Note 1.Basis of Consolidation, Presentation and Liquidity

We harness proprietary big data predictive analytics, artificial intelligence and Presentation telehealth, combined with human intervention, to deliver improved member health and cost savings to health plans through integrated technology enabled treatment solutions. It is our mission to provide access to affordable and effective care, thereby improving health and reducing cost of care for people who suffer from the medical consequences of behavioral health conditions; helping these people and their families achieve and maintain better lives.

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-Q10-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-K10-K for the year-ended December 31, 2016, 2017, from which the balance sheet, as of December 31, 2016, have2017, has been derived.

Our ability to fund our ongoing operations is dependent on increasing the number of members that are eligible for our solutions by signing new contracts, identifying more eligible members in existing contracts, and generating fees from existing and new contracts and the success of management’s plan to increase revenue and continue to control expenses. We currently operate our OnTrak solutions in nineteen 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 2018.

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. These conditions raise substantial doubt about our ability to continue as a going concern.  The accompanying financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We entered into contracts for additional revenue-generating health plan customers and expanding our OnTrak program within existing health plan customers.  To support this increased demand for services, we invested in the additional headcount needed to support these customers launching during the first quarter of 2018.  We have had a growing customer base and are able to fully scale our operations to service the contracts and future enrollment providing leverage in these investments that is expected to result in positive cash flow by the end of 2018. Based upon this expected positive cash flow, we believe we will have enough capital to cover expenses through at least the next twelve months. We will continue to monitor liquidity carefully and in the event we do not have enough capital to cover expense we will make the necessary and appropriate reductions in spending to remain cash flow positive.  However, if we were to 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 would need to finance these options via a debt financing rather than an equity financing.

All inter-company transactions have been eliminated in consolidation.

Note 2. Summary of Significant Accounting Policies

Revenue Recognition

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 contract (in thousands):

Because the Company’s contracts have an expected duration of one year or less, the Company has elected the practical expedient in ASC 606-10-50-14(a) to not disclose information about its remaining performance obligations.

Our Catasys contracts are generally designed to provide cash fees to us on a monthly basis, or an upfront case rate, or fee for service based on enrolled members. ToThe Company’s performance obligation is satisfied over time as the extent our contracts may includeOnTrak service is provided continuously throughout the service period. The Company recognizes revenue evenly over the service period using a time-based measure because the Company is providing a continuous service to the customer. Contracts with minimum performance guarantee; we reserve a portion of the fees that may be at risk until the performance measurement period is completed. To the extent we receive case ratesguarantees or other fees in advance thatprice concessions include variable consideration and are not subject to the revenue constraint. The Company uses an expected value method to estimate variable consideration for minimum performance guarantees we recognizeand price concessions. The Company has constrained revenue for expected price concessions during the case rate ratably over the twelve months of our program. We recognize any fees from sharing in the savings generated from enrolled members when we receive payment.period ending March 31, 2018.

Cost of Services

Cost of healthcare services 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 eOnOnTrak^TM 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. Cash is deposited with what we believe are highly credited, quality financial institutions.institutions. The deposited cash may exceed Federal Deposit Insurance Corporation (“FDIC”) insured limits. As of September 30, 2017, we had $6.8 million in March 31, 2018, cash and cash equivalents exceeding federally insured limits.limits totaled $1.2 million.

For the ninethree months ended September 30, 2017, threeMarch 31, 2018, five customers accounted for approximately 90%89% of the Company’s revenues (22%,20%,18%,15%,14%) and fivefour customers accounted for approximately 96%83% of accounts receivable.receivable (37%,18%,15%,13%).

Basic and Diluted Income (Loss) per Share

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

Common equivalent shares, consisting of 2,255,3813,920,531 and 1,178,8211,928,431 common shares for the ninethree months ended September 30, 2017 March 31, 2018 and 2016,2017, 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.

Share-Based Compensation

Our 2017 Stock Incentive Plan (the “2017“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“2010 Plan”). Incentive stock options (ISOs) under Section 422A of the Internal Revenue Code and non-qualified options (NSOs) are authorized under the2017 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, 2017, As of March 31, 2018, we had 243,8531,885,003 shares outstanding, of which 338,178 shares are vested and unvested692,184 shares outstanding and 2,333,334 sharesare available for future awards under the 2017 Plan.

Share-basedShare-based compensation expense attributable to continuing operations were $32,000$328,000 and $191,000$127,000 for the three and nine months ended September 30, 2017, compared with $174,000 March 31, 2018 and $523,000 for the same periods in 2016,2017, respectively.

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 consolidated statements of operations.

Share-based compensation expense recognized for employees and directors for the three and nine months ended September 30, 2017 was $32,000 and $191,000, compared with $174,000 and $523,000, for the same periods in 2016, respectively.

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 consolidated statements of operations for the three and nine months ended September 30, 2017 March 31, 2018 and 20162017, 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.

There were no options granted to employees and directors during the three and nine months ended September 30, 2017 March 31, 2018 and 2016,2017, respectively, under the 2017 Plan. Employee and director stock option activity for the three and nine months ended September 30, 2017 March 31, 2018 are as follows:

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 threeand nine months ended September 30, 2017 March 31, 2018 and 2016,2017, reflects the application of the simplified method prescribed in Securities and Exchange Commission (“SEC”)SEC Staff Accounting Bulletin (“SAB”) No.107 (as amended by SAB 110)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.

As of September 30, 2017, March 31, 2018, there was $127,500$4.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2017 Plan. That cost is expected to be recognized over a weighted-average period of approximately 1.023.26 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.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, March 31, 2018 and 2017, or during the same periods in 2016.

respectively. There was no share based share-based compensation expense relating to stock options and warrants recognized for the non-employees for the three and nine months ended September 30, March 31, 2018 and 2017, or respectively.

There were 24,000 and 0 warrants issued in exchange for investor relations services during the same periods in 2016.three months ended March 31, 2018 and 2017, respectively. Generally, the costs associated with warrants issued for services are amortized to the related expense on a straight-line basis over the related service periods.

There were 2,035,528 and 1,684,578 warrants outstanding as of March 31, 2018 and 2017, respectively.

Common Stock

In April 2017, we entered into an underwriting agreement with Joseph Gunnar & Co., LLC (“Joseph Gunnar”), as underwriter in connection with a public offering of the Company’s securities. Pursuant to the underwriting agreement, we agreed to issueThere were 24,000 and sell an aggregate 3,125,000 shares of common stock at a public offering price of $4.80 per share, and the purchase price to the underwriter after discounts and commission was $4.464 per share. The closing of the offering occurred on April 28, 2017. We received $15.0 million in gross proceeds in connection with the offering.

Pursuant to the underwriting agreement with Joseph Gunnar, we granted the underwriters a 45 day over-allotment option to purchase up to 468,750 additional shares of common stock at the public offering price less the applicable underwriter discount. In May, the underwriter acquired an additional 303,750 shares pursuant to such over-allotment option. We received $1.5 million in gross proceeds in connection with the over-allotment option.

In connection with the public offering, our common stock began trading on the NASDAQ Capital Market (“NASDAQ”) under the symbol “CATS” beginning on April 26, 2017.

In April 2017, several investors, including Acuitas Group Holdings, LLC (“Acuitas”), one hundred percent (100%) of which is owned by 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 our board of directors, exercised their option to convert their convertible debentures and received 2,982,994 shares of common stock. There was a loss on the conversion of the convertible debentures of $1.4 million for the nine months ended September 30, 2017.

In April 2017, Terren S. Peizer agreed to settle his deferred salary balance of $1.1 million for 233,734 shares of common stock. As a result, we recognized a loss on settlement of liability totaling $83,807 which is recorded to loss on issuance of common stock.

In April 2017, we filed a certificate of amendment to our Certificate of Incorporation, as amended and in effect, with the Secretary of State of the State of Delaware, implementing a 1-for-6 reverse stock split of our common stock, pursuant to which each six shares of issued and outstanding common stock converted into one share of common stock. Proportionate voting rights and other rights of common stock holders were not affected by the reverse stock split.  No fractional shares of common stock were issued as a result of the reverse stock split; stockholders were paid cash in lieu of any such fractional shares.

All stock options and warrants to purchase common stock outstanding and our common stock reserved for issuance under our equity incentive plans immediately prior to the reverse stock split were appropriately adjusted by dividing the number of affected shares of common stock by six and, as applicable, multiplying the exercise price by six as a result of the reverse stock split.

There were 0 and 28,98514,492 shares of common stock issued in exchange for investor relations services during the three and nine months ended September 30, 2017 March 31, 2018 and no common stock issued in exchange for investor relations services during the same period in 2016.2017, 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.

Income Taxes

We have recorded a full valuation allowance against our otherwise recognizable deferred tax assets as of September 30, 2017.  March 31, 2018.  As such, we have not recorded a provision for income tax for the period ended September 30, 2017.  March 31, 2018.  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.

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 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, 2017 March 31, 2018 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)(1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2)(2) an entity’sentity’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 table summarizes fair value measurements by level at September 30, 2017 March 31, 2018 for assets and liabilities measured at fair value:

Carrying amounts reported in the condensed consolidated balance sheet of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value due to their relatively short maturity. The fair value of borrowings is not considered to be significantly different from its carrying amount because stated rates for such debt reflect current market rates and conditions.

Financial instruments classified as Level III in the fair value hierarchy as of September 30, 2017, March 31, 2018, represent our liabilities measured at market value on a recurring basis which include warrant liabilities and derivative liabilities resulting from recent debt financing.and equity financings. In accordance with current accounting rules, the warrant liabilities with anti-dilution protectionand derivative liabilities are being marked-to-market each quarter-end until they are completely settled or expire. The warrants and derivative liabilities 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, 2017:March 31, 2018:

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 March 2017, we entered into amendments with the holders of certain outstanding warrants issued on April 17, 2015 and July 30, 2015 to eliminate certain anti-dilution provisions in such warrants, which caused us to reflect an associated liability of $5.3 million on our balance sheet as of December 31, 2016. Such amendments were contingent upon and did not take effect until the closing of the public offering. For each warrant share underlying the warrants so amended, the holder received the right to purchase an additional .2 shares of common stock. Two of the holders of such warrants, which owners hold warrants to purchase an aggregate of 11,049 shares of common stock, did not agree to the amendment. The warrant holders agreeing to the amendment include Acuitas and another accredited investor, who received additional warrants to purchase 31,167 and 13,258 shares of our common stock. In addition, several warrant agreements that had anti-dilution protection had a provision in the agreement that upon an up-listing to NASDAQ, the anti-dilution protection would be removed. The up-listing to NASDAQ occurred on April 26, 2017. The elimination of the anti-dilution provision resulted in the write-off of $6.2 million of the warrant liability as of September 30, 2017.

        In January 2017, we entered into a Subscription Agreement (the “Subscription Agreement”) with Acuitas, pursuant to which we received aggregate gross proceeds of $1,300,000 (the “Loan Amount”) in consideration of the issuance of (i) an 8% Series B Convertible Debenture due March 31, 2017 (the “January 2017 Convertible Debenture”) and (ii) five-year warrants to purchase shares of our common stock in an amount equal to one hundred percent (100%) of the initial number of shares of common stock issuable upon the conversion of the January 2017 Convertible Debenture, at an exercise price of $5.10 per share (the “January 2017 Warrants”). In addition, any warrants issued in conjunction with the December 2016 Convertible Debenture currently outstanding with Acuitas have been increased by an additional 25% warrant coverage, exercisable for an aggregate of 137,883 shares of the Company’s common stock. Acuitas agreed to extend the maturity date of the January 2017 Convertible Debenture to April 30, 2017 or until we completes a public offering, whichever came first. In April 2017, we used the net proceeds from the public offering to repay the Loan Amount including interest of $1.3 million.

       The January 2017 Warrants include, among other things, price protection provisions pursuant to which, subject to certain exempt issuances, the then exercise price of the January 2017 Warrants will be adjusted if we issue shares of our common stock at a price that is less than the then exercise price of the January 2017 Warrants. Such price protection provisions will remain in effect until the earliest of (i) the termination date of the January 2017 Warrants, (ii) such time as the January 2017 Warrants are exercised or (iii) contemporaneously with the listing of our shares of common stock on a registered national securities exchange.

       In connection with the Subscription Agreement described above, the number of Shamus warrants issued as part of the December 2016 Convertible Debenture were increased from 75% to 100% warrant coverage, exercisable for an aggregate of 14,706 shares of the Company’s common stock.Warrant Liabilities

The warrant liabilities were calculated using the Black-Scholes model based upon the following assumptions:assumptions:

We have issued warrants to purchase common stock in February 2012, April 2015, July 2015, August 2016, December 2016, January 2017, February 2017, March 2017, AprilJune 2017, and June 2017. SomeFebruary 2018. 11,049 of theour warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to anti-dilution provisions in somethe warrants that protect the holders from declines in our stock price, 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.

ForFor the three and nine months ended September 30, March 31, 2018 and 2017, we recognized a loss of $2,000$10,000 and a gain of $1.8$5.2 million, respectively, compared with a gain of $1.4 million and $673,000 for the same periods in 2016, respectively, related to the revaluation of our warrant liabilities.

Derivative Liability

In July 2015, we entered into a $3.55 million 12% Original Issue Discount Convertible Debenture due January 18, 2016 with Acuitas (the “July 2015 Convertible Debenture”). The conversion price of the July 2015 Convertible Debenture is $11.40 per share, subject to adjustments, including for issuances of common stock and common stock equivalents below the then current conversion or exercise price, as the case may be.  In October 2016, we entered into an amendment of the July 2015 Convertible Debenture which extended the maturity date of the Convertible Debenture from January 18, 2016 to January 18, 2017. In addition, the conversion price of the July 2015 Convertible Debenture was subsequently adjusted to $1.80 per share. The July 2015 Convertible Debentures are unsecured, bear interest at a rate of 12% per annum payable in cash or shares of common stock, subject to certain conditions, at our option, and are subject to mandatory prepayment upon the consummation of certain future financings. Acuitas agreed to extend the maturity date of the July 2015 Convertible Debenture to April 30, 2017 or until we completed a public offering, whichever came first. In April 2017, the July 2015 Convertible Debenture was converted into 2,385,111 shares of common stock and the derivative liability was written off.

For the three and nine months ended September 30, 2017, we recognized a gain of $0 and $132,000, respectively, compared with a loss of $3.5 million and $6.3 million for the same periods in 2016, related to the revaluation of our derivative liability.

Recently Issued or Newly Adopted Accounting Standards

In April 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-10, 2016-10,Revenue from Contracts with Customers (Topic 606)606)(“ASU 2016-10”), which amends certain aspects of the Board’s new revenue standard, ASU 2014-09,2014-09, Revenue from Contracts with Customers. The standard should be adopted concurrently with adoption of ASU 2014-092014-09, which is effective for annual and interim periods beginning after December 15, 2017.Early adoption is permitted. We have selected the modified retrospective approach as our transition method under ASU 2016-10 and the financial impact to the financial statements was to decrease retained earnings and deferred revenue by $1.9 million effective January 1, 2018 (Please see footnote 3).

In February 2016, FASB issued Accounting Standards Update (ASU) No.2016-02,Leases (Topic 842) (“ASU 2016-02”).Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the lease commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and 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. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606,Revenue from Contracts with Customers. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted.  Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. We are currently evaluating the potentialexpected impact that the standard could have on our condensed consolidated financial statements and related disclosures.

In June 2016, FASB issued ASU 2016-13,Financial Instruments - Credit Losses. 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. The Company is 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 condensed consolidated financial statements and related disclosures.

In July 2017, the Financial Accounting Standards Board (“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. The amendments in this update are intended to simplify the accounting for certain equity linkedfinancial instruments and embedded features with down round features that result in the strike price being reduced on the basis of the pricing of futureequity offerings. Under the new guidance, a down round feature will no longer need to be considered when determining whether certain financial instrumentsor embedded features should be classified as wellliabilities or equity instruments. That is, a down round feature will no longer preclude equity classification whenassessing whether an instrument or embedded feature is indexed to an entity's own stock. In addition, the amendments clarify existing disclosurerequirements for equity-classified instruments. These amendments are effective for fiscal years, and interim periods within those years, beginning afterDecember 15, 2018, with early adoption permitted. The adoption of this ASU should not have a material impact on our condensed consolidated financial statements.

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 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 available transition methods. Webasis 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 currently assessing whetherconditions 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 2016-10 will2014-15 did not have a material effect on our consolidated financial position or results of operations.

Note 3.ASC 606

        In May 2014, the FASB issued Accounting Standards Update (“ASU”) No.2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC 605 - Revenue Recognition (“ASC 605”) and most industry-specific guidance throughout ASC 605. The FASB has issued numerous updates that provide clarification on a number of specific issues as well as requiring additional disclosures. The core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.

We adopted ASC 606 effective January 1, 2018 using the modified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The cumulative effect of the changes made to our consolidated January 1, 2018 balance sheet for the adoption of ASU 2014-09, Revenue - Revenue from Contracts with Customers were as follows (in thousands): 

In March 2016,accordance with the FASB issued ASU 2016-09,Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting(“ASU 2016-09”), which outlines new provisions intended to simplify various aspects related to accounting for share-based payments and their presentation inrevenue standard requirements, the financial statements. The standard is effective beginning December 15, 2016, and interim periods within those annual periods. Earlydisclosure of the impact of adoption is permitted. The adoption of ASU 2016-09 did not have a material effect on our consolidated financial position or results of operations.

Note 3. Related Party Disclosure

In January 2017, we entered into the Subscription Agreement with Acuitas pursuant to which we received aggregate gross proceeds of $1.3 millionincome statement and warrants to purchase 254,904 shares of common stock. In April 2017, we used the net proceeds from the public offering to repay the Loan Amount including interest of $1.3 million. 

In January 2017, in connection with the Subscription Agreement described above, the number of Acuitas warrants issuedbalance sheet was as part of the December 2016 Convertible Debenture were increased from 75% to 100% warrant coverage, exercisable for an aggregate of 137,883 shares of our common stock.

In March 2017, we entered into an amendment with Acuitas of certain outstanding warrants issued in July 2015 to eliminate certain anti-dilution provisions in such warrants. Such amendment was contingent upon and did not take effect until the closing of the public offering. For each warrant share underlying the warrants so amended, the holder received the right to purchase an additional .2 shares of common stock. Acuitas received additional warrants to purchase 31,167 shares of our common stock in April 2017.

In April 2017, Acuitas purchased 181,154 shares of common stock for $869,539 in proceeds in connection with the public offering.

In April 2017, Acuitas converted its July 2015 convertible debenture totaling $4.3 million of principal and interest into 2,385,111 shares of common stock.

In April 2017, we used net proceeds from the public offering to repay Acuitas the December 2016 8% convertible debenture with accrued interest of $2.9 million.

In April 2017, Terren S. Peizer agreed to settle his deferred salary balance of $1.1 million for 233,734 shares of common stock, resulting in a loss on settlement of liability totaling $83,807 recorded to loss on issuance of common stock.

In addition, we have accounts payable outstanding with Mr. Peizer for travel and expenses of approximately $223,000 as of September 30, 2017.

       In January 2017, in connection with the Subscription Agreement described above, the number of Shamus warrants issued as part of the December 2016 Convertible Debenture were increased from 75% to 100% warrant coverage, exercisable for an aggregate of 14,706 shares of our common stock.

In March 2017, Shamus converted $1.3 million of their December 2016 Convertible Debentures and accrued interest for 276,204 shares of our common stock.follows (in thousands):

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 elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this report and our annual report filed on Form 10-K for the year ended December 31, 2016.2017.

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 our stock and other matters. Statements in this report that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Exchange Act of 1934, as amended (the “Exchange Act”) and Section 27A of the Securities Act of 1933, as amended. Such forward-looking statements, including, without limitation, those relating to the future business prospects, our revenue and income, wherever they occur, are necessarily estimates reflecting the best judgment of our senior management as of the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to 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, 20162017 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 provide harness proprietary big data basedpredictive analytics, artificial intelligence and predictive modeling driven behavioral healthcare servicestelehealth, combined with human intervention, to deliver improved member health and cost savings to health plans through integrated technology enabled treatment solutions. It is our OnTrak solution. mission to provide access to affordable and effective care, thereby improving health and reducing cost of care for people who suffer from the medical consequences of behavioral health conditions; helping these people and their families achieve and maintain better lives.

Our OnTrak solution issolution--contracted with a growing number of national and regional health plans--is designed to improve member health and at the same time lower costs to the insurer for underserved populations wheretreat members with behavioral health conditions are causingthat cause or exacerbatingexacerbate co-existing medical conditions. The program utilizes proprietary analytics andWe have a unique ability to engage these members, who do not otherwise seek behavioral healthcare, leveraging proprietary enrollment capabilities built on deep insights into the drivers of care avoidance matched with data driven motivational and consumer engagement and behavioral modification capabilities to assist members who otherwise do not seek care through a patient centric treatment thattechnologies.

OnTrak integrates evidence-based medical and psychosocial interventions along with care coaching in a 52-week outpatient solution. Our initial focus wasThe program is currently improving member health and, at the same time, is demonstrating reduced inpatient and emergency room utilization, driving a more than 54 percent reduction in total health insurers' costs for enrolled members. OnTrak is available to members with substance use disorders, but we have expanded our solution to assist members with anxietyof several leading health plans in Connecticut, Florida, Georgia, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, West Virginia and depression. Wisconsin.

Operations

We currently operate our OnTrak solutions in Connecticut, Florida, Georgia, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, West Virginia and Wisconsin. We provide services to commercial (employer funded), managed Medicare Advantage, and managed Medicaid and duel eligible (Medicare and Medicaid) populations.

Recent Developments

Amendments to Outstanding Warrants and Extension of Existing Debentures

In March 2017, we entered into amendments with the holders of certain outstanding warrants issued on April 17, 2015 and July 30, 2015 to eliminate certain anti-dilution provisions in such warrants, which caused us to reflect an associated liability of $5.3 million on our balance sheet as of December 31, 2016. Such amendments were contingent upon and did not take effect until the closing of the public offering described below. For each warrant share underlying the warrants so amended, the holder received the right to purchase an additional .2 shares of common stock. Two of the holders of such warrants, which owners hold warrants to purchase an aggregate of 11,049 shares of common stock, did not agree to the amendment. The warrant holders agreeing to the amendment include Acuitas and another accredited investor, who received additional warrants to purchase 31,167 and 13,258 shares of our common stock. In addition, several warrant agreements that had anti-dilution protection had a provision in the agreement that upon an up-listing to NASDAQ, the anti-dilution protection would be removed. The up-listing to NASDAQ occurred on April 26, 2017. The elimination of the anti-dilution provision resulted in the write-off of $6.9 million of the warrant liability as of September 30, 2017.

Reverse Stock Split

On April 21, 2017, we filed a certificate of amendment to our Certificate of Incorporation, as amended and in effect, with the Secretary of State of the State of Delaware implementing a 1-for-6 reverse stock split of the Company's common stock, pursuant to which each 6 shares of issued and outstanding common stock converted into 1 share of common stock. Proportionate voting rights and other rights of common stock holders were not affected by the reverse stock split.  No fractional shares of common stock were issued as a result of the reverse stock split; stockholders were paid cash in lieu of any such fractional shares. The 1-for-6 reverse stock split became effective at 5:00 p.m., Eastern Time, on April 24, 2017, and our common stock began trading on the OTCQB Marketplace on a post-split basis at the open of trading on April 25, 2017. Our post-reverse split common stock has a new CUSIP number: 149049 504. Other terms of the common stock were not affected by the reverse stock split.  The common stock will continue to trade under the symbol "CATS." 

All stock options and warrants to purchase common stock outstanding and our common stock reserved for issuance under our equity incentive plans immediately prior to the reverse stock split were appropriately adjusted by dividing the number of affected shares of common stock by six and, as applicable, multiplying the exercise price by six as a result of the reverse stock split.

Public Offering

On April 25, 2017, we entered into an underwriting agreement with Joseph Gunnar & Co., LLC (“Joseph Gunnar”), as underwriter in connection with a public offering of our securities. Pursuant to the underwriting agreement, we agreed to issue and sell an aggregate of 3,125,000 shares of common stock at a public offering price of $4.80 per share, and the purchase price to the underwriter after discounts and commissions was $4.464 per share. The closing of the offering occurred on April 28, 2017.

Pursuant to the underwriting agreement, we issued to the underwriter a warrant for the purchase of an aggregate of 156,250 shares of common stock for an aggregate purchase price of $100. The exercise price of the warrant is equal to 125% of the public offering price in the offering, or $6.00 per share of common stock.

NASDAQ Uplisting

In connection with the public offering, our common stock began trading on the Nasdaq Capital Market under the symbol “CATS” beginning on April 26, 2017.

Exercise of Over-Allotment Option

Pursuant to the underwriting with Joseph Gunnar dated April 25, 2017, we granted the underwriters a 45-day over-allotment option to purchase up to 468,750 additional shares of common stock at the public offering price less the applicable underwriter discount. On May 2, 2017, the underwriter acquired an additional 303,750 shares pursuant to such over-allotment option.

Operations

        We currently operate our OnTrak solutions in Connecticut, Florida, Georgia, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Missouri, New Jersey, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Virginia, West Virginia and Wisconsin. We provide services to commercial (employer funded), managed Medicare Advantage, and managed Medicaid and dueldual eligible (Medicare and Medicaid) populations. We have generated fees from our launched programs and expect to launch additional customers and increase enrollment and fees throughout 2017.2018. However, there can be no assurance that we will generate such fees or that new programs will launch as we expect.

RESULTS OF OPERATIONS

Table of Summary Consolidated Financial Information

The table below and the discussion that follows summarize our results of consolidated operations for the three and nine months ended September 30, 2017March 31, 2018 compared to the three and nine months ended September 30, 2016:March 31, 2017:

Summary of Consolidated Operating Results

Loss from operations before provision for income taxes for the three and nine months ended September 30, 2017March 31, 2018 was $3.1 million and $10.9$4.2 million, compared with a net loss of $7.4 million and $16.4$21.8 million for the same periodsperiod in 2016, respectively.2017. The difference primarily relates to the decrease in interest expense, the decrease in the loss on conversion of note, the decrease in the loss from change in fair value of warrant liability, and the decrease in the loss from change in fair value of the derivative liability for the three and nine months ended September 30, 2017,March 31, 2018, compared to the same periodsperiod in 2016.2017.

Revenues

During the ninethree months ended September 30, 2017,March 31, 2018, we have expanded OnTrak for one customer into two new lines of business, another customer expanded into their largest state by membership, and launched enrollment with atwo new health planplans in Oklahoma. In addition, at the endIllinois and Tennessee, expanded with two of the second quarter 2017 we saw a significantour current health plans, and have continued to increase enrollment, which has resulted in our eligible member population as a result of another customer with programs in eight states resolving a previous data extraction issue. That increase in eligible membership is expected to primarily impact future quarters. These expansions were offset to some extent by two customers exiting certain health exchange and Medicaid markets, and one customer suspending new enrollments. Overall, there was a net increase in the number of patients enrolled in our solutions compared with the same period in 2016. Enrolled2017, this was offset by the timing of billing for certain members as of September 30, 2017 was 33% greater than September 30, 2016.who we bill on a per claim basis. For the three months ended March 31, 2018, net enrollment increased by approximately 74% over the same period in 2017. Recognized revenue decreased by $141,000 and increased by $1.4 million,$89,000, or (11)% and 42%5%, for the three and nine months ended September 30, 2017,March 31, 2018, compared with the same periodsperiod in 2016, respectively. We reserve a portion, and in some cases all, of the fees we receive related to enrolled members, as the fees are subject to performance guarantees or are received as case rates in advance at the time of enrollment. Fees deferred for performance guarantees are recognized when those guarantees are satisfied and fees received in advance are recognized ratably over the period of enrollment. Deferred revenue increased by $1.7 million from December 31, 2016.2017.

Cost of Healthcare Services

Cost of healthcare services consists primarily of salaries related to our care coaches, outreach specialists, 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 $411,000 and $979,000$922,000 for the three and nine months ended September 30, 2017,March 31, 2018, compared with the same periods in 2016, respectively,2017, relates primarily to the increase in members being treated, the addition of care coaches, outreach specialists, community care coordinators and other staff to manage the increasing number of enrolled members. In addition, we hire staff in preparation for anticipated future customer contracts and corresponding increases in members eligible for OnTrak. The costs for such staff are included in Costcost of Healthcare Serviceshealthcare services during training and ramp-up periods.

General and Administrative Expenses

Total general and administrative expense increased by $379,000 and $1.6$1.2 million for the three and nine months ended September 30, 2017,March 31, 2018, compared with the same periodsperiod in 2016.2017. The increase in general and administrative expenses was due primarily related to investments in data science, IT and software development to support growth and drive efficiency. In addition, there was an increase of approximately $200,000 in salaries to service our contracts and increasing number of enrolled members, investments in key personnel to support future growth, and investor relations servicesnon-cash share based compensation expense during the nine months ended September 30, 2017.first quarter of 2018 related to the issuance of stock options in the fourth quarter of 2017 which are being amortized over the related vesting periods.

Depreciation and Amortization

Depreciation and amortization was immaterial for the three and nine months ended September 30, 2017 and 2016, respectively.

Interest Expense

Interest expense decreased by $3.2$2.9 million and $731,000 for the three and nine months ended September 30, 2017, respectively,March 31, 2018, compared with the same periodsperiod in 2016.2017. The decrease is primarily relatedrelates to the valueissuance of theour convertible debentures and warrants issued duringin connection with those convertible debentures in the third quarter2017 period. The majority of 2016these instruments were either converted to equity or paid in full in April 2017 and as a result there was no significant expense for the 2016 Convertible Debentures as well as the amortization of the debt discount on the 2016 Convertible Debentures. No such issuance occurred during the third quarter of 2017.three months ended March 31, 2018.

Loss of conversion of note

Loss on conversion of note during the three and nine months ended September 30, 2017 relates to the conversion of the July 2015 convertible debenture and a portion of the December 2016 convertible debentures.Convertible Debentures for the three months ended March 31, 2017. No such conversion occurred for the same period during 2016.

Loss on issuance of common stock

      Loss on the issuance of common stock relates to the issuance of common stock to Acuitas in the public offering and to pay Terren Peizer’s deferred salary.2018.

Change in fair value of warrant liability

We have issued warrants to purchase common stock in February 2012, April 2015, July 2015, August 2016, December 2016, January 2017, February 2017, March 2017, April 2017, and June 2017. Some of theFebruary 2018. 11,049 warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to anti-dilution provisions in somethe 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 loss from change in fair value forfor the warrants was $1.4 million and $1.1$5.2 million for the three and nine months ended September 30, 2017, respectively,March 31, 2018 compared with the same periodsperiod in 2016, respectively.2017.

In April 2017, we removed the anti-dilution protection in most of our warrants. We will continue to mark-to-market the remaining warrants with anti-dilution protection to market value each quarter-end until they are completely settled or expire.

Change in fair value of derivative liability

The change in fair value of derivative liabilities was $3.5 million and $6.2$10.6 million for the three and nine months ended September 30, 2017, respectively,March 31, 2018, compared with the same periods in 2016.2017. The derivative liability was the result of the issuance of the July 2015 Convertible Debenture, which was converted into 2,385,111 shares of common stock in April 2017.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

As of November 13, 2017,May 14, 2018, we had a balance of approximately $5.9$1.5 million cash on hand. We had a working capital deficit of approximately $2.5$1.5 million as of September 30, 2017.March 31, 2018. 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 $588,000$1.1 million per month, excluding non-current accrued liability payments. In April 2017, we closed on a public offering for aggregate gross proceeds of $16.5 million prior to deducting underwriter discounts, commission and other estimated offering expenses.month.  We expect our current cash resources to cover expenses through at least the next twelve months, however, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.

Our ability to fund our ongoing operations is dependent on increasing the number of members that are eligible for our solutions by signing new contracts, identifying more eligible members in existing contracts, and generating fees from existing and new contracts and the success of management’s plan to increase revenue and continue to control expenses. We currently operate our OnTrak solutions in nineteen 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 2018.

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. These conditions raise substantial doubt about our ability to continue as a going concern.  The accompanying financial statements do not reflect any adjustments that might result if we were unable to continue as a going concern. We entered into contracts for additional revenue-generating health plan customers and expanding our OnTrak program within existing health plan customers.  To support this increased demand for services, we invested in the additional headcount needed to support these customers launching during the first quarter of 2018.  We have had a growing customer base and are able to fully scale our operations to service the contracts and future enrollment providing leverage in these investments that is expected to result in positive cash flow by the end of 2018. Based upon this expected positive cash flow, we believe we will have enough capital to cover expenses through at least the next twelve months. We will continue to monitor liquidity carefully and in the event we do not have enough capital to cover expense we will make the necessary and appropriate reductions in spending to remain cash flow positive.  However, if we were to 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 would need to finance these options via a debt financing rather than an equity financing.

Cash Flows

We used $5.3$3.4 million of cash forfrom operating activities during the ninethree months ended September 30, 2017March 31, 2018 compared with $4.5$1.6 million in the same period in 2016.2017. The increase in cash used in operating activities reflects the increase in the number of enrolled members being treated,and the addition of care coaches and clinical care coordinators to our staff to manage the increasing number of enrolledin preparation for anticipated future increases in members the expansion of our programeligible for one customer into two new lines of business, another customer expanding into their largest state by membership, and the launch of a new health plan in Oklahoma. In addition, at the end of the second quarter 2017 we saw a significant increase in our eligible member population as a result of another customer with programs in either states resolving a previous data extraction issue. Significant non-cash adjustments to operating activities for the nine months ended September 30, 2017 included a loss on conversion of convertible debentures of $1.4 million, a fair value adjustment on warrant liability of $1.8 million, and amortization of debt discount and issuance costs of $3.3 million related to the January 2017 convertible debenture.OnTrak.

CapitalThere were no capitalized capital expenditures for the ninethree months ended September 30, 2017 were not material.March 31, 2018. We anticipate that capital expenditures will increase in the future as we replace our computer systems that are reaching the end of their useful lives, upgrade equipment to support our increased number of enrolled members and enhance the reliability and security of our systems. These future capital expenditure requirements will depend upon many factors, including obsolescence or failure of our systems, progress with expanding the adoption of our solutions, 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.

OurThere was $9,000 net cash providedused by financingfinancing activities was $11.7 million for the ninethree months ended September 30, 2017,March 31, 2018, compared with net cash provided by financing activities of $5.5$1.1 million for the ninethree months ended September 30, 2016, respectively.March 31, 2017. Cash provided by financing activities for the ninethree months ended September 30, 2017March 31, 2018 consisted of the gross proceeds from the issuancereduction of common stock from the public offering of $16.5 million, the gross proceeds from the convertible debenture providedcapital leases by Acuitas Group Holdings, LLC (“Acuitas”), one hundred percent (100%) of which is owned by Terren S. Peizer, Chairman and Chief Executive Officer of the Company, in January 2017 of $1.3 million, offset by transaction costs of $1.7 million for the public offering and the payment of convertible debentures of $4.4 million$9,000, leaving a balance of $6.9$1.4 million in cash and cash equivalents at September 30, 2017.as of March 31, 2018.

As discussed above, we currently expend cash at a rate of approximately $588,000$1.1 million per month. We also anticipate cash inflow to increase during 20172018 as we continue to service our executed contracts and sign new contracts. We expect our current cash resources to cover our operations through at least the next twelve months,months; however, delays in cash collections, revenue, or unforeseen expenditures could impact this estimate.

OFF BALANCE SHEET ARRANGEMENTS

As of September 30, 2017,March 31, 2018, 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 related to the fair value of warrants, the estimation of the fair value of our derivative liabilities,revenue recognition, and share-based compensation expense, involve our most significant judgments and estimates that are material to our consolidated financial statements. They are discussed further below.

Warrant Liabilities

The warrant liabilities were calculated using the Black-Scholes model based upon the following assumptions:

We have issued warrants to purchase common stock in February 2012, April 2015, July 2015, August 2016, December 2016, January 2017, February 2017, March 2017, AprilJune 2017, and June 2017. SomeFebruary 2018. 11,049 of theour warrants are being accounted for as liabilities in accordance with FASB accounting rules, due to anti-dilution provisions in somethe warrants that protect the holders from declines in our stock price, 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 warrant liabilities were calculated using the Black-Scholes model based upon the following assumptions:

ForFor the three and nine months ended September 30,March 31, 2018 and 2017, we recognized a loss of $2,000$10,000 and a gain of $1.8$5.2 million, respectively, compared with a gain of $1.4 million and $673,000 for the same periods in 2016, respectively, related to the revaluation of our warrant liabilities.

Revenue Recognition

        In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC 605 - Revenue Recognition (“ASC 605”) and most industry-specific guidance throughout ASC 605. The FASB has issued numerous updates that provide clarification on a number of specific issues as well as requiring additional disclosures. The core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.

In April 2017, we removedWe adopted ASC 606 effective January 1, 2018 using the anti-dilution protectionmodified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in mosteffect for those periods. The cumulative effect of the changes made to our warrants. We will continue to mark-to-marketconsolidated January 1, 2018 balance sheet for the remaining warrantsadoption of ASU 2014-09,Revenue - Revenue from Contracts with anti-dilution protection to market value each quarter-end until they are completely settled or expire.Customers were as follows (in thousands): 

Derivative Liabilities