CATS Catasys Inc

Note 1.   Basis of Consolidation and Presentation

We harness proprietary big data predictive analytics, artificial intelligence and telehealth, combined with human interaction, to deliver improved member health and cost savings to health plans. We identify, engage and treat health plan members with unaddressed behavioral health conditions that worsen medical comorbidities.  Our mission is to help improve the health and save the lives of as many people as possible. 

We apply advanced data analytics and predictive modeling to identify members with untreated behavioral health conditions, whether diagnosed or not, and coexisting medical conditions that may be impacted through treatment in the On Trak program.  We then uniquely engage health plan members who do not typically seek behavioral healthcare by leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance.  Our technology enabled On Trak solution is an integrated suite of services that includes evidence-based psychosocial and medical interventions delivered either in-person or via telehealth, nurse-led care coaching and local community support. We believe that the program is currently improving member health and, at the same time, demonstrating reduced medical utilization, driving a reduction in total health plan costs for enrolled members.

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

As of March 31, 2019, cash and restricted cash was $1.7 million and we had a working capital deficit of approximately $2.6 million. We could continue to incur negative cash flows and operating losses for the next twelve months. Our average cash burn rate is approximately $1.5 million per month including a one-time delay in customer collections totaling approximately $925,000. We expect our current cash resources and available borrowings (see Note 8) to cover expenses through at least the next twelve months, however, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.

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

Management’s Plans

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

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

Note 2.   Accounting Standards and Significant Accounting Policies

Revenue , Deferred Revenue and Performance Obligations

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

The following table disaggregates our revenue by business line:

Our contracts are generally designed to provide cash fees to us on a monthly basis, an upfront case rate, or fee for service based on enrolled members. Our performance obligation is satisfied over time as the On Trak service is provided continuously throughout the service period. We recognize revenue evenly over the service period using a time-based measure because we are providing a continuous service to the customer. Contracts with minimum performance guarantees or price concessions include variable consideration and are subject to revenue constraint. We use an expected value method to estimate variable consideration for minimum performance guarantees and price concessions. We have constrained revenue for expected price concessions during the three months ended March 31, 2019.

Cost of R evenue

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

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Net l oss per s hare

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

Common equivalent shares, consisting of 5,966,224 and 3,920,531 shares for the three months ended March 31, 2019 and 2018, respectively, issuable upon the exercise of stock options and warrants have been excluded from the diluted earnings per share calculation as their effect is anti-dilutive.

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

Leases

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

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

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

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Recently Issued or Newly Adopted Accounting Standards

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

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

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

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

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

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

Note 3 . Accounts Receivable

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

Depreciation expense was $38,000 and $85,000 for the three months ended March 31, 2019 and 2018, respectively.

Note 5 . Common Stock

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

In addition, there were 0 and 24,000 shares of common stock issued in exchange for investor relations services during the three months ended March 31, 2019 and 2018, respectively. Generally, the costs associated with shares issued for services are amortized to the related expense on a straight-line basis over the related service periods.

Note 6 . Stock Compensation

Our 2017 Stock Incentive Plan (the “2017 Plan”), provides for the issuance of up to 2,333,334 shares of our common stock and an additional 243,853 shares of our common stock that are represented by awards granted under our 2010 Stock Incentive Plan (the “2010 Plan”). In August 2018, at our Annual Stockholders Meeting, Stockholders approved an amendment to the Company's 2017 Plan, among other things, to provide for an additional 1,400,000 shares to be issued in connection with awards granted thereunder (the “2017 Amended Plan”). In February 2019, we increased the number of shares in the 2017 Plan by 552,884 shares as allowed in the 2017 Plan for annual increases to the number of shares available under the 2017 Plan. Incentive stock options (ISOs) under Section 422A of the Internal Revenue Code and non-qualified options (NSOs) are authorized under the 2017 Amended Plan. We have granted stock options to executive officers, employees, members of our board of directors, and certain outside consultants. The terms and conditions upon which options become exercisable vary among grants; however, option rights expire no later than ten years from the date of grant and employee and board of director awards generally vest over three to five years on a straight-line basis. As of March 31, 2019, we had 4,291,116 and 50,000 vested and unvested stock options outstanding issued to employees and directors and non-employees accordingly and 188,955 shares reserved for future awards.

Stock compensation expense attributable to operations was $1,024,000 and $328,000 for the three months ended March 31, 2019 and 2018, respectively.

As of March 31, 2019, there was $9.9 million of total unrecognized compensation cost related to non-vested stock compensation arrangements granted under the 2017 Amended Plan. That cost is expected to be recognized over a weighted-average period of approximately 3.05 years.          

CATASYS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Stock Options and Warrants - Non- E mployees

There were 50,000 options issued to non-employees for the three months ended March 31, 2019 at an exercise price of $9.93 per share and none issued to non-employees as of December 31, 2018.

As of March 31, 2019, there was $312,000 of total unrecognized compensation cost related to non-vested stock compensation arrangements granted under the 2017 Amended Plan. That cost is expected to be recognized over a weighted-average period of approximately 2.91 years 

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

Note 7 . Leases

We lease office space under agreements classified as operating leases that will expire April 2019. In September 2018, we entered into a lease for our new corporate offices located in Santa Monica, CA for 7,869 rentable square feet. The lease is for 48 months beginning in April 2019 with a base rent of approximately $48,000, subject to annual adjustments. In connection with lease agreement for our new corporate offices in Santa Monica, we incurred a $408,000 letter of credit which is recorded on the balance sheet as restricted cash, long term, All of our lease liabilities result from the lease of our corporate headquarters in Los Angeles, CA, which expires in April 2019, and our new headquarters in Santa Monica, CA, which expires in 2023. Such leases do not require any contingent rental payments, impose any financial restrictions, or contain any residual value guarantees. Certain of our leases include renewal options and escalation clauses; renewal options have not been included in the calculation of the lease liabilities and right of use assets as we are not reasonably certain to exercise the options.Variable expenses generally represent our share of the landlord’s operating expenses. We do not act as a lessor or have any leases classified as financing leases.

As of March 31, 2019, we had no operating lease liabilities or right of use assets included on our balance sheet.

The following summarizes quantitative information about the our operating leases: 

We incurred rent expense of approximately $77,000 and $73,000 for the three months ended March 31, 2019 and 2018.

Note 8 . Debt

In June 2018, we entered into a venture loan and security agreement (the “Loan Agreement”) with Horizon Technology Finance Corporation (the “Horizon”), which provides for up to $7.5 million in loans to the Company, including initial loans in the amount of $5.0 million funded upon signing of the Loan Agreement. An additional $2.5 million loan was subject to the Company’s achievement of billings of not less than $5.0 million during any three consecutive month period on or prior to November 30, 2018. In August 2018, we incurred the additional $2.5 million loan as a result of our achievement of the trailing three-month billings exceeding $5.0 million on or prior to November 30, 2018. In addition, in June 2018, we entered into a loan and security agreement (the “A/R Facility”). in connection with a $2.5 million receivables financing facility with Corporate Finance, a division of Heritage Bank of Commerce (“Heritage”). The A/R Facility provides for the borrower entities to borrow up to 85% of the Company’s eligible accounts receivable, as defined in the A/R Facility. In February 2019, we borrowed $976,000 on the A/R Facility twice during the month, of which none is outstanding as of March 31, 2019.

In March 2019, we entered into an amended and restated venture loan and security agreement (as so amended and restated, the “Amended Loan Agreement”) with Horizon, which provides for up to $15.0 million in loans to us, including initial term loans in the amount of $7.5 million previously funded under the original Loan Agreement entered into in June 2018 and an additional up to $7.5 million loan in three revolving tranches of $2.5 million in availability, subject to our achievement of trailing three month billings exceeding $5.9 million, $7.0 million and $8.0 million, respectively. An initial advance of $2.5 million was funded upon the execution and delivery of the Amended Loan Agreement, subject to repayment if the foregoing $5.9 million threshold is not reached by July 1, 2019. We concurrently entered into an amendment to the previously disclosed $2.5 million A/R Facility with Heritage intended primarily to reflect the amendment and restatement of the Amended Loan Agreement.

Repayment of the Revolving Loan is on an interest-only basis through September 30, 2020, followed by monthly payments of principal and accrued interest until maturity on the date which is the earliest of: (a) September 30, 2022, (b) the date of acceleration of such loan, following an event of default (c) or the date of prepayment.

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

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

In connection with our entry into the Amended Loan Agreement, we issued Horizon 40,921 warrants to purchase shares of common stock with an aggregate value of up to $600,000 (depending on the level of availability under the Loan Agreement) at the trailing volume weighted average price of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants (the “Horizon Warrants”). In no event will the Company be required to issue more than 19.9% of its currently outstanding common stock pursuant to the Horizon Warrants. The per share exercise price of the Horizon Warrants is $9.93.

We recorded approximately $105,000 in debt issuance costs associated with the Amended Loan Agreement.

During the three months ended March 31, 2019 and 2018, we incurred debt related interest expense of approximately $321,000 and $1,000, respectively. Interest expense for the three months ended March 31, 2019 included amortization of debt discount of approximately $44,000 related to the A/R Facility and amortization of debt discount of $56,000 related to the Horizon Loan Agreement.

Note 9 . Fair Value Measurements 

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

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

For the three months ended March 31, 2019 and 2018, we recognized a loss of $91,000 and $10,000, respectively, related to the revaluation of our warrant liabilities.

In connection with the Amended Loan Agreement, we issued Horizon 40,279 seven-year warrants to purchase an aggregate of $600,000 (depending on the level of availability under the Loan Agreement) at the trailing volume weighted average price of our common stock on the NASDAQ Capital Market for the five days preceding the relative dates of grants (the “Horizon Warrants”) at a per share exercise price equal to the lower of (i) $9.93 or (ii) the price per share of any securities that may be issued by us in an equity financing during the 18 months following the agreement date (“Horizon Warrants”). In no event will we be required to issue more than 19.9% of our currently outstanding common stock pursuant to the Horizon Warrants. In addition, the Horizon Warrant agreement provides for additional warrant shares to be issued, contingent on additional borrowings under the Revolving Loan, and determined by reference to a future common stock price (5-day VWAP when the condition is met).  We adopted, ASU, No. 2017-11, as of January 1, 2019. However, given the number of variable features, the Horizon Warrants have been classified as a liability at the time of issuance and as of March 31, 2019 in accordance with ASC 815. We valued the Horizon Warrants using a Monte Carlo model and the fair value of the Horizon Warrants were recorded as a discount to the debt obligation.

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