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EX-31 - EXHIBIT 31.2 - CATASYS, INC.ex31-2.htm

 

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 September 30, 2014

 

Commission File Number 001-31932

 


 

CATASYS, 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.)

 

11601 Wilshire Boulevard, Suite 950, Los Angeles, California 90025

(Address of principal executive offices, including zip code)

 

(310) 444-4300

(Registrant's telephone number, including area code)

 

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

 

Yes☑          No☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    

 

Yes☑          No☐

 

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

 

Large accelerated filer ☐      Accelerated filer  ☐      Non-accelerated filer  ☐      Smaller reporting company  ☑

 

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

 

Yes☐            No☑

 

As of November 13, 2014, there were 24,576,840 shares of registrant's common stock, $0.0001 par value, outstanding.

 

 
1

 

 

TABLE OF CONTENTS

 

 

PART I - FINANCIAL INFORMATION

3

       
 

ITEM 1. Financial Statements

3

       
   

Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013

3
       
   

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)

4
       
   

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited)

5
       
   

Notes to Condensed Consolidated Financial Statements

6

       
 

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

17
       
 

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

23

       
 

ITEM 4. Controls and Procedures

23

       

PART II – OTHER INFORMATION

24

       
 

ITEM 1. Legal Proceedings

24

     
 

ITEM 1A. Risk Factors

24

     
 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

24

     
 

ITEM 3. Defaults Upon Senior Securities

24

     
 

ITEM 4. Mine Safety Disclosures

24

     
 

ITEM 5. Other Information

24

     
 

ITEM 6. Exhibits

24

 

 

In this report, except as otherwise stated or the context otherwise requires, the terms “we,” “us” or “our” refer to Catasys, Inc. and our wholly-owned subsidiaries. Our common stock, par value $0.0001 per share, is referred to as “common stock.”

 

 
2

 

  

 

PART I - FINANCIAL INFORMATION

 

Item 1.     Financial Statements

 

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

   

September 30,

         

(In thousands, except for number of shares)

 

2014

   

December 31,

 
   

(unaudited)

   

2013

 

ASSETS

               

Current assets

               

Cash and cash equivalents

  $ 1,532     $ 1,136  

Receivables, net of allowance for doubtful accounts of $18 and $0, respectively

    172       173  

Receivables from related party

    -       115  

Prepaids and other current assets

    76       275  

Total current assets

    1,780       1,699  

Long-term assets

               

Property and equipment, net of accumulated depreciation of $1,975 and $2,001, respectively

    373       366  

Intangible assets, net of accumulated amortization of $414 and $401, respectively

    105       118  

Deposits and other assets

    387       440  

Total Assets

  $ 2,645     $ 2,623  
                 

LIABILITIES AND STOCKHOLDERS' DEFICIT

               

Current liabilities

               

Accounts payable

  $ 304     $ 1,148  

Accrued compensation and benefits

    1,374       1,181  

Deferred revenue

    988       534  

Other accrued liabilities

    657       1,270  

Total current liabilities

    3,323       4,133  

Long-term liabilities

               

Deferred rent and other long-term liabilities

    282       160  

Capital leases

    23       26  

Warrant liabilities

    40,196       16,347  

Total Liabilities

    43,824       20,666  
                 

Stockholders' deficit

               

Preferred stock, $0.0001 par value; 50,000,000 shares authorized; no shares issued and outstanding

    -       -  

Common stock, $0.0001 par value; 500,000,000 shares authorized; 24,411,051 and 18,835,571 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively

    2       2  

Additional paid-in-capital

    211,552       209,169  

Accumulated deficit

    (252,733 )     (227,214 )

Total Stockholders' Deficit

    (41,179 )     (18,043 )

Total Liabilities and Stockholders' Deficit

  $ 2,645     $ 2,623  

 

 

See accompanying notes to the financial statements.

 

 
3

 

 

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

 

(In thousands, except per share amounts)

 

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Revenues

                               

Healthcare services revenues

  $ 370     $ 109     $ 881     $ 315  
                                 

Operating expenses

                               

Cost of healthcare services

    346       162       878       454  

General and administrative

    1,596       1,246       4,642       4,120  

Depreciation and amortization

    30       7       82       18  

Total operating expenses

    1,972       1,415       5,602       4,592  
                                 

Loss from operations

    (1,602 )     (1,306 )     (4,721 )     (4,277 )
                                 

Other Income

    -       -       1,194       -  

Interest expense

    (2 )     (1 )     (2,776 )     (771 )

Change in fair value of warrant liability

    1,397       2,231       (18,995 )     2,607  

Income/(Loss) from continuing operations before provision for income taxes

    (207 )     924       (25,298 )     (2,441 )

Provision for income taxes

    3       2       7       5  

Income/(Loss) from continuing operations

  $ (210 )   $ 922     $ (25,305 )   $ (2,446 )
                                 

Loss from discontinued operations, net of income taxes

  $ -     $ (242 )   $ (213 )   $ (735 )
                                 

Net Income/(Loss)

  $ (210 )   $ 680     $ (25,518 )   $ (3,181 )
                                 
                                 

Basic net income (loss) from continuing operations per share:

  $ (0.01 )   $ 0.06     $ (1.17 )   $ (0.18 )
                                 

Basic weighted number of shares outstanding

    23,513       14,286       21,569       13,429  
                                 

Diluted net income (loss) from continuing operations per share:

  $ (0.01 )   $ 0.05     $ (1.17 )   $ (0.18 )
                                 

Diluted weighted number of shares outstanding

    23,513       19,364       21,569       13,429  
                                 

Basic net income (loss) from discontinued operations per share:

  $ 0.00     $ (0.02 )   $ (0.01 )   $ (0.05 )
                                 

Basic weighted number of shares outstanding

    23,513       14,286       21,569       13,429  
                                 

Diluted net loss from discontinued operations per share:

  $ 0.00     $ (0.01 )   $ (0.01 )   $ (0.05 )
                                 

Diluted weighted number of shares outstanding

    23,513       19,364       21,569       13,429  

 

 

See accompanying notes to the financial statements.

 

 
4

 

 

CATASYS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

 

(In thousands)

 

Nine Months Ended

September 30,

 
   

2014

   

2013

 

Operating activities:

               

Net loss

  $ (25,518 )   $ (3,181 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Loss from discontinued operations

  $ 213     $ 735  

Depreciation and amortization

    82       18  

Issuance costs included in interest expense

    2,771       769  

Write-off of accrued liabilities

    (1,194 )     -  

Deferred rent

    122       -  

Share-based compensation expense

    39       165  

Transaction Costs

    350       -  

Fair value adjustment on warrant liability

    18,995       (2,607 )

Changes in current assets and liabilities:

               

Receivables

    1       (137 )

Prepaids and other current assets

    201       137  

Deferred revenue

    454       389  

Accounts payable and other accrued liabilities

    48       59  

Net cash used by operating activities of continuing operations

  $ (3,436 )   $ (3,653 )

Net cash used by operating activities of discontinued operations

  $ (215 )   $ (624 )

Net cash used by operating activities

  $ (3,651 )   $ (4,277 )
                 

Investing activities:

               

Purchases of property and equipment

  $ (64 )   $ -  

Deposits and other assets

    53       (3 )

Net cash used by investing activities

  $ (11 )   $ (3 )
                 

Financing activities:

               

Proceeds from the issuance of common stock and warrants

  $ 4,000     $ 1,535  

Proceeds from the exercise of warrants

    77       23  

Capital lease obligations

    (19 )     (9 )

Net cash provided by financing activities

  $ 4,058     $ 1,549  
                 

Net increase (decrease) in cash and cash equivalents

  $ 396     $ (2,731 )

Cash and cash equivalents at beginning of period

    1,136       3,153  

Cash and cash equivalents at end of period

  $ 1,532     $ 422  
                 

Supplemental disclosure of cash paid

               

Income taxes

  $ 11     $ 37  

Supplemental disclosure of non-cash activity

               

Common stock issued for exercise of warrants

  $ 166     $ 156  

Property and equipment acquired through capital leases and other financing

  $ 16     $ 13  

 

 

See accompanying notes to the financial statements.

 

 
5

 

 

Catasys, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 1. Basis of Consolidation, Presentation and Going Concern

 

The accompanying unaudited condensed 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 in our most recent Annual Report on Form 10-K for the year-ended December 31, 2013, from which the December 31, 2013 balance sheet has been derived.

 

Our financial statements have been prepared on the basis that we will continue as a going concern. At September 30, 2014, cash and cash equivalents amounted to $1.5 million and we had a working capital deficit of approximately $1.5 million. In January 2014, May 2014, and September 2014, we closed on financings of approximately $1.0, $1.5, and $1.5 million, respectively. We have incurred significant operating losses and negative cash flows from operations since our inception. During the nine months ended September 30, 2014, our cash used in operating activities of continuing operations was $3.4 million. We anticipate that we could continue to incur negative cash flows and net losses for the next twelve months. The financial statements do not include any adjustments relating to the recoverability of the carrying amount of the recorded assets or the amount of liabilities that might result from the outcome of this uncertainty. As of September 30, 2014, these conditions raised substantial doubt as to our ability to continue as a going concern. We expect our current cash resources to cover expenses through the end of December 2014, however delays in cash collections, revenue, or unforeseen expenditures, could negatively impact our estimate. We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to stockholders.

 

Our ability to fund our ongoing operations and continue as a going concern is also dependent on signing and generating fees from existing and new contracts for our Catasys managed care programs and the success of management’s plans to increase revenue and continue to control expenses. We are operating our programs in Kansas, Louisiana, Massachusetts, Oklahoma, West Virginia, Kentucky, Wisconsin, and Florida. We launched our program in Florida in the third quarter of 2014, and we expect to commence enrollment for another customer in New Jersey during the fourth quarter. We have generated fees from the launched programs and expect to increase enrollment and fees throughout 2014. However, there can be no assurance that we will generate such fees or that new programs will launch as we expect.

 

We have elected to discontinue our license and management fee segment. We shut down the operations effective April 1, 2014 and all of the assets were absorbed by the Company.

 

Note 2. Summary of Significant Accounting Policies

 

Revenue Recognition

 

        Our Catasys contracts are generally designed to provide cash fees to us on a monthly basis based on enrolled members. To the extent our contracts may include a minimum performance guarantee, we reserve a portion of the monthly fees that may be at risk until the performance measurement period is completed. To the extent we receive case rates that are not subject to the performance guarantees, we recognize the case rate ratably over twelve months.

 

 
6

 

 

Cost of Services

 

Cost of healthcare services consists primarily of salaries related to our care coaches, healthcare provider claims payments, and fees charged by our third party administrators for processing these claims. Healthcare services cost of services is recognized in the period in which an eligible member receives services. We contract with doctors and licensed behavioral healthcare professionals, on a fee-for-services 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 OnTrakTM database within the contracted timeframe, with all required billing elements correctly completed by the service provider.

 

Cash Equivalents and Concentration of Credit Risk 

 

We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Financial instruments that potentially subject us to a concentration of credit risk consist of cash and cash equivalents, and accounts receivable. Cash is deposited with what we believe are highly credited, quality financial institutions. The deposited cash may exceed Federal Deposit Insurance Corporation (“FDIC”) insured limits. At September 30, 2014, cash and cash equivalents exceeding federally insured limits totaled $1.3 million.

 

For the nine months ended September 30, 2014, two customers accounted for approximately 53% of revenues and three customers accounted for approximately 90% of accounts receivable.

 

Basic and Diluted Income (Loss) per Share

 

Basic income (loss) per share is computed by dividing the net income (loss) to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and dilutive common equivalent shares outstanding during the period.

 

Common equivalent shares, consisting of 22,112,493 incremental common shares for the three and nine months ended September 30, 2014, 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, consisting of 5,077,669 incremental common shares for the three months ended September 30, 2013, issuable upon the exercise of stock options and warrants have been included in the diluted earnings per share calculation. These shares have not been included for the nine months ended September 2013 because their effect is anti-dilutive.

  

 
7

 

 

   

Three Months Ended

September 30

   

Nine Months Ended

September 30

 

(in thousands, except per share amounts)

 

2014

   

2013

   

2014

   

2013

 
                                 

Numerator

                               
                                 

Net income (loss) from continuing operations

  $ (210 )   $ 922     $ (25,305 )   $ (2,446 )
                                 

Net income (loss) from discontinued operations

  $ -     $ (242 )   $ (213 )   $ (735 )
                                 

Net income (loss)

  $ (210 )   $ 680     $ (25,518 )   $ (3,181 )
                                 

Denominator

                               
                                 

Weighted-average common shares outstanding

    23,513       14,286       21,569       13,429  
                                 

Shares used in calculation - basic

    23,513       14,286       21,569       13,429  
                                 

Shares issuable for stock options and warrants

    -       5,078       -       -  
                                 

Shares used in calculation - diluted

    23,513       19,364       21,569       13,429  
                                 

Net income (loss) per share from continuing operations

                               
                                 

Basic

  $ (0.01 )   $ 0.06     $ (1.17 )   $ (0.18 )
                                 

Diluted

  $ (0.01 )   $ 0.05     $ (1.17 )   $ (0.18 )
                                 

Net income (loss) per share from discontinued operations

                               
                                 

Basic

  $ -     $ (0.02 )   $ (0.01 )   $ (0.05 )
                                 

Diluted

  $ -     $ (0.01 )   $ (0.01 )   $ (0.05 )

 

Share-Based Compensation

 

Our 2010 Stock Incentive Plan, as amended (the “Plan”), provides for the issuance of up to 1,825,000 shares of our common stock. Incentive stock options (ISOs) under Section 422A of the Internal Revenue Code and non-qualified options (NSOs) are authorized under the 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, but 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. At September 30, 2014, we had 398,676 vested and unvested shares outstanding and 1,369,087 shares available for future awards under the Plan.

 

Share-based compensation expense attributable to continuing operations were $13,000 and $39,000 for the three and nine months ended September 30, 2014, compared with $48,000 and $165,000, respectively, for the same periods in 2013.

  

 
8

 

 

Stock Options – Employees and Directors

 

We measure and recognize compensation expense for all share-based payment awards made to employees and directors based on estimated fair values on the date of grant. We estimate the fair value of share-based payment awards using the Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the condensed consolidated statements of operations.

 

Share-based compensation expense recognized for employees and directors for the three and nine months ended September 30, 2014 amounted to $11,000 and $34,000, compared with $47,000 and $141,000, respectively, for the same periods in 2013.

 

Share-based compensation expense recognized in our condensed consolidated statements of operations for the three and nine months ended September 30, 2014 and 2013, includes compensation expense for share-based payment awards granted prior to, but not yet vested, as of January 1, 2006, based on the grant date fair value estimated in accordance with the pro-forma provisions of Statement of Financial Accounting Standards (“SFAS”) 123, and for the share-based payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of the Accounting Standards Codification (“ASC”) 718. For share-based awards issued to employees and directors, share-based compensation is attributed to expense using the straight-line single option method. Share-based compensation expense recognized in our condensed consolidated statements of operations for the three and nine months ended September 30, 2014 and 2013, is based on awards ultimately expected to vest, reduced for estimated forfeitures. Accounting rules for stock options require forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

During the three and nine months ended September 30, 2014 and 2013, there were no options granted to employees. Employee and director stock option activity for the three and nine months ended September 30, 2014 are as follows:

 

           

Weighted Avg.

 
   

Shares

   

Exercise Price

 

Balance December 31, 2013

    461,000     $ 19.69  
                 

Granted

    -     $ -  

Cancelled

    -     $ -  
                 

Balance March 31, 2014

    461,000     $ 19.69  
                 

Granted

    -     $ -  

Cancelled

    (83,000 )   $ 20.15  
                 

Balance June 30, 2014

    378,000     $ 19.59  
                 

Granted

    -     $ -  

Cancelled

    -     $ -  
                 

Balance September 30, 2014

    378,000     $ 19.59  

 

 

The expected volatility assumptions have been based on the historical and expected volatility of our stock, measured over a period generally commensurate with the expected term. The weighted average expected option term for the three and nine months ended September 30, 2014 and 2013, 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.

  

 
9

 

 

As of September 30, 2014, there was $11,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of approximately 0.31 years.          

 

Stock Options and Warrants – Non-employees

 

We account for the issuance of options and warrants for services from non-employees by estimating the fair value of warrants issued using the Black-Scholes pricing model. This model’s calculations include the option or warrant exercise price, the market price of shares on grant date, the weighted average risk-free interest rate, the expected life of the option or warrant, and the expected volatility of our stock and the expected dividends.

 

For options and warrants issued as compensation to non-employees for services that are fully vested and non-forfeitable at the time of issuance, the estimated value is recorded in equity and expensed when the services are performed and benefit is received. For unvested shares, the change in fair value during the period is recognized in expense using the graded vesting method.

 

There were no options issued to non-employees for the three and nine months ended September 30, 2014 and 2013, respectively. Share-based compensation expense relating to stock options and warrants recognized for non-employees was $2,000 and $5,000 for the three and nine months ended September 30, 2014, and $1,000 and $23,000 for the three and nine months ended September 30, 2013, respectively.

 

Non-employee stock option activity for the three and nine months ended September 30, 2014, are as follows:

 

           

Weighted Avg.

 
   

Shares

   

Exercise Price

 

Balance December 31, 2013

    21,000     $ 28.40  
                 

Granted

    -     $ -  

Cancelled

    -     $ -  
                 

Balance March 31, 2014

    21,000     $ 28.40  
                 

Granted

    -     $ -  

Cancelled

    -     $ -  
                 

Balance June 30, 2014

    21,000     $ 28.40  
                 

Granted

    -     $ -  

Cancelled

    -     $ -  
                 

Balance September 30, 2014

    21,000     $ 28.40  

 

 

Common Stock

 

In September 2014, we entered into securities purchase agreements (the “September Agreements”) with several investors, relating to the sale and issuance of an aggregate of 750,000 shares of common stock for aggregate gross proceeds of approximately $1.5 million (the “September Offering”).

 

In May 2014, we entered into securities purchase agreements (the “May Agreements”) with several investors, including Crede CG III, Ltd. (“Crede”), an affiliate of Terren S. Peizer, Chairman and Chief Executive Officer of the Company, and Shamus, LLC (“Shamus”), a company owned by David E. Smith, a member of the Company’s board of directors, relating to the sale and issuance of an aggregate of 2,586,210 shares of common stock and warrants (the “May Warrants”) to purchase an aggregate of 2,586,210 shares of common stock at an exercise price of $0.58 per share for aggregate gross proceeds of approximately $1.5 million (the “May Offering”). The May Agreements provide that in the event that we effectuate a Reverse Split and the VWAP Period declines from the closing price on the trading date immediately prior to the effective date of the Reverse Split, that we shall issue the Adjustment Shares to the investors.

  

 
10

 

 

In January 2014, we entered into securities purchase agreements (the “January Agreements”) with several investors, including Crede, relating to the sale and issuance of an aggregate of 1,724,141 shares of common stock and warrants (the “January Warrants”) to purchase an aggregate of 1,724,141 shares of common stock at an exercise price of $0.58 per share for aggregate gross proceeds of approximately $1.0 million (the “January Offering”). The January Agreements provide that in the event that we effectuate a Reverse Split and the VWAP Period declines from the closing price on the trading date immediately prior to the effective date of the Reverse Split, that we shall issue the Adjustment Shares to the investors.

 

There were 55,000 and 255,000 shares of common stock issued in exchange for consulting services or settlement of claims during the three and nine months ended September 30, 2014. There were no shares of common stock issued in exchange for various services or settlement of claims during the three and nine months ended September 30, 2013. The costs associated with shares issued for services are being amortized the related expense on a straight-line basis over the related service periods. For the three and nine months ended September 30, 2014, share-based compensation expense relating to all common stock issued for consulting services was $110,000 and $350,000, compared with $1,000 and $23,000 for the same periods in 2013, respectively.

 

Income Taxes

 

We have recorded a full valuation allowance against our otherwise recognizable deferred tax assets as of September 30, 2014.  As such, we have not recorded a provision for income tax for the period ended September 30, 2014.  We utilize the liability method of accounting for income taxes as set forth in ASC 740, Income Taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. In determining the need for valuation allowances, we consider projected future taxable income and the availability of tax planning strategies.  After evaluating all positive and negative historical and perspective evidences, management has determined it is more likely than not that our deferred tax assets will not be realized. 

 

We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where there is a greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is less than 50% likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.  Based on management's assessment of the facts, circumstances and information available, management has determined that all of the tax benefits for the period ended September 30, 2014 should be realized.   

 

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.

  

 
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The following table summarizes fair value measurements by level at September 30, 2014 for assets and liabilities measured at fair value:

 

   

2014

 
                                 

(Dollars in thousands)

 

Level I

   

Level II

   

Level III

   

Total

 

Certificates of deposit

  $ 122     $ -     $ -     $ 122  

Total assets

  $ 122     $ -     $ -     $ 122  
                                 

Warrant liabilities

  $ -     $ -     $ 40,196     $ 40,196  

Total liabilities

  $ -     $ -     $ 40,196     $ 40,196  

 

Financial instruments classified as Level III in the fair value hierarchy as of September 30, 2014, represent our liabilities measured at market value on a recurring basis which include warrant liabilities resulting from recent debt and equity financings. In accordance with current accounting rules, the warrant liabilities are being marked-to-market each quarter-end until they are completely settled. The warrants are valued using the Black-Scholes option-pricing model, using both observable and unobservable inputs and assumptions consistent with those used in our estimate of fair value of employee stock options. See Warrant Liabilities below.

 

The following table summarizes our fair value measurements using significant Level III inputs, and changes therein, for the three and nine months ended September 30, 2014:

 

   

Level III

 
   

Warrant

 

(Dollars in thousands)

 

Liabilities

 

Balance as of December 31, 2013

  $ 16,347  

Issuance of warrants

    2,310  

Change in fair value

    (5,101 )

Balance as of March 31, 2014

  $ 13,556  

Issuance (exercise) of warrants, net

    2,871  

Change in fair value

    25,493  

Balance as of June 30, 2014

  $ 41,920  

Issuance (exercise) of warrants, net

    (327 )

Expiration of warrants

    (44 )

Change in fair value

    (1,353 )

Balance as of September 30, 2014

  $ 40,196  

 

Intangible Assets

 

As of September 30, 2014, the gross and net carrying amounts of intangible assets that are subject to amortization are as follows:

 

   

Gross

                   

Amortization

 

(In thousands)

 

Carrying

   

Accumulated

   

Net

   

Period

 
   

Amount

   

Amortization

   

Balance

   

(in years)

 

Intellectual property

  $ 519     $ (414 )   $ 105       7  

 

 
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During the three and nine months ended September 30, 2014, we did not acquire any new intangible assets and at September 30, 2014, all of our intangible assets consisted of intellectual property, which is not subject to renewal or extension. We had no intangible impairment for the three and nine months ended September 30, 2014 or 2013.

 

Additionally, it is important to note that our overall business model, business operations and future prospects of our business have not changed materially since we performed the reviews and analysis noted above, with the exception of the timing, and annualized amounts of expected revenue.

 

Estimated remaining amortization expense for intangible assets for the current year and each of the next five years ending December 31 is as follows:

  

(In thousands)

       

Year

 

Amount

 

2014 (3 months)

  $ 4  

2015

  $ 16  

2016

  $ 16  

2017

  $ 16  

2018

  $ 16  

    

Property and Equipment

 

Property and equipment are stated at cost, less accumulated depreciation. Additions and improvements to property and equipment are capitalized at cost. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which range from two to seven years for furniture and equipment. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the related lease term, which is typically five to seven years.

 

Warrant Liabilities

 

In May 2014, we entered into the May Agreements with several investors relating to the sale and issuance of an aggregate of 2,586,210 shares of common stock and warrants to purchase an aggregate of 2,586,210 shares of common stock at an exercise price of $0.58 per share for aggregate gross proceeds of approximately $1.5 million. The May Agreements provide that in the event that we effectuate a Reverse Split and the VWAP period declines from the closing price on the trading date immediately prior to the effective date of the Reverse Split, that we shall issue the Adjustment Shares to the investors.

 

The May Warrants expire in May 2019, and contain anti-dilution provisions. As a result, if we, in the future, issue or grant any rights to purchase any of our common stock, or other securities convertible into our common stock, for a per share price less than the exercise price of the May Warrants, the exercise price of the May Warrants will be reduced to such lower price, subject to customary exceptions. In the event that Adjustment Shares are issued, the number of shares that may be purchased under the May Warrants shall be increased by an amount equal to the Adjustment Shares. In addition, the exercise price is subject to adjustment in the event that the VWAP during the VWAP period is less than the exercise price prior to the VWAP Period.

 

In January 2014, we entered into the January Agreements with several investors relating to the sale and issuance of an aggregate of 1,724,141 shares of common stock and warrants to purchase an aggregate of 1,724,141 shares of common stock at an exercise price of $0.58 per share for aggregate gross proceeds of approximately $1.0 million. The January Agreements provide that in the event that we effectuate a Reverse Split and the VWAP period declines from the closing price on the trading date immediately prior to the effective date of the Reverse Split, that we shall issue the Adjustment Shares to the investors.

 

The January Warrants expire in January 2019, and contain anti-dilution provisions. As a result, if we, in the future, issue or grant any rights to purchase any of our common stock, or other securities convertible into our common stock, for a per share price less than the exercise price of the January Warrants, the exercise price of the January Warrants will be reduced to such lower price, subject to customary exceptions. In the event that Adjustment Shares are issued, the number of shares that may be purchased under the January Warrants shall be increased by an amount equal to the Adjustment Shares. In addition, the exercise price is subject to adjustment in the event that the VWAP during the VWAP period is less than the exercise price prior to the VWAP Period.

  

 
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We have issued warrants to purchase common stock in July 2010, October 2010, November 2010, December 2011, February 2012, April 2012, May 2012, September 2012, December 2012, April 2013, October 2013, January 2014, and May 2014. The warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

 

For the three and nine months ended September 30, 2014, we recognized a non-operating gain of $1.4 million and a non-operating loss of $19.0 million, respectively, compared with a non-operating gain of $2.2 million and $2.6 million for the same periods in 2013, respectively, related to the revaluation of our warrant liabilities.

 

Recently Issued or Newly Adopted Accounting Standards

 

In August 2014, the FASB issued FASB ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, (“ASU 2014-15”). ASU 2014-15 changes to the disclosure of uncertainties about an entity’s ability to continue as a going concern. Under U.S. GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. Even if an entity’s liquidation is not imminent, there may be conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern. Because there is no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related note disclosures, there is diversity in practice whether, when, and how an entity discloses the relevant conditions and events in its financial statements. As a result, these changes require an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that financial statements are issued. Substantial doubt is defined as an indication that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that financial statements are issued. If management has concluded that substantial doubt exists, then the following disclosures should be made in the financial statements: (i) principal conditions or events that raised the substantial doubt, (ii) management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations, (iii) management’s plans that alleviated the initial substantial doubt or, if substantial doubt was not alleviated, management’s plans that are intended to at least mitigate the conditions or events that raise substantial doubt, and (iv) if the latter in (iii) is disclosed, an explicit statement that there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 is effective for periods beginning after December 15, 2016. The adoption of ASU 2013-15 will not have a material effect on our consolidated financial position or results of operations.

  

 
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Note 3. Discontinued Operations

 

We elected to discontinue our license and management fees segment. We shut down the operations effective April 1, 2014, and all of the assets were absorbed by the Company. The revenues and expenses of discontinued operations for the three and nine months ended September 30, 2014 and 2013, are as follows: 

 

    Three months ended     Nine months ended  
    September 30,     September 30,  
    (unaudited)     (unaudited)  

(in thousands)

 

2014

   

2013

   

2014

   

2013

 
                                 

Revenues

  $ -     $ 21     $ 25     $ 83  
                                 

Expenses

                               

Cost of license and management services

  $ -     $ 59     $ 55     $ 174  

General and administrative expenses

                               

Salaries and benefits

    -       114       96       358  

Other expenses

    -       55       83       173  

Depreciation and amortization

    -       35       4       113  

Total expenses

  $ -     $ 263     $ 238     $ 818  
                                 

Gain (loss) from discontinued operations

  $ -     $ (242 )   $ (213 )   $ (735 )

 

The carrying amount of the assets and liabilities of discontinued operations, were as follows: 

 

           

(audited)

 
   

September 30

   

December 31,

 

(in thousands)

 

2014

   

2013

 

Cash and cash equivalents

  $ 1     $ 24  

Receivables, net

    -       24  

Total assets

  $ 1     $ 48  
                 

Accounts payable

    -       25  

Intercompany Payable

    18       13,119  

Total liabilities

  $ 18     $ 13,144  
                 

Net assets (liabilities) of discontinued operations

  $ (17 )   $ (13,096 )

 

Note 4. Related Party Disclosure

 

In December 2010, we entered into a three-year sublease agreement with Xoftek, Inc., an affiliate of our Chairman and Chief Executive Officer, to sublease approximately one-third of our office space for a three-year term for a monthly rent of approximately $11,000 per month. The related party receivable as of September 30, 2014 and December 31, 2013 was $0 and $115,000, respectively. This is net of an offset against this receivable of $0 and $186,000 payable to our Chairman and Chief Executive Officer at September 30, 2014 and December 31, 2013, respectively. We have offset approximately $382,000 in payables due to our Chairman and Chief Executive Officer as of September 30, 2014.

 

Crede, an affiliate of our Chairman and Chief Executive Officer, participated in our January 2014 and May 2014 Offerings. Crede received approximately 3,662,932 shares of our common stock and warrants to purchase an aggregate 3,662,932 shares of common stock at a price of $0.58 per share, for gross proceeds of approximately $2.1 million.

 

Shamus, a company owned by David E. Smith, a member of the Company’s board of directors, participated in our May 2014 Offering. Shamus received approximately 344,828 shares of our common stock and warrants to purchase an aggregate 344,828 shares of common stock at a price of $0.58 per share, for gross proceeds of approximately $200,000.

  

 
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Note 5. Other Income/Write-off of Liabilities

 

During the quarter ended June 30, 2014, the statute on a research contract, initially entered into in 2005 and amended and breached in 2010 expired in accordance with Section 337 of the California Code of Civil Procedures. Accordingly, we wrote off all balances included in accounts payable and accrued liabilities on our books relating to this contract. The amount recorded to Other Income was approximately $0 and $1.2 million for the three and nine months ended September 30, 2014, respectively.

 

 
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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 financial statements including the related notes, and the other financial information included in this report.

 

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION

 

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 stock of Catasys 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 and Section 27A of the Securities Act of 1933. 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 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, 2013 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.

 

OVERVIEW

 

General

 

We are a healthcare services company, providing specialized health services designed to assist health plans and other third party payors to manage and treat their high cost substance dependence members through a network of healthcare providers and our employees.  The OnTrak program was designed to address substance dependence as a chronic disease. The program seeks to lower costs and improve member health through the delivery of integrated medical and psychosocial interventions in combination with long term “care coaching.”  

 

Recent Developments

 

On September 29, 2014, we entered into securities purchase agreements with several accredited investors, related to the sale and issuance of an aggregate of 750,000 shares of our shares of common stock, at a price of $2.00 per share, for aggregate gross proceeds of $1.5 million. Chardan Capital Markets, LLC acted as the sole placement agent for this private placement, in consideration for which it received 55,000 unregistered shares of our common stock.  

 

Operations

 

In the third quarter of 2014, we operated our integrated substance dependence solutions for third-party payors in Kansas, Louisiana, Massachusetts, Oklahoma, Kentucky, West Virginia, Wisconsin, and Florida. We launched our program in Florida in the third quarter of 2014, and we expect to commence enrollment for another customer in New Jersey during the fourth quarter of 2014. However as our customers control significant portions of implementation, there are no assurances that commencement will not be delayed. We believe that our Catasys offerings address a high cost segment of the healthcare market for substance dependence, and we are currently marketing our Catasys integrated substance dependence solutions to managed care health plans on a case rate, monthly fee, or fee-for-service basis, which involves educating third party payors on the disproportionately high cost of their substance dependent population and demonstrating the potential for improved clinical outcomes and reduced cost associated with using our Catasys programs.

  

 
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Discontinued Operations

 

We have elected to discontinue our license and management fees segment. We shut down the operations effective April 1, 2014 and all of the assets were absorbed by the Company.

 

RESULTS OF OPERATIONS

 

Table of Summary Consolidated Financial Information

 

The table below and the discussion that follows summarizes our results of consolidated operations for the three and nine months ended September 30, 2014 and 2013:

 

(In thousands, except per share amounts)

 

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Revenues

                               

Healthcare services revenues

  $ 370     $ 109     $ 881     $ 315  
                                 

Operating expenses

                               

Cost of healthcare services

    346       162       878       454  

General and administrative

    1,596       1,246       4,642       4,120  

Depreciation and amortization

    30       7       82       18  

Total operating expenses

    1,972       1,415       5,602       4,592  
                                 

Loss from operations

    (1,602 )     (1,306 )     (4,721 )     (4,277 )
                                 

Other Income

    -       -       1,194       -  

Interest expense

    (2 )     (1 )     (2,776 )     (771 )

Change in fair value of warrant liability

    1,397       2,231       (18,995 )     2,607  

Income/(Loss) from continuing operations before provision for income taxes

    (207 )     924       (25,298 )     (2,441 )

Provision for income taxes

    3       2       7       5  

Income/(Loss) from continuing operations

  $ (210 )   $ 922     $ (25,305 )   $ (2,446 )
                                 

Loss from discontinued operations, net of income taxes

  $ -     $ (242 )   $ (213 )   $ (735 )
                                 

Net Income/(Loss)

  $ (210 )   $ 680     $ (25,518 )   $ (3,181 )
                                 
                                 

Basic net income (loss) from continuing operations per share:

  $ (0.01 )   $ 0.06     $ (1.17 )   $ (0.18 )
                                 

Basic weighted number of shares outstanding

    23,513       14,286       21,569       13,429  
                                 

Diluted net income (loss) from continuing operations per share:

  $ (0.01 )   $ 0.05     $ (1.17 )   $ (0.18 )
                                 

Diluted weighted number of shares outstanding

    23,513       19,364       21,569       13,429  
                                 

Basic net income (loss) from discontinued operations per share:

  $ 0.00     $ (0.02 )   $ (0.01 )   $ (0.05 )
                                 

Basic weighted number of shares outstanding

    23,513       14,286       21,569       13,429  
                                 

Diluted net loss from discontinued operations per share:

  $ 0.00     $ (0.01 )   $ (0.01 )   $ (0.05 )
                                 

Diluted weighted number of shares outstanding

    23,513       19,364       21,569       13,429  

 

 
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Summary of Consolidated Operating Results

 

We had net loss from continuing operations before provision for income taxes of $207,000 and $25.3 million for the three and nine months ended September 30, 2014, compared with a net gain of $924,000 and a net loss of $2.4 million for the same period in 2013, respectively. The difference primarily relates to the change in fair value of warrant liability for the three and nine months ended September 30, 2014, respectively, compared to the same period in 2013.

 

Revenues

 

As of September 30, 2014, seven healthcare services contracts were operational resulting in a significant increase in the number of patients being treated compared with the same period in 2013. Recognized revenue increased by $261,000 and $566,000, or 239% and 180%, for the three and nine months ended September 30, 2014, compared with the same period in 2013, respectively. Some of the revenue related to these contracts is initially recorded to deferred revenue as the revenue is subject to performance guarantees, or in the case of case rates received upon enrollment, recognized ratably over the period of enrollment..

 

Cost of Healthcare Services

 

Cost of healthcare services consists primarily of salaries related to our care coaches, healthcare provider claims payments to our network of physicians and psychologists, and fees charged by our third party administrators for processing these claims.  The increase of $184,000 and $424,000 for the three and nine months ended September 30, 2014, compared with the same period in 2013, relates primarily to the increase in members being treated, the mix in members treated, and the addition of care coaches and clinical care coordinators to our staff to manage the increasing number of customers we are servicing, as well as the increasing numbers of enrolled members.

 

General and Administrative Expenses

 

Total general and administrative expense increased by $350,000 and $522,000 for the three and nine months ended September 30, 2014, compared with the same period in 2013, respectively. The increase was due primarily to an increase in salaries and benefits expense as a result of us hiring more employees to service our increasing number of contracts, and investor relations services.

 

Other Income

 

The increase of $1.2 million in other income relates to the write off of all balances in accounts payable and accrued liabilities related to a liability under a previous research contract on which the statute of limitations expiredduring the second quarter of 2014.

 

Interest Expense

 

Interest expense increased by $1,000 and $2.0 million for the three and nine months ended September 30, 2014 compared with the same period in 2014 related to the issuance of warrants as part of our January and May 2014 financings.

 

Change in fair value of warrant liability

 

We issued warrants to purchase common stock in July 2010, October 2010, November 2010, December 2011, February 2012, April 2012, May 2012, September 2012, December 2012, April 2013, October 2013, January 2014, and May 2014. The warrants are being accounted for as liabilities in accordance with Financial Accounting Standards Board (“FASB”) accounting rules, due to provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

 

The decrease in the change in fair value for the warrants was $834,000 and $21.6 million for the three and nine months ended September 30, 2014 compared with the same periods in 2013.

  

 
19

 

 

We will continue to mark-to-market the warrants to market value each quarter-end until they are completely settled.

 

Depreciation and Amortization

 

Depreciation and amortization was immaterial for the three and nine months ended September 30, 2014 and 2013, respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity and Going Concern

 

As of November 13, 2014, we had a balance of approximately $446,000 cash on hand. We had working capital deficit of approximately $1.5 million at September 30, 2014. We have incurred significant operating losses and negative operating cash flows since our inception. We could continue to incur negative cash flows and operating losses for the next twelve months. Our current cash burn rate is approximately $450,000 per month, excluding non-current accrued liability payments. We expect our current cash resources to cover expenses through the end of December 2014, however delays in cash collections, revenue, or unforeseen expenditures, could impact our estimate. We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to stockholders.

 

In September 2014, we entered into securities purchase agreements with several investors, relating to the sale and issuance of an aggregate of 750,000 shares of common stock, for aggregate gross proceeds of approximately $1,500,000.

 

In May 2014, we entered into securities purchase agreements with several accredited investors, including Crede CG III, Ltd., an affiliate of Terren S. Peizer, our Chairman and Chief Executive Officer of the Company, and Shamus, LLC, a company owned by David E. Smith, a member of our board of directors, relating to the sale and issuance of an aggregate of 2,586,210 shares of common stock, and warrants (the “May Warrants”) to purchase an aggregate of 2,586,210 shares of Common Stock at an exercise price of $0.58 per share for an aggregate gross proceeds of approximately $1,500,000. The May Warrants expire in May 2019, and contain anti-dilution provisions. As a result, if we, in the future, issue or grant any rights to purchase any of our common stock, or other security convertible into our common stock, for a per share price less than the exercise price of the May Warrants, the exercise price of the May Warrants will be reduced to such lower price, subject to customary exceptions.

 

In January 2014, we entered into securities purchase agreements with several investors, including Crede CG III, Ltd., an affiliate of Mr. Peizer, Chairman and Chief Executive Officer of the Company, relating to the sale and issuance of an aggregate of 1,724,141 shares of common stock, and warrants (the “January Warrants”) to purchase an aggregate of 1,724,141 shares of common stock at an exercise price of $0.58 per share for aggregate gross proceeds of approximately $1,000,000. The January Warrants expire in January 2019, and contain anti-dilution provisions. As a result, if we, in the future, issue or grant any rights to purchase any of our common stock, or other security convertible into our common stock, for a per share price less than the exercise price of the January Warrants, the exercise price of the January Warrants will be reduced to such lower price, subject to customary exceptions.

 

Our ability to fund our ongoing operations and continue as a going concern is also dependent on signing new contracts and generating fees from existing and new contracts for our Catasys managed care programs and the success of management’s plans to increase revenue and continue to control expenses. We are currently operating programs in Kansas, Massachusetts, Oklahoma, Louisiana, Kentucky, West Virginia, Wisconsin, and Florida. We expect to commence enrollment for another customer in New Jersey during the fourth quarter of 2014. We have generated fees from the launched programs and expect to continue to increase enrollment and fees throughout 2014. However, there can be no assurance that we will generate such fees. We are in need of additional capital, however, there is no assurance that additional capital can be timely raised in an amount which is sufficient for us or on terms favorable to us and our stockholders, if at all. If we do not obtain additional capital, there is a significant doubt as to whether we can continue to operate as a going concern and we will need to curtail or cease operations or seek bankruptcy relief. If we discontinue operations, we may not have sufficient funds to pay any amounts to stockholders.

  

 
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Cash Flows

 

We used $3.4 million of cash for continuing operating activities during the nine months ended September 30, 2014 compared with $3.7 million in the same period in 2013. Significant non-cash adjustments to operating activities for the nine months ended September 30, 2014 included share-based compensation expense of $39,000, depreciation and amortization of $87,000, equity issuance costs of $2.8 million, the write-off of accrued liabilities of $1.2 million, and a fair value adjustment on warrant liability of $19.0million.

 

Capital expenditures for the three and nine months ended September 30, 2014 were not material. Our future capital expenditure requirements will depend upon many factors, including obsolescence or failure of our systems, progress with expanding the adoption of our programs, and our marketing efforts, the necessity of, and time and costs involved in obtaining, regulatory approvals, competing technological and market developments, and our ability to establish collaborative arrangements, effective commercialization, marketing activities and other arrangements.

 

Our net cash provided by financing activities was $4.1 million for the nine months ended September 30, 2014, compared with net cash provided by financing activities of $1.5 million for the nine months ended September 30, 2013. Cash provided by financing activities for the nine months ended September 30, 2014 consisted of the net proceeds from the securities offerings in January 2014, May 2014 and September 2014, leaving a balance of $1.5 million in cash and cash equivalents at September 30, 2014.

 

OFF BALANCE SHEET ARRANGEMENTS

 

As of September 30, 2014, we had no off-balance sheet arrangements.

 

CRITICAL ACCOUNTING ESTIMATES

 

The discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. We base our estimates on experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. On an on-going basis, we evaluate the appropriateness of our estimates and we maintain a thorough process to review the application of our accounting policies. Our actual results may differ from these estimates.

 

We consider our critical accounting estimates to be those that (1) involve significant judgments and uncertainties, (2) require estimates that are more difficult for management to determine, and (3) may produce materially different results when using different assumptions. We have discussed these critical accounting estimates, the basis for their underlying assumptions and estimates and the nature of our related disclosures herein with the audit committee of our Board of Directors. We believe our accounting policies specific to the fair value of warrants, share-based compensation expense, and the impairment assessment for intangible assets, involve our most significant judgments and estimates that are material to our consolidated financial statements. They are discussed further below.

 

Warrant Liabilities

 

We issued warrants to purchase common stock in July 2010, October 2010, November 2010, December 2011, February 2012, April 2012, May 2012, September 2012, December 2012, April 2013, October 2013, January 2014, and May 2014. The warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

  

 
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For the three and nine months ended September 30, 2014, we recognized a non-operating gain of $1.4 million and a non-operating loss of $19.0 million, respectively, compared with a non-operating gain of $2.2 million and $2.6 million for the same periods in 2013, respectively, related to the revaluation of our warrant liabilities.

 

Share-based compensation expense

 

We account for the issuance of stock, stock options, and warrants for services from non-employees based on an estimate of the fair value of options and warrants issued using the Black-Scholes pricing model. This model’s calculations include the exercise price, the market price of shares on grant date, weighted average assumptions for risk-free interest rates, expected life of the option or warrant, expected volatility of our stock and expected dividend yield.

 

The amounts recorded in the financial statements for share-based compensation expense could vary significantly if we were to use different assumptions. For example, the assumptions we have made for the expected volatility of our stock price have been based on the historical volatility of our stock, measured over a period generally commensurate with the expected term. If we were to use a different volatility than the actual volatility of our stock price, there may be a significant variance in the amounts of share-based compensation expense from the amounts reported. The weighted average expected option term for the three and nine months ended September 30, 2014 and 2013, reflects the application of the simplified method set out in SEC Staff Accounting Bulletin No. 107, which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.

 

From time to time, we have retained terminated employees as part-time consultants upon their resignation from the Company. Because the employees continue to provide services to us, their options continue to vest in accordance with the original terms. Due to the change in classification of the option awards, the options are considered modified at the date of termination. The modifications are treated as exchanges of the original awards in return for the issuance of new awards. At the date of termination, the unvested options are no longer accounted for as employee awards and are accounted for as new non-employee awards. The accounting for the portion of the total grants that have already vested and have been previously expensed as equity awards is not changed. There were no employees moved to consulting status for the three and nine months ended September 30, 2014 and 2013, respectively.

 

Impairment of Intangible Assets

 

We have capitalized significant costs for acquiring patents and other intellectual property directly related to our products and services. We review our intangible assets for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. In reviewing for impairment, we compare the carrying value of such assets to the estimated undiscounted future cash flows expected from the use of the assets and/or their eventual disposition. If the estimated undiscounted future cash flows are less than their carrying amount, we record an impairment loss to recognize a loss for the difference between the assets’ fair value and their carrying value. Since we have not recognized significant revenue to date, our estimates of future revenue may not be realized and the net realizable value of our capitalized costs of intellectual property or other intangible assets may become impaired.

 

During the three and nine months ended September 30, 2014, we did not acquire any new intangible assets and at September 30, 2014, all of our intangible assets consisted of intellectual property, which is not subject to renewal or extension. We had no intangible impairment for the three and six months ended September 30, 2014 or 2013.

  

 
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RECENT ACCOUNTING PRONOUNCEMENTS

 

In August 2014, the FASB issued FASB ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, (“ASU 2014-15”). ASU 2014-15 changes to the disclosure of uncertainties about an entity’s ability to continue as a going concern. Under U.S. GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. Even if an entity’s liquidation is not imminent, there may be conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern. Because there is no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related note disclosures, there is diversity in practice whether, when, and how an entity discloses the relevant conditions and events in its financial statements. As a result, these changes require an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that financial statements are issued. Substantial doubt is defined as an indication that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that financial statements are issued. If management has concluded that substantial doubt exists, then the following disclosures should be made in the financial statements: (i) principal conditions or events that raised the substantial doubt, (ii) management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations, (iii) management’s plans that alleviated the initial substantial doubt or, if substantial doubt was not alleviated, management’s plans that are intended to at least mitigate the conditions or events that raise substantial doubt, and (iv) if the latter in (iii) is disclosed, an explicit statement that there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 is effective for periods beginning after December 15, 2016. The adoption of ASU 2013-15 will not have a material effect on our consolidated financial position or results of operations.

 

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

Item 4.     Controls and Procedures

 

Disclosure Controls

 

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 September 30, 2014. Based on this evaluation, our principal executive officer and our principal financial officer have concluded that 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 September 30, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II – OTHER INFORMATION

 

Item 1.     Legal Proceedings

 

None.

 

Item 1A.     Risk Factors

 

There have been no material changes in our risk factors from those disclosed in our most recent Annual Report on Form 10-K.

 

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

In September 2014, we issued 55,000 restricted shares of common stock to a consultant for investor relations services to be performed in September 2014. These securities were issued without registration pursuant to exemption afforded by Section 4(a)(2) of the Securities Act of 1933.

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 4.     Mine Safety Disclosures.

 

Not applicable.

 

Item 5.     Other Information

 

Effective November 13, 2014, Minal Patel resigned from his position as a member of our Board of Directors. Mr. Patel also resigned from his positions as member of our Compensation Committee and Corporate Governance Committee of the Board of Directors.  Mr. Patel accepted a position with a healthcare company whose policies prohibit officers from serving as a member of any for-profit company board of directors. 

 

Effective November 13, 2014, Steve Gorlin was appointed as a member of our Board of Directors to fill the vacancy created by the resignation of Mr. Patel. 

 

Mr. Gorlin, age 77, an entrepreneur who has founded numerous successful biotechnology and pharmaceutical companies over the last 40 years, including Medivation and Entremed. He currently serves as Executive Chairman to Conkwest, Inc. and served as Chairman of the Board of MiMedx, Inc., a wound care Company, from November 2006 to June 2013.  Mr. Gorlin served many years on the Business Advisory Council to the Johns Hopkins School of Medicine as well as on the advisory board of the Johns Hopkins BioMedical Engineering Advisory Board. 

 

Mr. Gorlin will be entitled to receive the same compensation as the other non-employee directors of the Company are entitled to receive. There are no arrangements or understandings between Mr. Gorlin and any other person pursuant to which he was selected as a director. The Company is not aware of any transaction in which Mr. Gorlin has an interest requiring disclosure under Item 404(a) of Regulation S-K.

 

Item 6.     Exhibits

 

Exhibit 10.1

Form of Securities Purchase Agreement, dated September 29, 2014, between Catasys, Inc. and accredited investors (incorporated by reference to Exhibit 10.1 of Catasys Inc.’s Form 8-K filed with the Securities and Exchange Commission on September 30, 2014.)

Exhibit 31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS

XBRL Instance

101.SCH

XBRL Taxonomy Extension Schema

101.CAL

XBRL Taxonomy Extension Calculation

101.DEF

XBRL Taxonomy Extension Definition

101.LAB

XBRL Taxonomy Extension Labels

101.PRE

XBRL Taxonomy Extension Presentation

 

 
24

 

 

 

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.

 

 

CATASYS, INC.

     
     

Date:   November 14, 2014

By:  

/s/ TERREN S. PEIZER  

 

 

Terren S. Peizer 

 

 

Chief Executive Officer

(Principal Executive Officer) 

 

 

   

Date:   November 14, 2014

By:  

/s/ SUSAN ETZEL

   

Susan Etzel

   

Chief Financial Officer

(Principal Financial and Accounting Officer) 

 

 

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