti-Kickback Law, and some apply to items and services reimbursable by any payor, including private insurers.
In addition, the federal ban on physician self-referrals, commonly known as the Stark Law, prohibits, subject to certain exceptions, physician referrals of Medicare patients to an entity providing certain “designated health services” if the physician or an immediate family member of the physician has any financial relationship with the entity. A “financial relationship” is created by an investment interest or a compensation arrangement. Penalties for violating the Stark Law include the return of funds received for all prohibited referrals, fines, civil monetary penalties, and possible exclusion from the federal health care programs. In addition to the Stark Law, many states have their own self-referral bans, which may extend to all self-referrals, regardless of the payor.
The federal False Claims Act imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment to the federal government. Under the False Claims Act, a person acts knowingly if he has actual knowledge of the information or acts in deliberate ignorance or in reckless disregard of the truth or falsity of the information. Specific intent to defraud is not required. Violations of other laws, such as the Anti-Kickback Law or the FDA prohibitions against promotion of off-label uses of drugs, can lead to liability under the federal False Claims Act. The qui tam provisions of the False Claims Act allow a private individual to bring an action on behalf of the federal government and to share in any amounts paid by the defendant to the government in connection with the action. The number of filings of qui tam actions has increased significantly in recent years. When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 and $11,000 for each false claim. Conduct that violates the False Claims Act may also lead to exclusion from the federal health care programs. Given the number of claims likely to be at issue, potential damages under the False Claims Act for even a single inappropriate billing arrangement could be significant. In addition, various states have enacted similar laws modeled after the False Claims Act that apply to items and services reimbursed under Medicaid and other state health care programs, and, in several states, such laws apply to claims submitted to all payors.
On May 20, 2009, the Federal Enforcement and Recovery Act of 2009, or FERA, became law, and it significantly amended the federal False Claims Act. Among other things, FERA eliminated the requirement that a claim must be presented to the federal government. As a result, False Claims Act liability extends to any false or fraudulent claim for government money, regardless of whether the claim is submitted to the government directly, or whether the government has physical custody of the money. FERA also specifically imposed False Claims Act liability if an entity “knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.” As a result, the knowing and improper failure to return an overpayment can serve as the basis for a False Claims Act action. In March 2010, Congress passed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, collectively the ACA, which also made sweeping changes to the federal False Claims Act. The ACA also established that Medicare and Medicaid overpayments must be reported and returned within 60 days of identification or when any corresponding cost report is due.
Finally, the Health Insurance Portability and Accountability Act of 1996 and its implementing regulations created the crimes of health care fraud and false statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including a private insurer. The false statements statute prohibits knowingly and willfully falsifying, concealing, or covering up a material fact or making any materially false, fictitious, or fraudulent statement in connection with the delivery of or payment for health care benefits, items, or services. A violation of this statute is a felony and may result in fines, imprisonment, or exclusion from the federal health care programs.
Federal or state authorities may claim that our fee arrangements, our agreements and relationships with contractors, hospitals and physicians, or other activities violate fraud and abuse laws and regulations. If our business practices are found to violate any of these laws or regulations, we may be unable to continue with our relationships or implement our business plans, which would have an adverse effect on our business and results of operations. Further, defending our business practices could be time consuming and expensive, and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully.
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Our business practices may be subject to state regulatory and licensure requirements.
Our business practices may be regulated by state regulatory agencies that generally have discretion to issue regulations and interpret and enforce laws and rules. These regulations can vary significantly from jurisdiction to jurisdiction, and the interpretation of existing laws and rules also may change periodically. Some of our business and related activities may be subject to state health care-related regulations and requirements, including managed health care, utilization review (UR) or third-party administrator-related regulations and licensure requirements. These regulations differ from state to state, and may contain network, contracting, and financial and reporting requirements, as well as specific standards for delivery of services, payment of claims, and adequacy of health care professional networks. If a determination is made that we have failed to comply with any applicable state laws or regulations, our business, financial condition and results of operations could be adversely affected.
If our providers or experts are characterized as employees, we would be subject to employment and withholding liabilities.
We structure our relationships with our providers and experts in a manner that we believe results in an independent contractor relationship, not an employee relationship. An independent contractor is generally distinguished from an employee by his or her degree of autonomy and independence in providing services. A high degree of autonomy and independence is generally indicative of a contractor relationship, while a high degree of control is generally indicative of an employment relationship. Although we believe that our providers and experts are properly characterized as independent contractors, tax or other regulatory authorities may in the future challenge our characterization of these relationships. If such regulatory authorities or state, federal or foreign courts were to determine that our providers or experts are employees, and not independent contractors, we would be required to withhold income taxes, to withhold and pay social security, Medicare and similar taxes and to pay unemployment and other related payroll taxes. We would also be liable for unpaid past taxes and subject to penalties. As a result, any determination that our providers or experts are our employees could have a material adverse effect on our business, financial condition and results of operations.
We may be subject to healthcare anti-fraud initiatives, which may lead to penalties and adversely affect our business.
State and federal government agencies are devoting increased attention and resources to anti-fraud initiatives against healthcare providers and the entities and individuals with whom they do business, and such agencies may define fraud expansively to include our business practices, including the receipt of fees in connection with a healthcare business that is found to violate any of the complex regulations described above. While to our knowledge we have not been the subject of any anti-fraud investigations, if such a claim were made, defending our business practices could be time consuming and expensive and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully.
Our use and disclosure of patient information is subject to privacy and security regulations, which may result in increased costs.
In providing administrative services to healthcare providers and operating our treatment programs, we may collect, use, disclose, maintain and transmit patient information in ways that will be subject to many of the numerous state, federal and international laws and regulations governing the collection, use, disclosure, storage, privacy and security of patient-identifiable health information, including the administrative simplification requirements of the Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (HIPAA) and the Health Information Technology for Economic and Clinical Health Act of 2009 (HITECH). The HIPAA Privacy Rule restricts the use and disclosure of certain patient information (“Protected Health Information” or “PHI”), and requires safeguarding that information. The HIPAA Security Rule and HITECH establish elaborate requirements for safeguarding PHI transmitted or stored electronically. HIPAA applies to covered entities, which may include healthcare facilities and also includes health plans that will contract for the use of our programs and our services. HIPAA and HITECH require covered entities to bind contractors that use or disclose protected health information (or “Business Associates”) to compliance with certain aspects of the HIPAA Privacy Rule and all of the HIPAA Security Rule. In addition to contractual liability, Business Associates are also directly subject to regulation by the federal government. Direct liability means that we are subject to audit, investigation and enforcement by federal authorities. HITECH imposes breach notification obligations requiring us to report breaches of “Unsecured Protected Health Information” or PHI that has not been encrypted or destroyed in accordance with federal standards. Business Associates must report such breaches so that their covered entity customers may in turn notify all affected patients, the federal government, and in some cases, local or national media outlets. We may be required to indemnify our covered entity customers for costs associated with breach notification and the mitigation of harm resulting from breaches that we cause. If we are providing management services that include electronic billing on behalf of a physician practice or facility that is a covered entity, we may be required to conduct those electronic transactions in accordance with the HIPAA regulations governing the form and format of those transactions. Services provided under our Ontrak
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solution not only require us to comply with HIPAA and HITECH but also Title 42 Part 2 of the Code of Federal Regulations (“Part 2”). Part 2 is a federal, criminal law that severely restricts our ability to use and disclose drug and alcohol treatment information obtained from federally-supported treatment facilities. Our operations must be carefully structured to avoid liability under this law. Our Ontrak solution qualifies as a federally funded treatment facility which requires us to disclose information on members only in compliance with Title 42.
In addition to the federal privacy regulations, there are a number of state laws governing the privacy and security of health and personal information. The penalties for violation of these laws vary widely and the area is rapidly evolving.
In 2018, California passed the California Consumer Privacy Act (the “CCPA”), which gives consumers significant rights over the use of their personal information, including the right to object to the “sale” of their personal information. In 2020, Californians voted to enact the California Privacy Rights Act (CPRA), which amends the CCPA by expanding consumers' rights in their personal information and creating a new governmental agency to interpret and enforce the statute. Most provisions of the CPRA will become effective on January 1, 2023. While information covered by HIPAA is generally exempt from the applicability of the CCPA as amended by the CPRA, the rights of consumers under the CCPA may restrict our ability to use personal information in connection with our business operations. The CCPA also provides a private right of action for certain security breaches.
In 2019, New York passed a law known as the SHIELD Act, which expands data breach reporting obligations and requires companies to have robust data security programs in place. More recently, New York and other states, including Washington, have introduced significant privacy bills, and Congress is debating federal privacy legislation, which if passed, may restrict our business operations and require us to incur additional costs for compliance.
In addition, several foreign countries and governmental bodies, including the E.U., Brazil and Canada, have laws and regulations concerning the collection and use of personally identifiable information obtained from their residents, including identifiable health information, which are often more restrictive than those in the U.S. laws and regulations in these jurisdictions apply broadly to the collection, use, storage, disclosure and security of personally identifiable information, including health information, identifying, or which may be used to identify, an individual, such as names, email addresses and, in some jurisdictions, Internet Protocol (IP) addresses, device identifiers and other data. Although we currently conduct business only in the United States of America, these laws and regulations could become applicable to us in the event we expand our operations into other countries. These and other obligations may be modified and interpreted in different ways by courts, and new laws and regulations may be enacted in the future.
Within the EEA, the General Data Protection Regulation ("GDPR") took full effect on May 25, 2018, superseding the 1995 European Union Data Protection Directive and becoming directly applicable across E.U. member states. The GDPR includes more stringent operational requirements for processors and controllers of personal data (including health information) established in and outside of the EEA, imposes significant penalties for non-compliance and has broader extra-territorial effect. As the GDPR is a regulation rather than a directive, it applies throughout the EEA, but permits member states to enact supplemental requirements if they so choose. Noncompliance with the GDPR can trigger fines of up to the greater of €20 million or 4% of global annual revenues. Further, a Data Protection Act substantially implementing the GDPR was enacted in the U.K., effective in May 2018. It remains unclear, however, how U.K. data protection laws or regulations will develop in the medium to longer term and how data transfers to and from the U.K. will be regulated in light of the U.K.'s withdrawal from the E.U. In addition, some countries are considering or have enacted legislation requiring local storage and processing of data that could increase the cost and complexity of delivering our services.
We believe that we have taken the steps required of us to comply with laws governing the privacy and security of personal information, including health information privacy and security laws and regulations, in all applicable jurisdictions, both state and federal. However, we may not be able to maintain compliance in all jurisdictions where we do business. In addition, to the extent we disclose such information to our third-party service providers in the course of our business, we may be indirectly liable for their misuse or other unauthorized disclosure of such personal information (including health information). Failure to maintain compliance, or changes in state or federal privacy and security laws could result in civil and/or criminal penalties and could have a material adverse effect on our business, including significant reputational damage associated with a breach. Under HITECH, we are subject to prosecution or administrative enforcement and increased civil and criminal penalties for non-compliance, including a four-tiered system of monetary penalties. We are also subject to enforcement by state attorneys general who were given authority to enforce HIPAA under HITECH, and who have authority to enforce state-specific data privacy and security laws. If regulations change, if we expand the territorial scope of our operations, or if it is determined that we are not in compliance with privacy regulations, we may be required to modify aspects of our program, which may adversely affect program results and our business or profitability.
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Security breaches, loss of data and other disruptions could compromise sensitive information related to our business, prevent us from accessing critical information or expose us to liability, which could adversely affect our business and our reputation.
In the ordinary course of our business, we collect and store sensitive data, including legally protected patient health information, personally identifiable information about our employees, intellectual property, and proprietary business information. We manage and maintain our applications and data utilizing an off-site co-location facility. These applications and data encompass a wide variety of business critical information including research and development information, commercial information and business and financial information.
The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure may be vulnerable to attacks by hackers, viruses, breaches or interruptions due to employee error or malfeasance, breaches or interruptions due to the malfeasance or negligence of any of our third-party service providers, terrorist attacks, earthquakes, fire, flood, other natural disasters, power loss, computer systems failure, data network failure, Internet failure or lapses in compliance with privacy and security mandates. We may be subject to distributed denial of service (DDOS) attacks by hackers aimed at disrupting service to patients and customers. Our response to such DDOS attacks may be insufficient to protect our network and systems. In addition, there has been a continuing increase in the number of malicious software attacks in a wide variety of different industries, including malware, ransomware, and email phishing scams, particularly since the start of the COVID-19 pandemic. Any such virus, breach or interruption could compromise our networks and the information stored there could be accessed by unauthorized parties, publicly disclosed, lost or stolen. We have measures in place that are designed to detect and respond to such security incidents and breaches of privacy and security mandates. Nonetheless, we cannot guarantee our backup systems, regular data backups, security protocols, network protection mechanisms and other procedures currently in place, or that may be in place in the future, will be adequate to prevent or remedy network and service interruption, system failure, damage to one or more of our systems, data loss, security breaches or other data security incidents. We might be required to expend significant capital and resources to protect against or address such incidents. Any access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information (such as HIPAA and state data security laws), government enforcement actions and regulatory penalties. We may also be required to indemnify our customers for costs associated with having their data on our system breached. Unauthorized access, loss or dissemination could also interrupt our operations, including our ability to provide treatment, bill our customers, provide customer support services, conduct research and development activities, process and prepare company financial information, manage various general and administrative aspects of our business and damage our reputation, or we may lose one or more of our customers, especially if they felt their data may be breached, any of which could adversely affect our business.
Certain of our professional healthcare employees, such as nurses, must comply with individual licensing requirements.
All of our healthcare professionals who are subject to licensing requirements, such as our care coaches, are licensed in the state in which they provide professional services in person. While we believe our nurses provide coaching and not professional services, one or more states may require our healthcare professionals to obtain licensure if providing services telephonically across state lines to the state’s residents. Healthcare professionals who fail to comply with these licensure requirements could face fines or other penalties for practicing without a license, and we could be required to pay those fines on behalf of our healthcare professionals. If we are required to obtain licenses for our nurses in states where they provide telephonic coaching, it would significantly increase the cost of providing our product. In addition, new and evolving agency interpretations, federal or state legislation or regulations, or judicial decisions could lead to the implementation of out-of-state licensure requirements in additional states, and such changes would increase the cost of services and could have a material effect on our business.
Risks related to our preferred stock
Our Series A Preferred Stock ranks junior to all of our indebtedness and other liabilities.
In the event of our bankruptcy, liquidation, dissolution or winding-up of our affairs, our assets will be available to pay obligations on the Series A Preferred Stock only after all of our indebtedness and other liabilities have been paid. The rights of holders of the Series A Preferred Stock to participate in the distribution of our assets will rank junior to the prior claims of our current and future creditors and any future series or class of preferred stock we may issue that ranks senior to the Series A Preferred Stock. Also, the Series A Preferred Stock effectively ranks junior to all existing and future indebtedness and to the indebtedness and other liabilities of our existing subsidiaries and any future subsidiaries. Our existing subsidiaries are, and future subsidiaries would be, separate legal entities and have no legal obligation to pay any amounts to us in respect of dividends due on the Series A Preferred Stock.
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At March 31, 2022, our total liabilities equaled $27.6 million. If we are forced to liquidate our assets to pay our creditors, we may not have sufficient assets to pay amounts due on any or all of the Series A Preferred Stock then outstanding.
Certain of our existing or future debt instruments may restrict the authorization, payment or setting apart of dividends on the Series A Preferred Stock. The Note Agreement restricts the payment of dividends on the Series A Preferred Stock and contains events of default which could result in acceleration of such indebtedness upon the occurrence of certain events, including failure to meet certain financial covenants and the payment of dividends on, or redemption amounts in respect of, the Series A Preferred Stock in violation of the Note Agreement. While the conditional amendment to the Note Agreement entered into in connection with our issuance of the Series A Preferred Stock (the “Conditional Amendment”) permits the payment of dividends on the Series A Preferred Stock for the first eight periods following issuance, thereafter we may only pay such dividends so long as there is no default or event of default under the Note Agreement. Accordingly, there can be no assurance that we will remain in compliance with the terms of the Conditional Amendment, and if we default, we may be contractually prohibited from paying dividends on the Series A Preferred Stock or any amounts in redemption of or otherwise in respect of, the Series A Preferred Stock. Also, future offerings of debt or senior equity securities may adversely affect the market price of the Series A Preferred Stock. If we decide to issue debt or senior equity securities in the future, it is possible that these securities will be governed by an indenture or other instruments containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of the Series A Preferred Stock and may result in dilution to owners of the Series A Preferred Stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. The holders of the Series A Preferred Stock will bear the risk of our future offerings, which may reduce the market price of the Series A Preferred Stock and will dilute the value of their holdings in us.
We may not be able to pay dividends on the Series A Preferred Stock if we have insufficient cash or available ‘surplus’ as defined under Delaware law to make such dividend payments.
Our ability to pay cash dividends on the Series A Preferred Stock requires us to have either net profits or positive net assets (total assets less total liabilities) over our capital, and that we have sufficient working capital in order to be able to pay our debts as they become due in the usual course of business. Our ability to pay dividends may also be impaired if any of the risks described in this Annual Report on Form 10-K, including the documents incorporated by reference herein, were to occur. Also, payment of our dividends depends upon our financial condition and other factors as our board of directors may deem relevant from time to time. We cannot assure you that our businesses will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock, if any, and preferred stock, including the Series A Preferred Stock to pay our indebtedness or to fund our other liquidity needs.
We have established a segregated account that was funded with a portion of the proceeds from sales of Series A Preferred Stock to pre-fund quarterly dividend payments on the Series A Preferred Stock until August 2022, although the payment of such amounts on deposit to holders of the Series A Preferred Stock is subject to compliance with applicable laws and with the foregoing limitations. Additionally, once the funds in the segregated account are exhausted, there can be no assurance that we will have sufficient cash flow from operations to continue such dividend payments. The amounts on deposit are also assets of our consolidated entity and while we have agreed not to use such amount for any corporate purposes other than payments of dividends on the Series A Preferred Stock, such account will be subject to a lien in favor of the collateral agent for the 2024 Notes and otherwise be available to our creditors generally in the event holders of our indebtedness or other obligations arising in the ordinary course of business seek to pursue remedies under bankruptcy or insolvency laws or otherwise. In addition, our Board of Directors may determine that the use of such amount on deposit for other corporate purposes is required pursuant to the exercise of their fiduciary duties to our common stockholders. You should be aware that the pre-funded dividends may not be available to make such payments in the amounts and at the times required under the terms of the Series A Preferred Stock offering.
Our Certificate of Incorporation contains provisions limiting the transferability and conversion of the Series A Preferred stock.
As noted above, the Protective Amendment is designed to assist in protecting the long-term value of our accumulated NOLs by limiting certain transfers of our common stock and certain of our other securities coming within the rules of the Internal Revenue Service under Section 382, including the Series A Preferred Stock as such does not meet the exception provided by Section 1504(a) of the Code and related Treasury Regulation §1.382.-2(a)(3)(i) (collectively, “382 Stock”). While the Board of Directors has approved the issuance of our Series A Preferred Stock after determining that such issuance is not likely to result in a prohibited ownership shift, the Protective Amendment will continue to apply to the Series A Preferred Stock after issuance,
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including the restrictions on transfer and exchange, until such time as our Board of Directors approves the Protective Amendment Removal.
The market for our Series A Preferred Stock may not provide investors with adequate liquidity.
Our Series A Preferred Stock is listed on the Nasdaq Global Market. However, the trading market for the Series A Preferred Stock may not be maintained and may not provide investors with adequate liquidity. The liquidity of the market for the Series A Preferred Stock depends on a number of factors, including prevailing interest rates, our financial condition and operating results, the number of holders of the Series A Preferred Stock, the market for similar securities and the interest of securities dealers in making a market in the Series A Preferred Stock. We cannot predict the extent to which investor interest in our Company will maintain the trading market in our Series A Preferred Stock, or how liquid that market will be. If an active market is not maintained, investors may have difficulty selling shares of our Series A Preferred Stock.
Future issuances of preferred stock may reduce the value of the Series A Preferred Stock.
We may sell additional shares of preferred stock on terms that may differ from the Series A Preferred Stock. Such shares could rank on parity with or, subject to the voting rights referred to above (with respect to issuances of new series of preferred stock), senior to the Series A Preferred Stock as to distribution rights or rights upon liquidation, winding up or dissolution. The subsequent issuance of additional shares of Series A Preferred Stock, or the creation and subsequent issuance of additional classes of preferred stock on parity with the Series A Preferred Stock, could dilute the interests of the holders of Series A Preferred Stock offered hereby. Any issuance of preferred stock that is senior to the Series A Preferred Stock would not only dilute the interests of the holders of Series A Preferred Stock, but also could affect our ability to pay distributions on, redeem or pay the liquidation preference on the Series A Preferred Stock.
Market interest rates may materially and adversely affect the value of the Series A Preferred Stock.
One of the factors that influences the price of the Series A Preferred Stock is the dividend yield on the Series A Preferred Stock (as a percentage of the market price of the Series A Preferred Stock) relative to market interest rates. Continued increase in market interest rates, which are currently at low levels relative to historical rates, may lead prospective purchasers of the Series A Preferred Stock to expect a higher dividend yield (and higher interest rates would likely increase our borrowing costs and potentially decrease funds available for dividend payments). Thus, higher market interest rates could cause the market price of the Series A Preferred Stock to materially decrease.
The special exchange right that the Series A Preferred Stock is entitled to may make it more difficult for a party to acquire us or discourage a party from acquiring us.
The Series A Preferred Stock special exchange right may have the effect of discouraging a third party from making an acquisition proposal for us or of delaying, deferring or preventing certain of our change of control transactions under circumstances that otherwise could provide the holders of our Series A Preferred Stock with the opportunity to realize a premium over the then-current market price of such equity securities or that stockholders may otherwise believe is in their best interests.
Holders of the Series A Preferred Stock may be unable to use the dividends-received deduction and may not be eligible for the preferential tax rates applicable to “qualified dividend income.”
Distributions paid to corporate U.S. holders of the Series A Preferred Stock may be eligible for the dividends-received deduction, and distributions paid to non-corporate U.S. holders of the Series A Preferred Stock may be subject to tax at the preferential tax rates applicable to “qualified dividend income,” if we have current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. We do not currently have any accumulated earnings and profits. Additionally, we may not have sufficient current earnings and profits during future fiscal years for the distributions on the Series A Preferred Stock to qualify as dividends for U.S. federal income tax purposes. If the distributions fail to qualify as dividends, U.S. holders would be unable to use the dividends-received deduction and may not be eligible for the preferential tax rates applicable to “qualified dividend income.”
Holders of the Series A Preferred Stock may be subject to tax if we make or fail to make certain adjustments to the Exchange Rate of the Series A Preferred Stock even though you do not receive a corresponding cash dividend.
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The exchange rate for the Series A Preferred Stock special exchange right is subject to adjustment in certain circumstances. A failure to adjust (or to adjust adequately) such exchange rate after an event that increases your proportionate interest in us could be treated as a deemed taxable dividend to you. If you are a non-U.S. holder, any deemed dividend may be subject to U.S. federal withholding tax at a 30% rate, or such lower rate as may be specified by an applicable treaty, which may be set off against subsequent payments on the Series A Preferred Stock. In April 2016, the Internal Revenue Service issued new proposed income tax regulations in regard to the taxability of changes in exchange rights that will apply to the Series A Preferred Stock when published in final form and may be applied to us before final publication in certain instances.
Our revenues, operating results and cash flows may fluctuate in future periods, and we may fail to meet investor expectations, which may cause the price of our Series A Preferred Stock to decline.
Variations in our quarterly and year-end operating results are difficult to predict, and our income and cash flows may fluctuate significantly from period to period. If our operating results fall below the expectations of investors or securities analysts, the price of our Series A Preferred Stock could decline substantially. Specific factors that may cause fluctuations in our operating results include:
The Series A Preferred Stock represents perpetual equity interests in us, and it has no maturity or mandatory redemption date and are not redeemable at the option of investors under any circumstances. As a result, the Series A Preferred Stock will not give rise to a claim for payment of a principal amount at a particular date. As a result, holders of the Series A Preferred Stock may be required to bear the financial risks of an investment in the Series A Preferred Stock for an indefinite period of time. In addition, the Series A Preferred Stock will rank junior to all our current and future indebtedness and other liabilities. The Series A Preferred Stock will also rank junior to any other senior securities we may issue in the future with respect to assets available to satisfy claims against us.
The Series A Preferred Stock has not been rated.
We have not sought to obtain a rating for the Series A Preferred Stock. No assurance can be given, however, that one or more rating agencies might not independently determine to issue such a rating or that such a rating, if issued, would not adversely affect the market price of the Series A Preferred Stock. Also, we may elect in the future to obtain a rating for the Series A Preferred Stock, which could adversely affect the market price of the Series A Preferred Stock. Ratings only reflect the views of the rating agency or agencies issuing the ratings and such ratings could be revised downward, placed on a watch list or withdrawn entirely at the discretion of the issuing rating agency if in its judgment circumstances so warrant. Any such downward revision, placing on a watch list or withdrawal of a rating could have an adverse effect on the market price of the Series A Preferred Stock.
The market price of the Series A Preferred Stock could be substantially affected by various factors.
The market price of the Series A Preferred Stock depends on many factors, which may change from time to time, including:
• prevailing interest rates, increases in which may have an adverse effect on the market price of the Series A Preferred Stock;
• trading prices of similar securities;
• our history of timely dividend payments;
• the annual yield from dividends on the Series A Preferred Stock as compared to yields on other financial instruments;
• general economic and financial market conditions;
• government action or regulation;
• the financial condition, performance and prospects of us and our competitors;
• changes in financial estimates or recommendations by securities analysts with respect to us or our competitors in our industry;
• our issuance of additional preferred equity or debt securities;
• actual or anticipated variations in quarterly operating results of us and our competitors; and
• the ongoing impact of the global COVID-19 pandemic.
As a result of these and other factors, holders of the Series A Preferred Stock may experience a decrease, which could be substantial and rapid, in the market price of the Series A Preferred Stock, including decreases unrelated to our operating performance or prospects.
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A holder of Series A Preferred Stock has extremely limited voting rights.
The voting rights for a holder of Series A Preferred Stock are limited. Our shares of common stock are the only class of our securities that carry full voting rights. Voting rights for holders of the Series A Preferred Stock exist primarily with respect to voting on amendments to our certificate of incorporation, including the certificate of designations relating to the Series A Preferred Stock, that materially and adversely affect the rights of the holders of Series A Preferred Stock or authorize, increase or create additional classes or series of our capital stock that are senior to the Series A Preferred Stock. Other than the limited circumstances described in the Certificate of Designations establishing the Series A Preferred Stock and except to the extent required by law, holders of Series A Preferred Stock do not have any voting rights.
Risks related to our common stock
Failure to maintain effective internal controls could adversely affect our operating results and the market for our common stock.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we maintain internal control over financial reporting that meets applicable standards. As with many smaller companies with small staff, material weaknesses in our financial controls and procedures may be discovered. If we are unable, or are perceived as unable, to produce reliable financial reports due to internal control deficiencies, investors could lose confidence in our reported financial information and operating results, which could result in a negative market reaction and adversely affect our ability to raise capital.
Approximately 44% of our outstanding common stock is beneficially owned by our Executive Chairman, who has the ability to substantially influence the election of directors and other matters submitted to stockholders.
As of May 5, 2022, 9,114,155 shares were beneficially held of record by Acuitas Group Holdings, LLC (“Acuitas”), an entity indirectly wholly owned and controlled by Terren S. Peizer, the Company's Executive Chairman and largest stockholder, which represented beneficial ownership of approximately 44% of our outstanding shares of common stock. As a result, he has and is expected to continue to have the ability to significantly influence the election of our Board of Directors and the outcome of all other matters submitted to our stockholders. His interest may not always coincide with our interests or the interests of other stockholders, and he may act in a manner that advances his best interests and not necessarily those of other stockholders. One consequence to this substantial influence or control is that it may be difficult for investors to remove management of our Company. It could also deter unsolicited takeovers, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.
We incur increased costs as a result of operating as a public company, and our management devotes substantial time to compliance initiatives.
We incur significant legal, accounting and other expenses as a public company, including costs resulting from public company reporting obligations under the Exchange Act and regulations regarding corporate governance practices. The listing requirements of The Nasdaq Global Market and the rules of the Securities and Exchange Commission, or the SEC, require that we satisfy certain corporate governance requirements relating to director independence, filing annual and interim reports, stockholder meetings, approvals and voting, soliciting proxies, conflicts of interest and a code of conduct. Our management and other personnel devote a substantial amount of time to ensure that we comply with all of these requirements. Moreover, the reporting requirements, rules and regulations associated with being a public company result in significant legal and financial compliance costs and make some activities more time-consuming and costly. These reporting requirements, rules and regulations, coupled with the increase in potential litigation exposure associated with being a public company, could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or board committees or to serve as executive officers, or to obtain certain types of insurance, including directors’ and officers’ insurance, on acceptable terms and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage.
We are also subject to more stringent state law requirements. For example, on September 30, 2018, the then California Governor Jerry Brown signed into law Senator Bill 826, which generally requires public companies with principal executive offices in California to have a minimum number of females on the company’s board of directors. By December 31, 2019, each public company with principal executive offices in California was required to have at least one female on its board of directors. By December 31, 2021, each public company was required to have at least two females on its board of directors if the company has at least five directors, and at least three females on its board of directors if the company has at least six directors. We do not currently meet the December 31, 2021 requirement.
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Additionally, on September 30, 2020, California Governor Gavin Newsom signed into law Assembly Bill 979 (AB 979), which generally requires public companies with principal executive offices in California to include specified numbers of directors from "underrepresented communities." A director from an "underrepresented community" means a director who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender. On October 2, 2020, a lawsuit was filed titled Robin Crest, et al. v. Alex Padilla, in his official capacity as Secretary of State of the State of California, (No. 20ST-CV-37513) seeking the declaration of the quota mandate of AB 979 as unconstitutional, which ruling was issued on April 1, 2022.
Our stock price may be subject to substantial volatility, and the value of our stockholders' investment may decline.
The price at which our common stock trades fluctuates as a result of a number of factors, including the number of shares available for sale in the market, quarterly variations in our operating results and actual or anticipated announcements of our Ontrak solution, announcements regarding new or discontinued Ontrak solution contracts, new products or services by us or competitors, regulatory investigations or determinations, acquisitions or strategic alliances by us or our competitors, recruitment or departures of key personnel, the gain or loss of significant customers, changes in the estimates of our operating performance, actual or threatened litigation, market conditions in our industry and the economy as a whole.
Numerous factors, including many over which we have no control, may have a significant impact on the market price of our common stock, including:
● announcements of new products or services by us or our competitors;
● current events affecting the political, economic and social situation in the United States;
● trends in our industry and the markets in which we operate;
● changes in financial estimates and recommendations by securities analysts;
● acquisitions and financings by us or our competitors;
● the gain or loss of a significant customer;
● quarterly variations in operating results;
● the operating and stock price performance of other companies that investors may consider to be comparable;
● purchases or sales of blocks of our securities; and
● issuances of stock.
We have used the market price of our common stock to establish future payment obligations to stockholders of acquisition targets in the past and may continue to do so in the future; any decline in the market price regardless of whether due to our performance or external market dynamics would give rise to a payment obligation to such holders. Furthermore, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and attention of our management.
Future sales of common stock by existing stockholders, or the perception that such sales may occur, could depress our stock price.
The market price of our common stock could decline as a result of sales by, or the perceived possibility of sales by, our existing stockholders. Most of our outstanding shares are eligible for public resale pursuant to Rule 144 under the Securities Act of 1933, as amended. As of March 31, 2022, approximately 9.1 million shares of our common stock are held by our affiliates and may be sold pursuant to an effective registration statement or in accordance with the volume and other limitations of Rule 144 or pursuant to other exempt transactions. Future sales of common stock by significant stockholders, including those who acquired their shares in private placements or who are affiliates, or the perception that such sales may occur, could depress the price of our common stock.
Future issuances of common stock and hedging activities may depress the trading price of our common stock.
Any future issuance of equity securities, including the issuance of shares upon direct registration, upon satisfaction of our obligations, compensation of vendors, exercise of outstanding warrants, or effectuation of a reverse stock split, could dilute the interests of our existing stockholders, and could substantially decrease the trading price of our common stock. As of March 31, 2022, we had outstanding options to purchase 3,505,469 shares of our common stock at exercise prices ranging from $5.74 to $86.57 per share and warrants to purchase 167,496 shares of our common stock at exercise prices ranging from $0.01 to $16.75 per share. Also, as of March 31, 2022, we had a total of 96,999 unvested RSUs outstanding. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy, in connection with acquisitions, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options or for other reasons.
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There may be future sales or other dilution of our equity, which may adversely affect the market price of our common stock.
In the future, we may need to raise additional funds through public or private financing, which might include sales of equity securities. The issuance of any additional shares of common stock or securities convertible into, exchangeable for, or that represent the right to receive common stock or the exercise of such securities could be substantially dilutive to holders of shares of our common stock. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series. The market price of our common stock could decline as a result of sales of shares of our common stock made after this offering or the perception that such sales could occur. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interests in our Company.
Provisions in our certificate of incorporation and Delaware law could discourage a change in control, or an acquisition of us by a third party, even if the acquisition would be favorable to you.
Our amended and restated certificate of incorporation and the Delaware General Corporation Law contain provisions (including the Section 382 Ownership Limit) that may have the effect of making more difficult or delaying attempts by others to obtain control of our Company, even when these attempts may be in the best interests of stockholders. In addition, our amended and restated certificate of incorporation authorizes our Board of Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with “interested stockholders.” These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests.
We do not expect to pay dividends in the foreseeable future.
We have paid no cash dividends on our common stock to date, and we intend to retain our future earnings, if any, to fund the continued development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future on our common stock. Further, any payment of cash dividends will also depend on our financial condition, results of operations, capital requirements and other factors, including contractual restrictions to which we may be subject, and will be at the discretion of our Board of Directors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In March 2022, we issued 55,555 unregistered, restricted shares of our common stock as consideration for consulting services to The Money Channel NYC INC. These shares were issued in reliance upon Section 4(a)(2) of the Securities Act as a transaction by an issuer not involving a public offering.
In March 2022, we issued 24,333 unregistered, restricted shares of our common stock as consideration for the payment of a portion of the $1.8 million stock price guarantee contingent liability, which was related to our acquisition of LifeDojo Inc. These shares were issued in reliance upon Section 4(a)(2) of the Securities Act as a transaction by an issuer not involving a public offering.
Also, in March 2022, we issued warrants to purchase an aggregate of 131,664 shares of the Company's common stock in connection with the Eight Amendment to the Note Purchase Agreement with Goldman Sachs Specialty Lending Group, L.P. This issuance was in reliance upon Section 4(a)(2) of the Securities Act as a transaction by an issuer not involving a public offering.
Item 3. Defaults Upon Senior Securities
None.
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Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information
None
Item 6. Exhibits
| Exhibit No. | Description | |||||||
| 4.1* | ||||||||
| 10.1* | ||||||||
| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1** | ||||||||
| 32.2** | ||||||||
| 101.INS* | XBRL Instance Document | |||||||
| 101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 104* | Cover Page Interactive Data File (formatted as Inline XBRL with applicable taxonomy extension information contained in Exhibits 101) | |||||||
_____________________
* Filed herewith.
** Furnished herewith.
# Management contract or compensatory plan or arrangement.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ONTRAK, INC. | ||||||||
| Date: May 11, 2022 | By: | /s/ JONATHAN MAYHEW | ||||||
| Jonathan Mayhew Chief Executive Officer (Principal Executive Officer) | ||||||||
| Date: May 11, 2022 | By: | /s/ BRANDON H. LAVERNE | ||||||
| Brandon H. LaVerne Chief Financial Officer (Principal Financial Officer) | ||||||||
| Date: May 11, 2022 | By: | /s/ JAMES J. PARK | ||||||
| James J. Park Chief Accounting Officer (Principal Accounting Officer) | ||||||||
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